1994 Mexican Currency Crisis

Topics: Foreign exchange market, Mexican peso, Mexico Pages: 15 (4579 words) Published: October 23, 2008
The purpose of this report is to analyse the reasons for, the impact of, and the measures taken in response to the Mexican currency crisis of 1994-1995. The first objective is to assess the reasons for the crisis. Why did Mexico, a once immensely desirable investment destination become the bain of the international financial community following December 1994?

The second and chief objective is to assess the impact of the crisis on the foreign exchange and stock markets. The report answers why the crisis adversely affected the Latin American market indices while the US market indices continued to rise.

The third objective is to analyse the measures taken in response to the crisis by the Mexican Government and other international organizations. The key conclusion reached with respect to these three objectives is that the ensuring financial crisis following December 1994 could have been averted. Blame centers on the inadequate response of the Mexican Government and its failure to recognise and act upon the underlying causes of the crisis in a time effective manner.

Beginnings of the Mexican Currency Crisis

Several events culminated in the eventuation of the Mexican currency crisis, the first of which occurred on December 20, 1994. This day, widely recognised as beginning of the crisis marked the devaluation of the Peso to the Dollar by Mexican President Ernesto Zedillo by approximately 15% to relieve the pressure on the Peso/Dollar exchange rate. This decision, which was made without consultation with the US Government or the International Monetary Fund, was not accompanied by supporting fiscal or monetary measures to sustain the devaluation.

As a result, between December 20 and 21, $4 billion in foreign reserves was withdrawn from the Mexican economy, leaving only $6 billion remaining in foreign reserves. This resulted in the Mexican Government floating the Peso on 22 December 1994 to prevent further depletion of its foreign reserves. Despite this, the downward pressure on the Peso continued as foreign investors sought to realise their investments before further depreciation of the Peso (Hassan, Kilic & Tufte, 2000). These events marked the beginning of the Mexican currency crisis.

Main Causes of the Mexican Currency Crisis

The unanticipated depreciation of the Peso did not occur as an isolated incident. Many events led to the culmination of the 1994 Mexican crisis of which the Mexican Government played an important role. Before 1993, Mexico had been through a period of widespread deregulation and privatisation of its economy. Mexico had reduced tariffs on imported goods and had achieved inflation rate stability due to a fixed exchange rate - characteristics similar to Chile prior to their financial crisis of 1981 (Williamson, 1995).
However, as a consequence of increased downward pressure on their managed devaluation policy, Mexico suffered significant withdrawals of its foreign reserves. Following the withdrawal of US$4.5 billion in foreign reserves on 22 December, the Bank of Mexico unsuccessfully offered $600 million in Government bonds, known as Tesobonos, of which it received only $28 million in bids tendered (Sachs, Tornell, Velasco, 1996). This event conveyed the lack of confidence by investors in the Mexican economy that in conjunction with other factors instigated the currency crisis (Eiteman, Stonehill, Moffett, 2007).

These additional factors included the:

-Mexican presidential elections, which are traditionally associated with devaluation of the Peso, were approaching in Mexico -Rise of US interest rates compared with the Mexican interest rates -Loss of investor confidence in Mexico due to politically linked assassinations -Loose monetary policy, which lead to a reduction in foreign capital inflows -The shift of fiscal policy to short term rather than long term borrowing (Williamson, 1995)

On March 23, 1994, Luis Donaldo Colosio, the ruling party’s...

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