The Mexican Peso Crisis

The Mexican Peso Crisis

This paper argues that the Mexican peso crisis of December 20 should have been expected and foreseeable. In the year preceding the crisis, there were several indicators suggesting that the Mexican economy and peso were already under extreme pressure. The economy bubble was ballooning to burst so much so that it was simply a crisis waiting to happen.

Evidences Signaling the Crisis

1. Decreasing Current Account Deficit versus Increasing Capital Account Balance

Mexico was running an increasing current account deficit from US$7.5 billion in 1990 to US$23.4 billion in 1993. This indicates an excess of private investing over private savings. However, the country was able to maintain an improving fiscal account from US$3.6 billion deficit in 1990 to US$0.7 billion surplus in 1993. The deficit in current account was financed through capital funds from abroad resulting the capital account to increase from US$8.4 billion in 1990 to US$33.8 billion in 1993.

The over-dependent on foreign capital flows had made the Mexican economy very vulnerable to any sudden and major flux of this capital fund which was very much dependent on the investors? confidence level in the Mexican economy.

The fact that majority of the capital funds was in the form of portfolio capital instead of foreign direct investment (FDI) had also worsen the situation. The ratio of portfolio capital to FDI had increased substantially from 1:1.3 in 1990 to 1:6.5 in 1993. Given the volatile nature, portfolio capital tends to respond with greater speed to changes in the environment.

2. Depletion of International Reserve

The central bank of Mexico has built up at high level of international reserve. The huge reserve was the result of the Mexican government?s policy of exchange intervention to prevent large fluctuation in the peso. In the beginning of 1994, the reserve amounted to US$26.4 billion but was depleted to a low US$6.7 billion in Mid Dec, flagging red light that the exchange mechanism had been pushed to the limit and the government can no longer hold on to the pegged peso to US dollar.

3. Increasing Fed Rate but Decreasing Mexican Interest Rate

Federal funds rate has risen the fifth time in 1994 on Nov 1994 and reaches 5.5%. This resulted in stronger dollar against peso as the quantity of US dollar reduced. This signaled problems for Mex...

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...ssibility of a devaluation of the peso

· According to Euromoney, Mexico?s ranking among borrowing countries improved between March and September 1994

Conclusion

The decreasing current account, increasing capital account, depleting international reserves, declining real GDP growth and increasing dollar-denominated tesobonos all pointed towards the vulnerability of the Mexican economy. In view of the repeated political unrests, Mr. Woo and the others should have expected this crisis. But they based their decisions on surface information and market sentiments that had over-valued the market potential.

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The Mexican Peso Crisis : the Foreseeable and the Surprise

Nora Lustig, Brookings Institution, June 1995

Mexico 1994 versus Thailand 1997

Thailand Development Research Institute, 1997

Exchange-Rate Regimes, Speculative Attacks and Currency Crisis

University of Essex

An Early Warning System for Financial Crisis

Dominic Barton, Roberto Newell and Gregory Wilson, Mc Kinsey & Company, 2003

The Impact of the Mexican Crisis of 94-95 on the Maquiladora Industry

Paul Cooney, Queens College

What NAFTA Brought to Mexicans?

Jim Callis, March 1998