Description
It explains the macroeconomic situation of Mexico, factors that caused the crisis, how did the crisis unfolded and the options in front of mexican government.
Mexican Peso Crisis 1994
Outline
? Debt Crisis 1982 ? Oil crisis 1986 ? Macroeconomic factors
? NAFTA ? Mexican Government’s stance ? Monetary Policy
? Factors Causing the crisis
? ? ? ?
? ? ? ? ?
Current account deficits Capital Account Political Shocks Us interest rates
Mexican Policy Options What Mexico Did Us Intervention Conclusion
? Crisis and the conclusion
MEXICO GDP GROWTH RATES – 1980s
GDP growth
10 8 6 4 2 0 1980 -2 -4 -6 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 GDP growth
Debt crisis
oil crisis
Source : IMF ;IFS
OIL PRICES
Debt crisis 1982
Increased fund availability in Eurodollar market ($ Denominated Bank Deposits of oil exporting countries) Fuelling Lending Boom Re-channeling funds to developing countries as loan credits
Oil Price Rise in 1973
World Recession of 1974-75
Decline in world commodity prices for minerals and agricultural goods
Exacerbating Developing Countries’ Debt Burden
•Record-high interest rates of the early 1980s - efforts to curb the oil-based inflation of the 1970s •Most LA Credits were priced to LIBOR rates ? debt-service costs grew progressively greater as these rates reached record levels •slowdown in world growth •drop in commodity prices for the second time in eight years left exports stagnant •Most new loans from 1979-82 to cover accrued interests and maintain consumption and not for productive investments
Oil crisis 1986
? Decline of OPEC
? Oil Exporters plunged into near bankruptcy
? Reduction in value and volume of oil exports ? Structural Adjustment Policy
? Reduction in quantitative controls on imports ? Encourage Foreign Investment ? Seeking Growth based on intl. competition ? Secure entrance of Mexico into GATT
Mexican Government’s stance
? Inflation major concern.
? Positive Primary balance
? Very small fiscal deficit of 0.5 % ? Current account deficit not a problem as it is caused by
private investment accompanied by capital account and not by fiscal deficit or monetary expansion. ? Dramatic improvements in Mexico’s economic environment, improvements such as lower inflation, a reduced budget deficit, privatization lower barriers to international trade, and an improved climate for foreign investors. ? These investments when completed will increase the productivity of Mexican economy and turn around the
Fiscal Deficit
60000 50000 Deficit ( in Million Pesos ) 40000
30000
20000 10000 0 -10000 -20000 -30000 -40000 -50000 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994
inflation
200 180 160 140 120 100 80 60 40 20 0 1981M1 1981M5 1981M9 1982M1 1982M5 1982M9 1983M1 1983M5 1983M9 1984M1 1984M5 1984M9 1985M1 1985M5 1985M9 1986M1 1986M5 1986M9 1987M1 1987M5 1987M9 1988M1 1988M5 1988M9 1989M1 1989M5 1989M9
inflation
Source : IMF ;IFS
Monetary Policy
? Sterilization
? A form of monetary action in which a central bank or
federal reserve attempts to insulate itself from the foreign exchange market to counteract the effects of a changing monetary base ? the central bank matches its purchases of international reserves with a sale of government bonds from its portfolio
? Quasi fluid Exchange rate
? At that time Mexico had a crawling peg exchange rate
system. Government intervention kept the exchange rate vis-à-vis the dollar within a narrow target band, but the upper limit of the band was raised slightly every day (2.3% per annum) by a preannounced amount, allowing for a gradual nominal depreciation (a “crawling peg”) of the peso
Overvalued Peso in 1990’s
? Real exchange Rate R = P/P*.E ? ?R = ?P/P - ?P*/P* - ?E/E ? Simply the real exchange rate is percentage change in price of
? ?
? ?
?
home country minus percentage change of prices in reference country and exchange rate Overvalued up to the extent of 40% (Dornbusch and Werner) Stanley Fischer (1994) notes, other countries, such as Spain and Israel, that have gone through major stabilization and reform programs have simultaneously experienced substantial appreciations, and Mexico’s appreciation in the early 1990s was consistent with their experiences. Difficult to determine the equilibrium level. Long-run average of observed real exchange rates shows 20 percent overvaluation. Taking real exchange rate starting in a period when the current account was either balanced or at a sustainable level (1989) shows overvaluation of 35% on CPI.
20
40
60
80
100
120
140
160
0 1989M1 1989M4 1989M7 1989M10 1990M1 1990M4 1990M7 1990M10 1991M1 1991M4 1991M7 1991M10 1992M1 1992M4 1992M7 1992M10 1993M1 1993M4 1993M7 1993M10 1994M1 1994M4 1994M7 1994M10
real exchage rate 1989M1 = 100
Source : IMF ;IFS
real exchage rate 1989M1 = 100
Current account deficits
? Increased from 2.8 percent of GDP in 1989 to an
7 percent of GDP in 1992. ? Cause - overvalued Peso ? The government promised to hold down inflation in import prices by limiting exchange rate depreciation to a rate smaller than the prevailing rate of inflation in Mexico ? Pacto act
? Limiting increase in wage and salaries ? To decrease inflation ? Unable to decrease domestic inflation to a level
enough to prevent overvaluation of peso
Capital account
? Big Surplus , 95$ billion between 1990 to 1994. ? Policy Reforms ? Low interest rates in US ? Optimistic view of Mexico’s capital inflow is that it
did not finance investment spending in new factories and equipment that would have helped Mexico in dealing with current account deficit. ? Instead, a large portion of the capital inflow went into short-term financial investments, such as bank deposits and government bonds, that could flow out of Mexico at tremendous speed if a financial crisis arose.
a
Cetes
? Short term bonds like treasury bills
? Very attractive for foreign investors
? During the second quarter of 1992, the rate on
?
?
? ?
three-month cetes averaged 13.27 percent (IMF, IFS). Exchange rate depreciation to no more than 2.3 percent per annum (promised by Mexican government). Us treasury bills yield 3.75 percent. Short term bonds , so low risk for investors. Short term liabilities for Mexican government.
Capital Account- forms
? Foreign direct investment
? ? ? ?
Long term Can’t be reversed quickly Low cost Total 24$ billion between 1990 to 1994
? Capital inflow ( purchase in Stock market)
? Total 28 $ billion between 1990 to 1994 ? Will effect Mexican stock market in case of crisis. ? Little pressure on foreign reserve
? Purchase of Bonds
? 43 $ billion over 5 years ? Mostly short term , 1-3 months ? Pose greatest danger to exchange rate peg
International reserve
? Large (28$billion dollar) ? Short term foreign liabilities ? Shifting of money by mexican residents ? As Calvo (1994,302) noted, even when Mexican
reserves peaked in1993, Mexico’s ratio of highly liquid government and bank liabilities was at least four times the size of net international reserves, the highest ratio in Latin America. ? The ratio of highly liquid government and bank liabilities (broad money M3 minus M1, which is mostly currency) to international reserves had risen from about four in1993, a level high enough to concern Calvo (1994), to an even more precarious nine in November 1994
10000.00
20000.00
25000.00
30000.00
15000.00
5000.00
0.00
Total Reserves minus Gold
Source : IMF ;IFS
1980M1 1980M6 1980M11 1981M4 1981M9 1982M2 1982M7 1982M12 1983M5 1983M10 1984M3 1984M8 1985M1 1985M6 1985M11 1986M4 1986M9 1987M2 1987M7 1987M12 1988M5 1988M10 1989M3 1989M8 1990M1 1990M6 1990M11 1991M4 1991M9 1992M2 1992M7 1992M12 1993M5 1993M10
Total Reserves minus Gold
Political Shock - Zapatista Mexican Rebellion
? Indigenous peasant based movement with some ? ? ?
?
urban intellectual leadership Mexico's most southern and poverty-stricken province, Chiapas. Democracy, freedom and justice – central objectives Chiapas had long voted for the ruling Revolutionary Institutional Party (PRI). Rebels caused political instability in the country.
Political shock- Assassination of Louis Donaldo Colosio (March 23 1994)
? Virtual winner of presidential election.
? Shot in very suspicious condition.
? His death heightened fears of political instability. ? Decrease in international reserves. Increase in
interest rate, exchange rate touched the ceiling. ? Ernesto Zedillo became new PRI candidate and won the election.
Other political shocks
? Resignation (later withdrawn) of the Minister of the ? ?
?
?
Interior, Jorge Carpizo. (june 27 1994) Kidnapping of a prominent Mexican businessman, Alfredo Harp ( June 25, 1994) Salinas' brother-in-law, José Francisco Ruiz Massieu, president of the PRI was also murdered (Sept 29 1994) Deputy Attorney General Mario Ruíz Massieu, a brother of the slain Francisco Ruíz Massieu resigned and claimed that important figures in the ruling party had ordered his brother’s assassination ( 18 Nov 1994) leaked rumors of changes in exchange rate policy
Graph relating , interest rates and political shocks
TREASURY BILL RATE
45.00 40.00
35.00
30.00 25.00 20.00 15.00 10.00 5.00 0.00 TREASURY BILL RATE
Source : IMF ;IFS
Graph relating Foreign reserve and political shocks
TOTAL RESERVES MINUS GOLD
35000.00
30000.00
25000.00
20000.00
15000.00
TOTAL RESERVES MINUS GOLD
10000.00
5000.00
0.00
Source : IMF ;IFS
US Interest rates
Federal Funds Rate
? Highly affected by the
6.00 5.00 4.00 3.00 2.00 1.00 0.00 Federal Funds R
interest rates in US as most of the foreign investment come from US. ? Low interest rate in US favors capital inflows in emerging economies. ? Fed fund rate increased to 5.5 percent in Nov 1994 from 3 percent a year ago.
Source : IMF ;IFS
Mexican Policy
? No major Policy change
? no devaluation in the revised pacto signed on
September 24 ? no increase in the rate of crawl, of the peso
? Pushed up the interest rates to tighten monetary
base but not enough to keep the premium over US treasury bills at earlier level. ? Successful election in Mexico increased confidence ? Central bank drastically decreased the interest rates ? Sterilization prevents to prevent the reduction og
North American Free Trade Agreement (NAFTA)
? Came into force on January 1, 1994.
? The goal of NAFTA was to eliminate barriers of
trade and investment between the USA, Canada and Mexico. ? Imports got cheaper for Mexico. ? Increased the confidence of investors in Mexican economy.
What NAFTA did for Mexico
PROS
? GDP has increased at
CONS
? Higher Unemployment – 10%
an average annual rate of 2.7 percent Underperformed ? Exports to the United States have quadrupled ? Trade Liberalization ? Dramatic Reduction of prices(cost of basic household goods in
?
? ?
?
increase in jobs in informal economy Crippled Mexican Farming prospects by opening competition to heavily subsidized U.S. farm industry Lack of liberalization of sectors not covered by NAFTA Mexico's dependence on the U.S. economy has increased markedly Average income of the selfemployed was substantially lower than that of the salaried labour force - Growth of lowincome employment
Composition of government debt
? 75 percent of foreign debt in cetes form ( dec 93)
? Reduced to 25% by introduction of Tesobonas
? Tesobonas
? Short term dollar denominated bonds ? Reduces risk for investor against exchange rates ? Interest 6 to 8 percent below the rates on cetes ? Devaluation of peso become ineffective to reduce
the debt burden of the government
Options with the Mexican government
? Tightening monetary policy
? Increasing interest rate ? Ending the policy of sterilizing reserve loss
? Abandon the exchange rate peg and allow the
peso to float
? complete repudiation of previous government ? public confidence shaken, the peso might have
fallen well below its long-run equilibrium value and helped set off another inflationary spiral
? Devalue the peso to its equilibrium level
? Small reserve to handle speculative attack in case
of crisis
New monetary institution
? Devalue peso
? Form currency board
? A currency board is required to convert domestic
money into international reserves at a fixed rate on demand. ? Domestic money is only issued in exchange for international reserves ? This practice ensures that the currency board always has enough international reserves to meet any demand to convert base money into international reserves at the fixed rate ? No support to Banking system
Devaluation of Peso 20 Dec 1994
? Widened the target band considerably by raising
the ceiling of the band while leaving the floor unchanged.
? $4.5 billion decrease in central bank reserves in
single-day. ? Increase in interest rate by 2.5%
? Dec 22 Government announced
? that it was abandoning the exchange rate target
bands and allowing the peso to flaot ? arranged a swap line of $7 billion with the United States and Canada
? Interest rates rose to 24.5% ( 10 % in 3 days) ? 40% devaluation of peso in a week
? The contrast between the severe market reaction
to the move to a floating peso and the relatively mild response to the initial devaluation suggests that Mexico might have been better off increasing the target band’s rate of crawl and making an earlier decision to devalue while reserves were still relatively high ? Peso reached a level of 82, 86 crisis ? Peso strengthened after agreement with US government and policy initiatives in 1995
Us intervention
? Pros
? Prevent job loss. Mexico was a big importer of US
goods ? prevent political turmoil or large rebellion in neighbor country ? New wave to illegal immigrants in US ? Prevent it spreading from other developing countries ? Prevent set of defaults of private entities
? Cons
? Moral hazard. the tendency for insurance by US
Govt. to encourage irresponsible behavior in the future
? $18 Billion support from US and other countries ? ? ? ?
(2 jan) Not enough to pay tesobonos getting mature Interest rate on tesobonos doubled. $20 billon from US,$ 18 billion form IMF and $ 13 billion from central banks U.S. contribution was taken from the exchange Stabilization Fund to avoid congressional vote
? The United States and Mexico negotiated the
terms of the loan agreement, which required that Mexico limit money and credit expansion and that Mexican oil export revenues be deposited in a special account at the Federal Reserve Bank of New York as a form of collateral (feb 22 ,1995) ? Peso stabilized after that
Conclusion
? Overvaluation of currency needs to be corrected
? A government trying to maintain a fixed or quasi-
fixed exchange rate needs to pay attention to the amount of short-term liabilities ? This episode highlights the severe constraints on monetary policy that arise if a government wants to maintain a fixed or quasi-pegged exchange rate
doc_737969027.pptx
It explains the macroeconomic situation of Mexico, factors that caused the crisis, how did the crisis unfolded and the options in front of mexican government.
Mexican Peso Crisis 1994
Outline
? Debt Crisis 1982 ? Oil crisis 1986 ? Macroeconomic factors
? NAFTA ? Mexican Government’s stance ? Monetary Policy
? Factors Causing the crisis
? ? ? ?
? ? ? ? ?
Current account deficits Capital Account Political Shocks Us interest rates
Mexican Policy Options What Mexico Did Us Intervention Conclusion
? Crisis and the conclusion
MEXICO GDP GROWTH RATES – 1980s
GDP growth
10 8 6 4 2 0 1980 -2 -4 -6 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 GDP growth
Debt crisis
oil crisis
Source : IMF ;IFS
OIL PRICES
Debt crisis 1982
Increased fund availability in Eurodollar market ($ Denominated Bank Deposits of oil exporting countries) Fuelling Lending Boom Re-channeling funds to developing countries as loan credits
Oil Price Rise in 1973
World Recession of 1974-75
Decline in world commodity prices for minerals and agricultural goods
Exacerbating Developing Countries’ Debt Burden
•Record-high interest rates of the early 1980s - efforts to curb the oil-based inflation of the 1970s •Most LA Credits were priced to LIBOR rates ? debt-service costs grew progressively greater as these rates reached record levels •slowdown in world growth •drop in commodity prices for the second time in eight years left exports stagnant •Most new loans from 1979-82 to cover accrued interests and maintain consumption and not for productive investments
Oil crisis 1986
? Decline of OPEC
? Oil Exporters plunged into near bankruptcy
? Reduction in value and volume of oil exports ? Structural Adjustment Policy
? Reduction in quantitative controls on imports ? Encourage Foreign Investment ? Seeking Growth based on intl. competition ? Secure entrance of Mexico into GATT
Mexican Government’s stance
? Inflation major concern.
? Positive Primary balance
? Very small fiscal deficit of 0.5 % ? Current account deficit not a problem as it is caused by
private investment accompanied by capital account and not by fiscal deficit or monetary expansion. ? Dramatic improvements in Mexico’s economic environment, improvements such as lower inflation, a reduced budget deficit, privatization lower barriers to international trade, and an improved climate for foreign investors. ? These investments when completed will increase the productivity of Mexican economy and turn around the
Fiscal Deficit
60000 50000 Deficit ( in Million Pesos ) 40000
30000
20000 10000 0 -10000 -20000 -30000 -40000 -50000 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994
inflation
200 180 160 140 120 100 80 60 40 20 0 1981M1 1981M5 1981M9 1982M1 1982M5 1982M9 1983M1 1983M5 1983M9 1984M1 1984M5 1984M9 1985M1 1985M5 1985M9 1986M1 1986M5 1986M9 1987M1 1987M5 1987M9 1988M1 1988M5 1988M9 1989M1 1989M5 1989M9
inflation
Source : IMF ;IFS
Monetary Policy
? Sterilization
? A form of monetary action in which a central bank or
federal reserve attempts to insulate itself from the foreign exchange market to counteract the effects of a changing monetary base ? the central bank matches its purchases of international reserves with a sale of government bonds from its portfolio
? Quasi fluid Exchange rate
? At that time Mexico had a crawling peg exchange rate
system. Government intervention kept the exchange rate vis-à-vis the dollar within a narrow target band, but the upper limit of the band was raised slightly every day (2.3% per annum) by a preannounced amount, allowing for a gradual nominal depreciation (a “crawling peg”) of the peso
Overvalued Peso in 1990’s
? Real exchange Rate R = P/P*.E ? ?R = ?P/P - ?P*/P* - ?E/E ? Simply the real exchange rate is percentage change in price of
? ?
? ?
?
home country minus percentage change of prices in reference country and exchange rate Overvalued up to the extent of 40% (Dornbusch and Werner) Stanley Fischer (1994) notes, other countries, such as Spain and Israel, that have gone through major stabilization and reform programs have simultaneously experienced substantial appreciations, and Mexico’s appreciation in the early 1990s was consistent with their experiences. Difficult to determine the equilibrium level. Long-run average of observed real exchange rates shows 20 percent overvaluation. Taking real exchange rate starting in a period when the current account was either balanced or at a sustainable level (1989) shows overvaluation of 35% on CPI.
20
40
60
80
100
120
140
160
0 1989M1 1989M4 1989M7 1989M10 1990M1 1990M4 1990M7 1990M10 1991M1 1991M4 1991M7 1991M10 1992M1 1992M4 1992M7 1992M10 1993M1 1993M4 1993M7 1993M10 1994M1 1994M4 1994M7 1994M10
real exchage rate 1989M1 = 100
Source : IMF ;IFS
real exchage rate 1989M1 = 100
Current account deficits
? Increased from 2.8 percent of GDP in 1989 to an
7 percent of GDP in 1992. ? Cause - overvalued Peso ? The government promised to hold down inflation in import prices by limiting exchange rate depreciation to a rate smaller than the prevailing rate of inflation in Mexico ? Pacto act
? Limiting increase in wage and salaries ? To decrease inflation ? Unable to decrease domestic inflation to a level
enough to prevent overvaluation of peso
Capital account
? Big Surplus , 95$ billion between 1990 to 1994. ? Policy Reforms ? Low interest rates in US ? Optimistic view of Mexico’s capital inflow is that it
did not finance investment spending in new factories and equipment that would have helped Mexico in dealing with current account deficit. ? Instead, a large portion of the capital inflow went into short-term financial investments, such as bank deposits and government bonds, that could flow out of Mexico at tremendous speed if a financial crisis arose.
a
Cetes
? Short term bonds like treasury bills
? Very attractive for foreign investors
? During the second quarter of 1992, the rate on
?
?
? ?
three-month cetes averaged 13.27 percent (IMF, IFS). Exchange rate depreciation to no more than 2.3 percent per annum (promised by Mexican government). Us treasury bills yield 3.75 percent. Short term bonds , so low risk for investors. Short term liabilities for Mexican government.
Capital Account- forms
? Foreign direct investment
? ? ? ?
Long term Can’t be reversed quickly Low cost Total 24$ billion between 1990 to 1994
? Capital inflow ( purchase in Stock market)
? Total 28 $ billion between 1990 to 1994 ? Will effect Mexican stock market in case of crisis. ? Little pressure on foreign reserve
? Purchase of Bonds
? 43 $ billion over 5 years ? Mostly short term , 1-3 months ? Pose greatest danger to exchange rate peg
International reserve
? Large (28$billion dollar) ? Short term foreign liabilities ? Shifting of money by mexican residents ? As Calvo (1994,302) noted, even when Mexican
reserves peaked in1993, Mexico’s ratio of highly liquid government and bank liabilities was at least four times the size of net international reserves, the highest ratio in Latin America. ? The ratio of highly liquid government and bank liabilities (broad money M3 minus M1, which is mostly currency) to international reserves had risen from about four in1993, a level high enough to concern Calvo (1994), to an even more precarious nine in November 1994
10000.00
20000.00
25000.00
30000.00
15000.00
5000.00
0.00
Total Reserves minus Gold
Source : IMF ;IFS
1980M1 1980M6 1980M11 1981M4 1981M9 1982M2 1982M7 1982M12 1983M5 1983M10 1984M3 1984M8 1985M1 1985M6 1985M11 1986M4 1986M9 1987M2 1987M7 1987M12 1988M5 1988M10 1989M3 1989M8 1990M1 1990M6 1990M11 1991M4 1991M9 1992M2 1992M7 1992M12 1993M5 1993M10
Total Reserves minus Gold
Political Shock - Zapatista Mexican Rebellion
? Indigenous peasant based movement with some ? ? ?
?
urban intellectual leadership Mexico's most southern and poverty-stricken province, Chiapas. Democracy, freedom and justice – central objectives Chiapas had long voted for the ruling Revolutionary Institutional Party (PRI). Rebels caused political instability in the country.
Political shock- Assassination of Louis Donaldo Colosio (March 23 1994)
? Virtual winner of presidential election.
? Shot in very suspicious condition.
? His death heightened fears of political instability. ? Decrease in international reserves. Increase in
interest rate, exchange rate touched the ceiling. ? Ernesto Zedillo became new PRI candidate and won the election.
Other political shocks
? Resignation (later withdrawn) of the Minister of the ? ?
?
?
Interior, Jorge Carpizo. (june 27 1994) Kidnapping of a prominent Mexican businessman, Alfredo Harp ( June 25, 1994) Salinas' brother-in-law, José Francisco Ruiz Massieu, president of the PRI was also murdered (Sept 29 1994) Deputy Attorney General Mario Ruíz Massieu, a brother of the slain Francisco Ruíz Massieu resigned and claimed that important figures in the ruling party had ordered his brother’s assassination ( 18 Nov 1994) leaked rumors of changes in exchange rate policy
Graph relating , interest rates and political shocks
TREASURY BILL RATE
45.00 40.00
35.00
30.00 25.00 20.00 15.00 10.00 5.00 0.00 TREASURY BILL RATE
Source : IMF ;IFS
Graph relating Foreign reserve and political shocks
TOTAL RESERVES MINUS GOLD
35000.00
30000.00
25000.00
20000.00
15000.00
TOTAL RESERVES MINUS GOLD
10000.00
5000.00
0.00
Source : IMF ;IFS
US Interest rates
Federal Funds Rate
? Highly affected by the
6.00 5.00 4.00 3.00 2.00 1.00 0.00 Federal Funds R
interest rates in US as most of the foreign investment come from US. ? Low interest rate in US favors capital inflows in emerging economies. ? Fed fund rate increased to 5.5 percent in Nov 1994 from 3 percent a year ago.
Source : IMF ;IFS
Mexican Policy
? No major Policy change
? no devaluation in the revised pacto signed on
September 24 ? no increase in the rate of crawl, of the peso
? Pushed up the interest rates to tighten monetary
base but not enough to keep the premium over US treasury bills at earlier level. ? Successful election in Mexico increased confidence ? Central bank drastically decreased the interest rates ? Sterilization prevents to prevent the reduction og
North American Free Trade Agreement (NAFTA)
? Came into force on January 1, 1994.
? The goal of NAFTA was to eliminate barriers of
trade and investment between the USA, Canada and Mexico. ? Imports got cheaper for Mexico. ? Increased the confidence of investors in Mexican economy.
What NAFTA did for Mexico
PROS
? GDP has increased at
CONS
? Higher Unemployment – 10%
an average annual rate of 2.7 percent Underperformed ? Exports to the United States have quadrupled ? Trade Liberalization ? Dramatic Reduction of prices(cost of basic household goods in
?
? ?
?
increase in jobs in informal economy Crippled Mexican Farming prospects by opening competition to heavily subsidized U.S. farm industry Lack of liberalization of sectors not covered by NAFTA Mexico's dependence on the U.S. economy has increased markedly Average income of the selfemployed was substantially lower than that of the salaried labour force - Growth of lowincome employment
Composition of government debt
? 75 percent of foreign debt in cetes form ( dec 93)
? Reduced to 25% by introduction of Tesobonas
? Tesobonas
? Short term dollar denominated bonds ? Reduces risk for investor against exchange rates ? Interest 6 to 8 percent below the rates on cetes ? Devaluation of peso become ineffective to reduce
the debt burden of the government
Options with the Mexican government
? Tightening monetary policy
? Increasing interest rate ? Ending the policy of sterilizing reserve loss
? Abandon the exchange rate peg and allow the
peso to float
? complete repudiation of previous government ? public confidence shaken, the peso might have
fallen well below its long-run equilibrium value and helped set off another inflationary spiral
? Devalue the peso to its equilibrium level
? Small reserve to handle speculative attack in case
of crisis
New monetary institution
? Devalue peso
? Form currency board
? A currency board is required to convert domestic
money into international reserves at a fixed rate on demand. ? Domestic money is only issued in exchange for international reserves ? This practice ensures that the currency board always has enough international reserves to meet any demand to convert base money into international reserves at the fixed rate ? No support to Banking system
Devaluation of Peso 20 Dec 1994
? Widened the target band considerably by raising
the ceiling of the band while leaving the floor unchanged.
? $4.5 billion decrease in central bank reserves in
single-day. ? Increase in interest rate by 2.5%
? Dec 22 Government announced
? that it was abandoning the exchange rate target
bands and allowing the peso to flaot ? arranged a swap line of $7 billion with the United States and Canada
? Interest rates rose to 24.5% ( 10 % in 3 days) ? 40% devaluation of peso in a week
? The contrast between the severe market reaction
to the move to a floating peso and the relatively mild response to the initial devaluation suggests that Mexico might have been better off increasing the target band’s rate of crawl and making an earlier decision to devalue while reserves were still relatively high ? Peso reached a level of 82, 86 crisis ? Peso strengthened after agreement with US government and policy initiatives in 1995
Us intervention
? Pros
? Prevent job loss. Mexico was a big importer of US
goods ? prevent political turmoil or large rebellion in neighbor country ? New wave to illegal immigrants in US ? Prevent it spreading from other developing countries ? Prevent set of defaults of private entities
? Cons
? Moral hazard. the tendency for insurance by US
Govt. to encourage irresponsible behavior in the future
? $18 Billion support from US and other countries ? ? ? ?
(2 jan) Not enough to pay tesobonos getting mature Interest rate on tesobonos doubled. $20 billon from US,$ 18 billion form IMF and $ 13 billion from central banks U.S. contribution was taken from the exchange Stabilization Fund to avoid congressional vote
? The United States and Mexico negotiated the
terms of the loan agreement, which required that Mexico limit money and credit expansion and that Mexican oil export revenues be deposited in a special account at the Federal Reserve Bank of New York as a form of collateral (feb 22 ,1995) ? Peso stabilized after that
Conclusion
? Overvaluation of currency needs to be corrected
? A government trying to maintain a fixed or quasi-
fixed exchange rate needs to pay attention to the amount of short-term liabilities ? This episode highlights the severe constraints on monetary policy that arise if a government wants to maintain a fixed or quasi-pegged exchange rate
doc_737969027.pptx