The Tequila Crisis(no, not just a

shortage)

Micah Brock, Michael Derocher,

Ryan Earley, Annie McDonough,

Matt Warchol

Once Upon a Time in Mexico

• In the late 1980’s and early 1990’s, Mexico was recovering from economic trouble.

• Government Reforms under Carlos Salinas (1988-1994)

Restructuring Debt under Brady PlanLarge Reduction in Budget DeficitUnilateral Cuts in Protectionist Trade BarriersPrivatization of Government Enterprises

Everything Looked Wonderful, But…

• NAFTA was set to take effect in 1994• Expected to encourage foreign investment

in Mexico, due to unique access to the U.S. market.

• The reforms came at a price, a growing current account (from $6B in 1989 to $20B in 1993)

• The current account hinted at an overvalued peso.

Current/Capital Accounts

According the to the famed scholar… John Stiver:

• Currency Crises usually occur due to a combination of

Bad Policies and

Bad Luck

Bad Policies…

• Overabundance of credit due to:– improved economic expectations– substantial reduction in public debt– real estate and stock market boom– strong private investment

• Excessive Credit becomes burden– Poor borrower screening– Credit-volume excesses– Slowdown of economic growth in 1993

Bad Policies…• Causes of Debt

– Bank reserve requirements eliminated– Banks hastily privatized without regard to “fit and proper criteria”

(selection of top officers, shareholders)– Banks purchased without proper capitalization → shareholders

leveraged acquisitions with loans provided by very banks bought out or from other reciprocally collaborating institutions

– Moral hazard increased because of unlimited backing of bank liabilities

– No capitalization rules based on market risk → encouraged asset-liability mismatches which led to highly liquid liability structure– Beginning in December 1990 foreigners allowed to purchase “domestic” (short-term) government debt → increased purchasing power by sellers due to decreased government debt– Implemented “Tesebonos” (short-term, dollar-indexed, peso-denominated Mexican government securities) → effective in short term by retaining $23 billion in foreign financing but magnitude dangerous if devaluation occurred

International Reserves

Political Events

• An argument could be made that the Mexican Peso crisis was the result of “bad luck”

• There were 4 major political events the year preceding the crisis

1st Event

• Armed guerrilla movement in province of Chiapas in January of ’94

2nd Event

• Assassination of ruling party’s presidential candidate, Luis Donaldo Colosio in March of ’94

3rd Event

• Kidnapping of Alfredo Harp, a prominent Mexican businessman, in June of ’94

4th Event

• Assassination of Jose Francisco Ruiz Massieu, a high ranking official in ruling party in September of ’94

• Brother of assassinated Massieu and Deputy Attorney General, Mario Ruiz Massieu, claimed other high ranking officials in ruling party ordered the assassination and that these officials along with the Attorney General (his supervisor) were obstructing his investigation

The Result?

The Tequila Crisis !!!

Exchange Rates

Peso per Dollar

0

1

2

3

4

5

6

7

8

9

1 60 119 178 237 296 355 414 473 532 591 650 709 768 827 886 945 1004 1063 1122 1181 1240 1299 1358 1417

Period

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Series1

Interest RatesMexican Monthly Interest Rates(Annualized)

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

90.00

100.00

1 5 9 13 17 21 25 29 33 37 41 45 49 53 57 61 65 69 73 77 81 85 89 93 97 101 105

Period

Inte

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t R

ate

s

Series1

Mexico After the Tequila Crisis

• Rapid growth– Exports grow rapidly– Other areas of the economy weak

• Credit Problems– Investors unable to get loans from Mexican banks

• Inflation Concerns– Fiscal policy vs. monetary policy – inconsistent

government behavior raises concerns

Conclusions

• Mexico is rapidly growing

• Inflation not yet a problem

• Government policies have enabled Mexico to partially protect against external shocks

Mexico in 2004

• High growth driven by strong global economy (especially U.S.) and demand, high commodities prices, rising household consumption and increased investment

• Inflation in check• Better distribution of debt, better healthcare, improving

infrastructure and decreasing budget deficits enabled largely by favorable world oil prices

• Huge gaps between the rich and the poor remain, unemployment rates still high, political and economic stability remains in question

Recommendations for Mexico in the future

• Take full advantage of the current favorable global economic climate

• Continue to strengthen its financial structure and banking systems