The Mexican Peso Crisis

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					The Mexican Peso

By Amber Gerard
Mexico Today      Exchange Rate - Mexican pesos (MXN) per US
                   dollar –
                     11.016 (2008)
                     10.8 (2007)

                  GDP PPP - $1.559 trillion (2008)
                  GDP PPP per capita - $14,200 (2008)
                  FDI - $278.9 billion (2008 est.)
                  Population - 111,211,789 (July 2009)

                  Inflation Rate - 6.2% (2008)
                  Current Account Balance - -$13.45 billion
                  Public Debt - 20.3% of GDP (2008)
                  External Debt - $181.2 billion (December 2008)
                  Stock of Money - $103.5 billion
                  Stock of Domestic Credit - $349.1 billion
                  Imports - $305.9 billion (2008)
                  Import Partners –
                      US 49.6%,
                      China 10.5%,
                      Japan 5.8%,
                      South Korea 4.5%
                  Exports - $294 billion (2008)
                  Export Partners –
                      US 82.2%,
                      Canada 2.4%,
                      Germany 1.5%
                  Reserves of Gold and Foreign Exchange
                      $91.99 billion (31 December 2008 est.)

     Industries - food and beverages, tobacco,
      chemicals, iron and steel, petroleum, mining,
      textiles, clothing, motor vehicles, consumer
      durables, tourism
     Agricultural products - corn, wheat, soybeans,
      rice, beans, cotton, coffee, fruit, tomatoes; beef,
      poultry, dairy products; wood products
Mexico’s Government
   Federal Republic - a state in which the powers of the central government are restricted
    and in which the component parts (states, colonies, or provinces) retain a degree of
    self-government; ultimate sovereign power rests with the voters who chose their
    governmental representatives.

   Structure - 31 states (estados, singular - estado) and 1 federal district* (distrito federal)

   Chief of State: President Felipe de Jesus CALDERON Hinojosa (since 1 December
    2006); note - the president is both the chief of state and head of government
    Head of Government: President Felipe de Jesus CALDERON Hinojosa (since 1
    December 2006)

   Elections: president elected by popular vote for a single six-year term; election last held
    on 2 July 2006 (next to be held 1 July 2012)

   Legislative Branch: Bicameral National Congress - consists of the Senate (128 seats;
    96 members are elected by popular vote to serve six-year terms, and 32 seats are
    allocated on the basis of each party's popular vote) Chamber of Deputies - (500 seats;
    300 members are elected by popular vote; remaining 200 members are allocated on the
    basis of each party's popular vote; to serve three-year terms)
    Economy Overview – 2009
   Mexico has a free market economy in the trillion dollar class. It contains a mixture of
    modern and outmoded industry and agriculture, increasingly dominated by the private

   Recent administrations have expanded competition in seaports, railroads,
    telecommunications, electricity generation, natural gas distribution, and airports.

   Per capita income is one-fourth that of the US; income distribution remains highly unequal.

   Trade with the US and Canada has nearly tripled since the implementation of NAFTA in

   Mexico has 12 free trade agreements with over 40 countries including, Guatemala,
    Honduras, El Salvador, the European Free Trade Area, and Japan, putting more than 90%
    of trade under free trade agreements.

   In 2007, during his first year in office, the Felipe CALDERON administration was able to
    garner support from the opposition to successfully pass a pension and a fiscal reform.

   However, the administration continues to face many economic challenges including the
    need to upgrade infrastructure, modernize labor laws, and allow private investment in the
    energy sector.
Mexico Then……
The CRISIS of 1982
   The macroeconomic policies of the 1970s left Mexico's economy highly vulnerable to
    external conditions

   By mid-1981, Mexico was beset by: falling oil prices, higher world interest rates, rising
    inflation, Chronically overvalued peso, Deteriorating balance of payments that spurred
    massive Capital flight, and there was excessive foreign debt requiring excessive amounts of
    foreign currency credit to service.

   The government had to devalue the peso three times during 1982.

   Increased burden on private sector's to service its dollar-denominated debt.

   Cut off from additional credit. In August 1982, it announced the nationalization of Mexico's
    private banking system. n August 1982 the Mexican government announced that it could not meet
    scheduled debt payments.

   1982-1988 - while Miguel de la Madrid was President, real income of Mexicans had fallen 40
    percent. Greater drop than occurred for Americans with the onset of the Great Depression

   Mexico's GDP grew at an average rate of just 0.1 percent per year between 1983 and 1988,
    while inflation grew on an average of 100%.

   Total investment fell at an average annual rate of 4 percent and public investment at an 11
    percent pace.

   There were fears that the government might fail to achieve fiscal balance, resulting in scarce
    credit and high domestic interest rates.

   The resulting reduction in domestic savings impeded growth, as did the government's rapid
    and drastic reductions in public investment
Things soon got better…
  1988 - (de la Madrid's final year as President) inflation was under
    control, fiscal and monetary discipline attained, structural
    reform in trade and public-sector management underway. But
    is was still hard for Mexico to attract foreign investment and
    return capital in quantities that were sufficient for sustained
  April 1989,Carlos Salinas de Gortari became President
  1989 - the government reached agreement with its commercial
    bank creditors to reduce its medium- and long-term debt.
  To increase capital inflows, Salinas lowered domestic borrowing
    costs, re-privatized the banking system, and broached the idea
    of a free-trade with the U.S.
  1993 – The economy started to grow again.
  By 1994, growth rebounded to almost 4 percent, after fiscal and
    monetary policies were relaxed and foreign investment was
    bolstered by the North American Free Trade Agreement
At last…….Stability!
  In November 1993, there was an agreement between the U.S. and
   Mexico, establishing the North American Development Bank (NAD
   Bank)) The NAD Bank uses capital and grant funds contributed by
   Mexico and the U.S. to help finance border environmental
   infrastructure projects certified by the BECC.
  BECC – The Border Environment Cooperation Development Bank
   works with local communities to develop and certify environmental
   infrastructure projects, such as wastewater treatment plants,
   drinking water systems, and solid waste disposal facilities.
  1993 - North American Agreement on Environmental Cooperation
   (NAAEC), creating the North American Commission on
   Environmental Cooperation under NAFTA by the U.S., Mexico,
   and Canada, to improve enforcement of environmental laws and
   to address common environmental concerns.
But sometimes, things are
“Too Good to be True”
  The PESO Crisis
    The Events
   Tuesday, 20 December 1994 - After assurances the previous week that the government was
    committed to exchange rate stability, on December 20 Jaime Serra Puche, the Finance
    Minister, announced that the upper limit of the exchange rate band would be raised by 13%. Mr.
    Serra made the announcement on radio and television rather than through official channels,
    and thus angered investors who felt that this was an inappropriate way to reveal a crucial policy
    shift. The exchange rate immediately depreciated to the top of the band.
   Wednesday, 21 December - Capital rushes out of the country. Reportedly the Mexican Central
    Bank spends $6 billion in reserves attempting to defend the peso, and by the end of the day the
    Central Bank's stock of reserves has fallen to under $6 billion.
   Thursday, 22 December - Despite the fact that the previous day the Mexican president
    Ernesto Zedillo affirmed the government's commitment to the new exchange band, early on the
    morming on December 22 the government let the peso float. The peso quickly depreciates
    another 15%.
   Monday, 26 December - Mr. Serra, the Finance Minister, schedules a news conference to
    provide information about the government's plans to address the crisis. The conference is
    canceled at the last moment. Investors continue to complain about the government's failure to
    provide information about its plans to address the crisis. The peso continues to depreciate.
   Tuesday, 27 December - The Central Bank and the Finance Ministry continue to remain silent,
    while the peso continues to drop and economic turmoil spreads. The peso depreciates to 5.45
    pesos to the dollar, meaning that its value is 36% less than on the previous Tuesday. An
    auction of dollar-denominated government bonds fails to attract capital, bringing in only $27.6
    million in bids to replace an issue of $774 million worth of bonds. Prices begin to rise and labor
    leaders push for wage renegotiations.
   Thursday, 29 December - President Zedillo appoints a new Finance Minister, Guillermo Ortiz
    Another way to assess Mexico's vulnerability is to consider the size of its current stock of outstanding
     foreign debt. Averaged over 1991-1993, the present value of Mexico's future debt service obligations
     (a measure of the stock of debt) amounted to 184% of exports of goods and services and 36% of
    The World Debt Tables classify a country as severely indebted if its debt is greater than 220% of
     exports or 80% of GDP. A country is considered moderately indicated if the debt indicators are less
     than the above figures but higher than 132% of exports or 48% of GDP. Thus Mexico's debt stock
     relative to its level of exports places it in the moderately indebted category, while the debt stock to
     GDP indicator falls in the less-indebted category.Moreover, other indicators of the relative size of
     Mexican debt show that the debt burden has been falling.
     The nominal value of foreign debt as a percentage of GDP has fallen from 58% in 1988 to 35% in
     1993, and nominal foreign debt as a share of exports has fallen from 249% in 1988 to 185% in 1993.
     Thus Mexico does not appear to have been sliding back into the kind of debt problem that emerged in
     1982 and crippled its economy in the mid-eighties.
    In assessing Mexico's vulnerability to a foreign exchange crisis, one should keep in mind that the total
     debt stock does not include portfolio equity investments and direct foreign investment. These types of
     capital flows have grown increasingly important in the 1990's. In 1993 they amounted to 53% of
     aggregate net long-term resource flows to developing countries. Portfolio investment is particularly
     volatile, and the flight of portfolio investment from Mexico played a key role in the crisis of December,
 “In most countries and in most situations the private sector cannot borrow on better
    terms than the government”

   There are two channels by which the credit-worthiness of the government affects the credit-

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The Shocks
Most experts now agree that the exchange rate crisis that shook Mexico at the end of
December, 1994, was made possible, if not inevitable, by policy mistakes stretching
back to at least March, 1994. Among the underlying weaknesses were an appreciated
real exchange rate, declining Central Bank reserves, and an unstable structure of public
and external debt. Nonetheless, poor handling of the initial exchange rate adjustment
probably exacerbated the crisis that developed.

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 Mexico's trade regime is among the most
  open in the world, with free trade
  agreements with the U.S., Canada, the
  EU, and many other countries (44 total).
  Since the 1994 devaluation of the peso,
  successive Mexican governments have
  improved the country's macroeconomic
  fundamentals. Inflation and public sector
  deficits are under control, while the
  current account balance and public debt
  profile have improved. As of October
“AFTER the 1994 peso crash, the risk of Mexico's difficulties spilling over
   into America was considered so great that the Clinton administration
   helped bail out its southern neighbor. In the first quarter of 2008, the
   boot was on the other foot, though the scale was entirely different. Now it
   was the turn of Banamex, one of Mexico's two largest banks, to help out
   Citigroup, its crisis-stricken parent. Banamex provided $453m of the $1.1
   billion Citi earned in net income from its overseas operations between
   January and March (Citi lost $5.1 billion overall). You could almost hear
   Vikram Pandit, Citi's new chief, mutter “Gracias, compadre.”

                                                    The Economist, 2008