The situation that arose in Mexico in 1995 after the devaluation of the peso by 15% sent the currency into a downward spiral over the succeeding months in what became known as the Mexican Peso Crisis. A currency crisis is defined by a sharp and unexpected decrease in the value of the currency. This was precisely the case in Mexico, losing over 60% of its value in less than four months. The drastic nature of the crisis came as a surprise to many because of the unprecedented success of the Mexican economy in the years before. Mexico had curbed its inflation, posted very impressive growth rates, and was reaping the global benefits of the imminent North American Free Trade Agreement. It certainly looked as if this historically unstable nation made a stand to become just the opposite, a country that stressed political and economic stability and strength. The seeds of the crisis had been planted in the form of policies, actions, and events that created an increasingly vulnerable economy and disaster was on the horizon. The following paper will examine both the causes and effects of the Mexican Peso Crisis of 1994. First, we must look back to the presidential term of Carlos Salinas and the policy actions that were undertaken in the early 1990s up through the months before the crisis. The growing state of vulnerability that the economy was subjected to was a direct result of decisions made during his term and the short term speculative investment during the same time. Secondly, we must be informed of the very unfavorable Mexican political climate in the months preceding the 1994 elections. Investor faith in Mexico declined drastically before the actual election due to both endogenous and exogenous economic factors. Then, the handling of the deteriorating economic situation and the devaluation of the peso by the new President, Ernesto Zedillo, which brought the country into the murky depths of a currency crisis shall be discussed. And finally, the speedy recovery of the Mexican economy due to successful policy changes and bailout loans from the International Monetary Fund and their northern neighbor, the United States of America, will wrap up the assessment of the Mexican economic situation that engulfed the country in the early to mid 1990s. In the conclusion, I will discuss whether or not the crisis could have been avoided. The Salinas Presidency
Mexico had historically adopted highly protectionist economic policies, but when Carlos Salinas became the country’s leader, he enacted a series of reforms that would liberalize the Mexican economy. His plan was to liberalize financial and trade markets, eliminate the fiscal sizable fiscal deficit, and pursue a strict monetary policy and rigid exchange rate policy that brought Mexico’s high rate of inflation under control. It seems as if Mexico was on the right track in the undertaking of these structural reforms, but the costs certainly outweighed the benefits. It was the combination of these factors that led to such a vulnerable economy (Heath).
One major problem was the dramatic increase in the extension of credit to the private sector as the government turned their fiscal deficit of 16% of GDP in 1987 to a surplus of 2% of GDP in 1991. Not only were businesses able to access this credit but the middle class Mexican was also taking advantage of this. This extension of credit aided in expanding businesses, as well as taking out loans on homes and other durable goods. The new option of credit resulted in large increases in consumption and a huge reduction in the savings rate (Heath). Along with this came a reduction in tariffs, which made imports much cheaper. Mexicans were buying imported consumer goods at an extremely rapid pace as a result of the liberalization of financial and trade markets.
The Mexican government began to increase their borrowing from abroad to finance their deficit in the current account, which was increasing annually as a...