Transcript
Mexico’s Financial Crisisof
1994-1995
Presented by:OKomal RanaOLaishram Boicha
SinghOSanchi AgarwalOSimran AgarwalONikita SharmaOArbind KumarOAashish Tiwari
Originsof
the crisis
Since 1930s :• followed ISI model1970s and 1980s : ISI into trouble Foreign exchange problem Jeopardizing foreign debt service1979-81 : Federal Reserve and ECB raised interest rates Decline in commodity prices Decline in export receipts Suspended payments – “DEBT CRISIS” Other countries in distress Financial support from IMF and WB2nd half of 1980s :Deregulation of economy, liberalized trade, internationalcapital flows, reduced import tariffs, reforms for inflow of portfoliocapital and FDI, expansion of domestic financial system
Early 1990s : Foreign trade agreement with NAFTA Further liberalized financial system Privatizing largest commercial banks Deregulation of banking system1989 : Negotiations of Mexico’s debt service finalized with
international creditors Mexican cos. started borrowing in financial markets Greater freedom for foreigners to invest in Mexico
Stock Exchange.After 1993 : Capital A/c of Mexico further liberalized. Govt. allowed local stock markets to trade foreign
securities
Mexican pegImportant strategy : to fix the value of the Mexican
peso to the US dollar.o Assurance to foreign investors that their
investments would not lose value under normal circumstances. This bolstered import-export business in Mexico.
o A fixed exchange rate allowed Mexican firms to borrow money in international markets to finance expansion in preparation for the opening of free trade with the US in Jan, 1995.
o A fixed exchange rate helped the Mexican authorities fight domestic inflation by forcing monetary policy to fluctuate according to BoP considerations, not political whims.
Consequences of financial liberalization
O Bank privatization:Privatizing and liberalizing led to a
major lending boomO Investors’ enthusiasm:Major boom in country’s stock
market and large increase in FDI
Mexico’s bank privatizationOLargest private banks
privatized in stages, by 1992, most commercial banks privatized
O Immediate boom in credit
1. Before 1982- implicit contract between bankers and Mexican Govt.
2. This created problem during exchange rate crisis of 1976 and 1982
3. Threat of nationalization, only credible action.
4. In 1982, banks and bankers participated in speculation against peso.
5. Therefore, most private banks nationalized.
6. Concentrated banking system- lent according to political priorities rather than on creditworthiness
Problems in bank privatizationO Bank privatization failed because of the
incentives the govt. provide to maximize the price investors paid for privatized banks.
O Govt. offered unusual privileges to winning investors i.e., lack of competitive system.
O Bidding process did not take into account bidder’s experience in the banking sector ( therefore, little hands on experience running commercial banks).
O Govt delayed adoption of international banking standards and allowed banks to lend or buy securities without keeping an apt amount of reserves against loan losses.
Weak regulation of banks (major handicaps)
O Regulators allowed banks to misreport the riskiness of their loan portfolios. When a loan was past due, only the interest in arrears was counted as non-performing.Banks were overstating the soundness of their B/S
O NBC ineffective at monitoring bank behaviour because officials were inexperienced. Poor accounting standard and lack of technology made it to difficult to calculate the riskiness.Commission lacked the authority and autonomy to
properly supervise banks.
OAlso, depositors were not tracking bank operations because of the favourable deposit insurance scheme.
OFOBAPROA not only guaranteed all deposits, but also guaranteed virtually all bank liabilities.Thus, the system was in a delicate position (because of excessive risk
taking) if any external shocks to occur.
Investor EnthusiasmO Fall in US interest rates coupled with Mexico’s reform
and liberalization drew investor’s attention.O Investor moved their money to Mexico and invested in
Mexican assets, the value of those assets went up together with the returns to investors.
O But growth rate did not justify such hype. Growth rate was 3% in 1992 and less than 2% in 1993. Investors, however, were betting on Mexico’s future.
Led to bubble-like dynamicO Main issue- as easily as money went into Mexico, it
could come out since their enthusiasm was based on expectations.
The system under stress in 1994
1994- a turbulent yearO On Jan 1, 1994, a group of rebels took control of
some largest towns in Chiapas.O In Feb, US Fed began to increase interest rates.O In March, Luis Donaldo Colosio, the presidential
candidate of the ruling party, PRI, was murdered.O A series of other political assassinations, kidnappings
of high profile executives disturbed the country.Other than this,O Household savings did not increase, foreign
borrowing increased, but gross fixed investment was not increasing.
O Foreign borrowing was not used to increase investments; aggregate demand rose because the govt boosted its consumption, but there was no increase in savings or investments.
Mexico’s macroeconomic indicators
O This series of events in 1994 changed investor expectations – led to capital flight which depleted the foreign exchange reserves.
O To accumulate foreign exchange reserves and strengthen the peso, Mexican govt issued debt indexed to the value of the US dollar to entice foreign and domestic investors to keep money in Mexico.
O This kept exchange rate stable during 1994 but Mexico was experiencing a credit boom, and inflation exceeded that of US, its main trading partner.
O Increased pressure on peso led to Central Bank raise interest rates – peso appreciated – imports into Mexico were cheaper and Mexican exports were expensive abroad.
Thus, foreign deficit worsened.O 1994 elections – Ernesto Zedilla won – chose a
new team to deal with crisis but Finance Minister continued. Also, leaked news about gradual depreciation of peso (by widening the band in which the exchange rate as allowed to fluctuate), created a panic among investors.
O This led to huge magnitude of capital outflows and panic in financial markets led the govt. to float the peso.
Consequences of the 1994 crisis Depreciation of peso Increased interest rates Continued capital flight Loan default Recession Overall, banking crisis As the Mexican economy continued to
collapse there was contagion to other emerging markets. This contagion of the Mexican crisis to other emerging markets in 1995 is referred to as THE TEQUILA EFFECT.
Total non-performing loans as a percentage of total loans in the Mexican Banking System, 1991-2003
Crisisand
The US Bailout
President Bill Clinton and a Treasury Dept team orchestrated a large scale standby loan for Mexico.
The credit line was for $50 bn, of which the US Treasury provided $20 bn; the remainder came from the IMF ($18 bn), the Bank for International Settlements ($10 bn), and private banks (about $3 bn).
The Mexican govt used only $13 bn from the US Treasury and repaid the money rather quickly.
The loan did help to stabilize the Mexican economy.
o It repaid the US ahead of schedule,o Regained market access quickly,o Rebuilt the reserves it had blown,o Overvalued exchange rate peg,o Pursued prudent macroeconomic
policies.
What did Mexico gain in the long term ?
In the 15 yrs that followed, there were no financial or exchange rate crises generated by the mismanagement of Mexico’s economy.
Trade with US and other countries expanded rapidly, and the business cycle of Mexico synchronized with that of the US.
Mexico became one of the single largest recipients of FDI among emerging markets, and saw GDP per capita (US$ PPP) grow from $8000 in 1995 to $15000 by 2008.
The banking system was now controlled by foreign banks. By 2008, foreign banks controlled about 80% of assets of the commercial banks.
Foreign banks were extremely risk averse and reduced their participation in the commercial credit business.
Mexico thus ended up with a more efficient and stronger banking system– at least better capitalized– but one that was lending less to the private sector.
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