Transcript Mexican and Asian Currency Crisis

Mexican Peso and Asian Currency
Crisis
Crisis
Mexican crisis
The 1994 economic crisis in Mexico, widely
known as the Mexican peso crisis, was
triggered by the sudden devaluation of the
Mexican peso in the early days of the
presidency of Ernesto Zedillo.
The crisis is also known in Spanish as el error
de diciembre — The December Mistake. In the
Southern Cone and Brazil, the impact that the
Mexican economic crisis had on the region was
labeled the Tequila Effect (Spanish: Efecto
Tequila, Portuguese: Efeito Tequila).
Economy in Mexico at the time of Crisis
 In 1993, 64% of capital inflows into Mexico went into portfolio
equity, 22% was composed of direct investment, and 14% was in the
form of long-term debt.
 Until the political and economic events of 1994, Mexico could
maintain the fixed peso value even though the current account
deficit. In the capital account, foreign savers seeking high rates of
return in Mexico's soaring equity markets and businesses with direct
investments in Mexico kept the peso demand strong. The increased
supply of pesos in the current account was offset by higher demand
in the capital account.
During this period the Mexican government issued large quantities
of short-term, dollar-indexed securities known as tesobonos.
U.S. Plan to Confine the Crisis
The Administration has proposed a package of loan guarantees to help restore
investor confidence in the devalued peso and in the Mexican financial markets.
These guarantees should enable Mexico to raise long- term funds in private capital
markets to pay off its short-term financial obligations. This should help restore
financial stability and prevent the crisis from spreading to other markets.
 What Conditions Must Mexico Meet?
 Clinton Administration officials state that the loan guarantees will
include strict financial conditions imposed on the Mexican
government to contain inflation, reduce Mexico's external deficit,
restore stability to the peso, and control wage increases.
 In addition, the United States should insist on continuing Mexican
government deregulation and privatization of its economy. If these
conditions are not rigorously drawn and enforced, there will be more
trouble later.
 Mexico also will be required to pay a risk fee in cash up front for
the right to use the guarantee.
 Is this Foreign Assistance, a Loan, or a Guarantee?
The package is not foreign assistance or a loan. The United States
will guarantee new borrowing by Mexico in order to restore investor
confidence. These guarantees carry some risks for the Treasury and the
U.S. taxpayer, but as long as Mexico repays its debt, as it has in the past,
this guarantee will have no effect on the U.S. budget.
 Does this Crisis Mean NAFTA was a Mistake?
The North American Free Trade Agreement (NAFTA) signed by Mexico,
the United States, and Canada in 1993 didn't cause the crisis, despite the
wild claims of the treaty's opponents. The U.S. relationship with Mexico
is such that it would require this kind of special treatment with or without
NAFTA. NAFTA is a trade agreement, not a monetary arrangement, and
Mexico would probably have experienced this crisis had NAFTA not
existed. Thanks to NAFTA, Mexico cannot raise tariffs against
increasing U.S. imports in a short-term response to the crisis. In any
event, support for a credit package should not be a referendum on
NAFTA.
Causes of the economic crisis of 1994
(1) The large Mexican current account deficit.
(2) A rise in U.S. interest rates resulted in an abrupt reversal of the flow
of financial money that had entered Mexico through the capital account.
(3) Assassination of Luis Donaldo colosio & Jose Fransisco Ruiz
increased anxiety about Mexico's political and social situation.
(4) In order to finance the historical deficit
(5) A steady drain of foreign exchange reserves.
 Out Comes of Peso Depreciation:
(1) The peso depreciation will lead to a significant jump in the inflation
rate.
(2) The Mexican current account deficit will fall as exports rise and more
costly imports decrease.
(3) The peso depreciation leaves the Mexican government no favorable
choices. The government can choose to use fiscal and monetary restraint
to prevent inflation. Or it can continue positive economic growth.
 Mexican Economy Rescue Program:
In early January, 1995, the new Mexican Finance Minister
Guillermo Ortiz announced a program to address the Mexican
economic crisis. The program had three components .
I. Minimize the inflationary effects of the devaluation.
II. Push forward structural reforms that promote the competitiveness of
the Mexican private sector.
III. Address the short-run concerns of investors and establish a coherent
floating exchange rate regime.
 How the IMF helps to resolve Economic Crisis
Balance of payments difficulties can arise and, in the worst case, build
into crises—even in the face of strong prevention efforts.
IMF has also been encouraging actions by debtor countries and their
creditors to facilitate a more orderly process for debt restructuring.
 The IMF's Role Prior to the 1994-95 Mexican Financial Crisis
Many of the participants saw much of the political upheaval of the recent
past to be a direct consequence of the financial chaos that had preceded
World War II.
1. The IMF's Original Mandate was to Supervise Fixed Exchange Rates
2. The Collapse of the Bretton Woods Par Value System Eliminated a
Principal Function of the IMF.
3. The IMF Searched for a New Role to Play on the World's Financial
Stage and Moved Toward Greater Surveillance of Member Countries'
Economic Policies.
4. The IMF (and the World Bank) Took Center Stage During the Debt
Crisis of the 1980s.
Rescuing the Mexican Economy From the Crisis
of 1994-95
(1) The U.S. Led the IMF Effort to "Save" Mexico and the FreeMarket Model of Development.
 The United States government organized a multilateral assistance
package to the Mexican government with financial commitments
approaching $50 billion dollars. The United States government
committed nearly $20 billion dollars to the rescue package, while the
IMF contributed another $18 billion dollars.
 Most important, goals of the rescue effort were to restore investor
confidence in the long-term prospects of the Mexican economy, and to
reassure countries with economies similar to Mexico's that the freemarket model of development was still viable.
(2) The United States and the IMF Provided Short-Term Credit to Help
Solve the Liquidity Crisis.
The Mexican government owed a lot of people a lot of U.S. dollars,
and it was obligated to fully repay its creditors in a short amount of time.
 After the peg collapsed, the peso instantly lost nearly 25% of its value,
making it much more difficult for the government to purchase dollars
with pesos.
The United States government and the IMF put together a multi-tiered
rescue package to alleviate the liquidity crisis in Mexico.
 Mexico needed a cash injection so that it could meet its obligations,
and so that confidence could be restored in the short-term stability of the
Mexican economy.
 The United States extended nearly $15 billion dollars to the Mexican
government by entering into short- and medium-term currency swap
agreements.
 The United States agreed to give dollars to the Mexican government
in exchange for pesos. Three months to a year later the Mexican
government would give the United States dollars in exchange for pesos.
 The IMF and the Mexican government entered into a stand-by
arrangement which, in part, provided Mexico with an immediate cash
injection (Special Drawing Rights). Of the nearly $18 billion in total
IMF commitments, almost $8 billion was available immediately after
the agreement was concluded. The other $10 billion was conditioned on
Mexico's meeting certain economic performance criteria—a method
termed "conditionality."
(3) The United States' Plan Attempted to Return Mexico to the
International Financial Markets.
 The United States and the IMF organized their plan to resolve the
liquidity crisis in Mexico, a plan was conceived to convert Mexico's
remaining short-term obligations to long-term debt, and in the
process demonstrate Mexico's financial strength to the world.
 United States agreed to guarantee long-term Mexican
government bonds which were to be sold in the international
financial markets.
 The net effect of this portion of the overall rescue package was
that Mexico was able to quickly return to the international financial
markets to start rebuilding its reputation as a successful and stable
country in which to invest
The Economic Crisis of 1997-99 Overviews
• Fixed exchange rate system pegged to the USD. When the Dollar rose,
consequently the ASEAN currencies grew too, resulting in lower
exports.
• Decline in Export competitiveness particularly in Electrical goods.
• The decrease in exports resulted in increased Trade and Current
Account deficit.
• The crisis first emerged in Thailand when as a crisis of loan
repayment. This led to fears of loan defaults and foreign short-term
creditors withdrew funds from Thai financial institutions.
• The withdrawal of ST credit led to pressure on forex reserves and the
value of Baht. The Bank of Thailand in its attempt to save the Baht lost
all its Reserves and had to request assistance from the IMF.
• The contagion then spread to Philippines, Malaysia and Indonesi.
The Asian financial crisis involves four basic
problems or issues:
(1) A shortage of foreign exchange in Thailand, Indonesia, South Korea
and other Asian countries that has caused the value of currencies and
equities to fall dramatically,
(2) Inadequately developed financial sectors and mechanisms for
allocating capital in the troubled Asian economies,
(3) Effects of the crisis on both the United States and the world.
(4) The role, operations, and replenishment of funds of the International
Monetary Fund.
Impact of the crisis
The crisis led to weaker, unstable exchange rates and weakened
Financial Institutions. To tackle this, the Government imposed higher
domestic Interest rates, which led to a slowdown in manufacturing
and industrial activity. This brought about huge unemployment and
an undesirable social impact – on food, healthcare and education. To
make matters worse, the financial crisis coincided with the worst
drought conditions in the ASEAN region. Since ASEAN is the fourth
largest trading block in the world, the spillover effect was on world
trade (mainly ASEAN’s trading partners).
Causes of the crisis in 1997
1. Weakness of Macro-Economic fundamentals
The basic weaknesses in the Macro-Economic fundamentals itself led to Low
productivity and competitiveness vis-à-vis other regions of the world. Weak
governments lacked the political autonomy or will to enact the deflationary policies
necessary to reduce current account deficits and domestic asset bubbles. They also
contributed to the cronyism and ethical problem that encouraged over borrowing,
over lending, and over investment in the private corporate sector as well as in state
projects.
2.Overvalued Exchange Rate & Openness of Capital
Account
Overvalued exchange rates tied to an appreciating U.S. dollar led to large current
account deficits and inadequate or declining long-term capital inflows. This resulted in
heavy dependence on short-term external debt and the depletion of foreign exchange
reserves. Borrowed Short-Term funds were invested in the Stock market and in Real
Estate. The overall quality of investments declined with reduction investor confidence
which was a result of bad news that the export market had slowed down.
IMF Financial Support Packages
Date Approved (1997)
Total Pledged
IMF
U.S.
World Bank
Asian Development Bank
Japan
Others
Change in Exchange Rate
(7/11/97- 1/22/98)
Change in Stock Market
(7/1/97-1/19/98)
Thailand
August 20
$17.2
$3.9
None
$1.5
$1.2
$4.0
$6.6
Indonesia
November 5
$40
$10.1
$ 3.0
$ 4.5
$ 3.5
$ 5.0
$26.0
South Korea
December 4
$57
$21.0
$5.0
$10.0
$ 4.0
$10.0
$ 7.0
-38%
-81%
-50%
-26%
-40%
-30%
Proposed Solutions
1. Stabilizing the Exchange Rate and Debt Management
2. Dealing with the Social impact
3. Strengthening the Financial sector
4. Adjustment of Industrial Structures
5. International Financial markets
6. Revitalizing the Financial Markets
ASEAN: Steps to Handle the Crisis
 The progressive openness of ASEAN economies
 Sound Financial measures
 The growing integration of the ASEAN economy
 The expansion and diversification of ASEAN