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Case Study II: The Mexican Peso Crisis
In a word, the 1994 economic crisis in Mexico – often referred to as the Mexican peso crisis – can be attributed to overspending. But, as with all crises, there is far more to it than just living beyond one’s means. This story involves rebellion, assassination, fratricide, corruption, money laundering, de-regulation, a lot of investor doubt and a near $50 billion bailout. For the country at least, it has a happy ending.
Although the Mexican peso crisis had a long lead-in time, it came to a head rather quickly and was dispatched with equal haste. Following almost a decade of economic stagnation and hyper-inflation, the Mexican government took its first step towards the liberalization of trade when it signed up to the General Agreement on Tariffs and Trade (GATT) in 1986. Deregulation of the capital markets and the banking system followed. In 1992, the ruling Institutional Revolutionary Party (PRI) signed up to reduce trade barriers with the US and Canada through the structure known as the North American Free Trade Area (NAFTA).
By the end of 1993, inflation had dropped to 7.05%, the lowest figure in 22 years, and foreign investment was coming in on the back of low US borrowing rates. To the casual observer, the future for Mexico looked rosy. But there was a catch. Not only was growth crawling along at an average of only 2.8% a year, but in the
build-up to his final year of office in 1994, Mexico’s President, Carlos Salinas de Gortari, had set out on a vote-winning but unsustainable spending spree.
Major investment programs in public health and education were underway which, whilst socially responsible and largely popular, were very public signs of the country’s profligacy. With the new banking freedom going largely unchecked, the level and quality of lending started to create ripples of concern amongst the domestic and international investor community. This concern was exacerbated by the realization that government spending had expanded the country’s deficit (it went from $6 billion in 1989 to around $20 billion by 1992 when it signed the NAFTA agreement) and it kept on growing. All the while, the peso’s strength was constricting exports and pushing up imports, further widening the gap. It was not long before talk of an overvalued peso started to circulate, in effect signaling the beginning of the end.
Adding to international investor concern was a widely held (but not necessarily correct) view that Mexico was undergoing a period of political instability. Chief among the worries was the January 1994 uprising in the state of Chiapas. The Zapatista Army of National Liberation (Ejército Zapatista de Liberación Nacional, EZLN), a revolutionary leftist group, had declared (an apparently largely non-violent) war on the Mexican state. The Zapatistas saw Salinas and his cronies as being out of touch with the will of the people and therefore an illegitimate power.
Having failed earlier to secure a popular uprising, EZLN turned its attentions to what it considered to be the divisive nature of Mexico’s signing of the NAFTA agreement, which came into effect on 1st January 1994. The agreement resulted in the removal of Article 27 Section VII of the Mexican Constitution. This had assured land reparations to Mexico’s indigenous people. The New Year’s Day revolt lasted just two weeks, but EZLN’s grievances were well-timed to punish the government by further damaging the country’s risk profile in the eyes of the investment community, putting a higher premium on Mexican assets.
With a sick budget deficit and a current account deficit (now standing at 7% of GDP) fueled by excessive
consumer spending and what was now clearly an over-valued peso, Salinas’ government needed to find funding from somewhere. It issued the tesobono (treasury bill), a debt instrument denominated in peso but indexed to (and paid out in) US dollars.
And then in March 1994, in the build-up to the election, came the assassination of Salinas’ intended political successor within PRI, Luis Donaldo Colosio. PRI had been the dominant force in the country for more than 60 years and it looked very much like Colosio’s election would be a shoo-in. Salinas’ eventual PRI successor, Ernesto Zedillo, did win in that August’s election, but just one month later, on 28thSeptember 1994, the party’s Secretary General (and Salinas’ brother-in-law), José Francisco Ruiz Massieu, was also assassinated
Use the above information to critically analyze the government possible intervention in the foreign exchange market, highlighting possible rationales of intervention, different types of interventions, tools of intervention, and most importantly the potential effect(s) of intervention. Relate your answers to the case
of the Mexican peso crisis as much as you can.
There are different types of intervention a government can took place as a tool to affect foreign exchange market which includes decenterlisation and centerlisation of economy ,globelisation ,direct purchase of foreign currency or domestic currency from market , issuing bond , increase or decrease public expenses .There can be direct as well indirect intervention from government side .it affects not not only foreign exchange market as well as economic condition of any company .
There is possible intervention in foreign exchange market although the market is governed from itself but time to time government take actions like devaluation of foreign currency to directly decrease the exchange rate for its own currency.
The Rationales of interventions are increase or decrease in the exports/imports, decrease/increase in the value of the currency foreign as well as domestic ,increase/decrease debt of a country, increase/decrease a countries foreign currency storage,reputation of a country strengthen or week , Investors faith increase or decrease .
Different type of interventions are direct and indirect and no interventions .I have already tell about the tools in first paragraph.
Potential effect or rationales are more or same but only difference is that potential effect is unknown by everyone because the foreign exchange market also affect by foreign interventions as well as it is auto governed . There may be other countries who may control your currency .
Case Study II: The Mexican Peso Crisis In a word, the 1994 economic crisis in Mexico...
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