Academic journal article Business Economics

The Mexican Peso Crisis: Impact on NAFTA and Emerging Markets

Academic journal article Business Economics

The Mexican Peso Crisis: Impact on NAFTA and Emerging Markets

Article excerpt

IN 1982, a drop in oil prices, then Mexico's main export, accompanied by a rise in U.S. interest rates, led to Mexico's declaration that it no longer could service its foreign debt. This announcement marked the beginning of the debt crisis of developing countries, plunging many of these economies into a decade-long stagnation that was finally overcome only in the 1990S.

Twelve years later, in 1994, another financial crisis in Mexico with global implications seems to threaten the growth prospects of the so-called "emerging economies," a term describing an increasingly larger group of fast-growing LDCs that have adopted market-oriented economic reforms, and that are capturing a growing share of world foreign investment., Most of these countries are found in East Asia, Latin America and Eastern Europe.

For many years, until the end of 1994, Mexico was considered a "model student" in its efforts to liberalize and modernize the economy and in the introduction of market-oriented economic policies. This special status seemed to be crowned with Mexico's 1994 entry into NAFTA, a club including two industrialized economies, Canada and the United States, and Mexico's entry into the Organization for Economic Cooperation and Development (OECD). The fact that this unexpected major crisis occurred in Mexico, in spite of its close link with the United States, has led to a serious reconsideration of the risk-return tradeoff of portfolio investment in developing economies.

The crisis might lead to the creation of new country-monitoring systems within existing international institutions and to a new approach to deal with similar crises in the future, one that allows for recovery by the affected economy, but avoids bailing out careless investors and countries failing to adopt the necessary structural reforms.[2]

EVOLUTION OF THE CRISIS

The Zapatista uprising in Chiapas, as well as several political assassinations and kidnappings of business executives combined with the rise of U.S. interest rates, made portfolio investment in Mexico less attractive to foreign investors. Persistent trade and current account deficits further undermined the stability of the Mexican currency. Facing an alarming decline in foreign reserves, the new administration of Ernesto Zedillo decided on December 20, 1994, to readjust the parity of the peso against the U.S. dollar. The intended adjustment consisted of a 13.5 percent lowering of the sliding peg around which the peso was allowed to move against the dollar.

Lack of experience and poor public relations in dealing with the currency realignment plus delays in announcement of a credible Mexican contingency plan and difficulties in crafting a U.S.-sponsored rescue package turned what was meant to be a rather minor realignment into a full-blown depreciation, with the peso going from approximately 3.3 per dollar in December 1994 to about 6.3 at the end of January, a depreciation of roughly 50 percent in one month.

Several months into the crisis, are there any signs of improvement in Mexico's external balances and economic situation? The answer is rather encouraging. After dropping to levels of approximately 8 pesos per dollar, the peso seems to have stabilized at a rate of about 6 per unit of the U.S. currency.

As a result of the roughly 50 percent devaluation implied by this exchange rate and the accompanying recession, the trade and current account deficits that provoked the crisis have, in the meantime, disappeared. Since February 1995, Mexico's trade deficit has turned into a growing surplus, presently standing at about U.S. $500 million per month. The current account deficit observed at the onset of the crisis might give place to a current account surplus for 1995.

Thus the devaluation seems to have solved the balance of payments disequilibrium as intended. However, any serious treatment of the crisis must also analyze the alternative policy options that could have been followed by Mexico in lieu of a devaluation. …

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