(Tiểu luận) midterm reportthe 1994 mexican peso crisis and its lessons forvietnam

FOREIGN TRADE UNIVERSITY FACULTY OF BANKING AND FINANCE -o0o - MIDTERM REPORT THE 1994 MEXICAN PESO CRISIS AND ITS LESSONS FOR VIETNAM Class: TCHE414(GD2-HK1-2324).1 Group: 19 Group members: Đỗ Minh Hải - 2113790024 Nguyễn Thế Giang - 2113790022 Lương Quỳnh Anh - 2113790003 Hoàng Thu Trang - 2113790062 Đinh Diệu Anh - 2112790005 Instructor: Assoc Prof., PhD Mai Thu Hien Hanoi, December 17th, 2023 GRADING RUBRIC Grade Description Actual grade Determining the issue: clear, logical, feasible (20%) Content: Logical analysis, direct addressing of the issue, real-world connections, up-to-date data, fulfilling 80-100% of the content requirements (50%) 8,5-10 (A) References: Diverse, engaging, complete citations, valid (10%) Format: Proper presentation, clear language expression, readability, error-free spelling; clear and appropriately formatted illustrations, tables (20%) 7-8,4 (B) Meet 70 to under 80% of grade A’s requirements 5,5-6,9 (C) Meet 50 to under 70% of grade A’s requirements 4-5,4 (D) Meet 40 to under 50% of grade A’s requirements Below (F) Meet under 40% of grade A’s requirements PREFACE In the early 1990s, Mexico implemented a highly robust economic restructuring program, attracting significant inflows of foreign capital to boost the nation’s economic development However, in 1994, the Peso (Mexico’s national currency) experienced significant depreciation The Mexican government, burdened by a massive trade deficit, witnessed the withdrawal of international capital from Mexico due to the weakened economy and escalating political risks As a result, it was unable to maintain the exchange rate stability between the peso and the US dollar With the aim of drawing lessons for Vietnam in the modern age, this essay will provide an overview of the crisis, delve into the root causes, and examine the measures that the Mexican government took to resolve the crisis TABLE OF CONTENTS PREFACE TABLE OF CONTENTS INTRODUCTION Overview of the crisis 1.1 The economy of the world and Mexico before the 1994 crisis 1.1.1 Changes in international investment and the global financial market 1.1.2 Mexico’s economic policies before 1988 1.1.3 Economic and financial reforms in Mexico since 1988 1.2 The unfolding of the 1994 crisis in Mexico Causes of the 1994 Mexican Peso crisis 2.1 Weaknesses in the Mexican economy 13 16 17 2.1.1 Prolonged trade deficit 17 2.1.2 Reduced savings in the private sector 17 2.1.3 The Peso’s appreciation 18 2.1.4 Mexico's relatively young banking system 19 2.2 Contradictions in Mexico's macroeconomic policies 19 2.2.1 Pegged exchange rate and the overvaluation of the currency 19 2.2.2 Monetary policy which encourages economic development 20 2.2.3 Monetary policy which regulates economic growth 21 How the crisis was dealt with and lessons for Vietnam 3.1 How the crisis was dealt with 22 22 3.1.1 Financial aid 22 3.1.2 Changes in fiscal policies 23 3.1.3 Changes in monetary policies 23 3.2 Lessons for Vietnam 24 3.2.1 Current Account 24 3.2.2 Macroeconomic balance 24 3.2.3 Exchange rate regime 25 3.2.4 Weakness in management and speculation 25 CONCLUSION 27 REFERENCES 28 INTRODUCTION The significant and massive scale of the Mexican Peso crisis (Tequila crisis) has been well-known since it took place in December 1994 It occurred due to a confluence of unfavorable political shocks, significant and expanding current account deficits, and policy missteps that have increased reserve losses and increased reliance on external short-term loans The "tequila" effect has caused events in Mexico to put significant pressure on financial markets and exchanges in various Asian and Latin American nations, as well as to heighten volatility As a result, it is of utmost importance for other countries in the world to understand and take lessons from the crisis and if this similar crisis happens again, policymakers at least, will know how to take the first steps to ease its consequences This research paper will walk readers through the primary causes of the Mexican crisis, the factors that contributed to the crisis's severity relative to previous financial upheavals, and more importantly, how the Mexican government dealt with the crisis through the implementation of specific policies, therefore, how other nations could prevent other currency crises from happening including Vietnam Our team also consulted previous research documents and supplemented some loose information Therefore, our team hopes that this paper will provide readers with a better grasp of the crisis's root causes, the actions that have been taken, and the necessary lessons for developing countries other countries, especially Vietnam Document continues below Discover more from: International Finance TCHE414 Trường Đại học… 253 documents Go to course 12 56 12 1.Vì Cách mạng tư sản Pháp triệt để International Finance 100% (5) Tiểu-luận-TCQT - Tiểu luận mơn Tài chính… International Finance 100% (3) Q&A - Tài tiền tệ International Finance 100% (2) PHÂN TÍCH HỢP ĐỒNG International Finance 100% (2) Chuỗi cung ứng Eleven - quản trị… International Finance 100% (2) 123doc anh huong cua moi truong marketi Overview of the crisis 1.1 The economy of the world and Mexico before 23 the 1994 crisis International 100% (2) 1.1.1 Changes in international investment and the global financial Finance market Due to the impact of opening up their economies to foreign investment, many developing countries achieved significant milestones in attracting foreign direct investment (FDI) during the first half of the 1990s The capital inflow into these countries amounted to around $40 billion in 1990, reaching a record high of $155 billion in 1993 In emerging economies in the Western hemisphere, the capital was increasingly concentrated in sensitive profit areas with high liquidity portfolios From 1990 to 1994, these investments accounted for 66% of the total capital inflow, in contrast to 30% for foreign direct investment The strong increase in capital flow to these emerging economies can be attributed to the following reasons: - Developing countries undertook restructuring debts from commercial banks and implemented comprehensive macroeconomic policies, notably financial reforms such as removing barriers to capital flow between countries - National border barriers and banking transaction costs were reduced, making it more affordable and accessible - Institutional investors, including reserve funds, insurance companies, pension funds, banks, and securities agencies, diversified their foreign investment portfolios - The decrease in investment interest rates in developed countries, such as the United States, increased the attractiveness of high-yield investments in emerging economies 1.1.2 Mexico’s economic policies before 1988 From the mid-1970s to the late 1980s, Mexico was trapped in a cycle of inflation and currency devaluation, making economic development difficult to achieve Controlling inflation and restoring the economy, with a particular focus on exchange rate stability, became a top priority for the Mexican government From 1954 to 1976, Mexico maintained a fixed exchange rate of peso/dollar = 12.5 This period coincided with significant economic development, accompanied by moderate inflation However, from the early 1970s, the peso weakened significantly due to a current account deficit and rising inflation By December 1976, mounting pressure on the balance of payments and uncontrollable capital flight led to the devaluation of the peso By the end of the year, the exchange rate had risen to 21 pesos per dollar, with an inflation rate of 60% Mexico plunged into a severe recession Under the management of President José Lopez Portillo (1976-82), the domestic currency continued to depreciate, reaching 27.25 pesos per dollar During this period, a sudden surge in oil prices left the Mexican government unable to implement economic recovery policies, forcing it to borrow extensively from abroad From 1982, global oil prices declined, reducing Mexico's external debt Faced with declining foreign exchange reserves and massive capital outflows, policymakers once again devalued the peso This time, the peso was devalued by 500% against the dollar, plunging the country into a devastating economic and financial crisis Inflation soared to over 60%, foreign exchange reserves dried up, and by August, Mexico temporarily suspended principal payments on its foreign debt In September, the banking system was nationalized, the exchange rate began to be adjusted, and by the end of the year, it had decreased to 160 pesos per dollar Under President Miguel de la Madrid (1982-88), Mexico adapted to a dual exchange rate policy One controlled rate for trade in goods and official debts, and one free-floating rate for other transactions The controlled rate depreciated daily under the scrutiny of the Mexican government Gradually, the controlled rate approached the free-floating rate By the end of 1986, these two rates were nearly equivalent, around 920 pesos per dollar During President de la Madrid's tenure, prioritizing payments on massive debts became a major focus Mexico became a net capital exporter The economy gradually lost its primary sources of financing, and economic development came to a halt under the burden of depreciating domestic currency, both internal and external debts, as well as inflationary pressures on the economy In mid-1987, Mexico faced another inflation crisis with sharply rising prices In November, Mexican banks stopped intervening in the foreign exchange market, and cash devalued significantly at 3000 pesos per dollar Once again, the stock market halted, and the inflation rate rose to 159% 1.1.3 Economic and financial reforms in Mexico since 1988 Since 1988, the Mexican government has embarked on comprehensive reform efforts to make the economy more open, efficient, and competitive The Mexican Pacto In the late 1980s, Mexico faced escalating inflation and the threat of hyperinflation due to unsuccessful policies implemented during the 1983-87 period to address a debt crisis Inflation was driven by credit expansion, fiscal deficits, and adjustments in official prices, exacerbating the economic challenges In response, authorities initiated a new stabilization strategy in November 1987, introducing a program called the “Pacto” in December 1987, which initially focused on freezing prices and wages, with wages serving as the nominal anchor and did not entail any exchange rate commitment However, from March to December 1988, the authorities explicitly adopted a fixed exchange rate (MXN/USD) This was modified in 1989 to a tablita-type policy to avoid a possible overvaluation of the currency as progress continued in bringing inflation under control This flexible system led to an annual depreciation of the peso by 16.7% in 1989, 11.4% in 1990, and 4.5% in 1991 Starting from November 1991, the peso/dollar exchange rate was allowed to fluctuate within a daily expanding limit The switch to the new regime was largely motivated by the occasional pressures for the currency to appreciate, induced by strong foreign capital inflows This limit permitted the depreciation rate of the peso against the dollar to range from 0.0002 to 3.05 pesos per dollar The depreciation rate for 1992 was 2.9% In October 1992, the upper limit of this rate was set at 0.0004 peso/dollar, resulting in a depreciation rate of 4.5% in 1993 Therefore, from late 1991 to August 1994, the exchange rate of the peso against the dollar depreciated within the range of 3.08 to 3.24 pesos per dollar reserves Except for Risks, The level of the State Bank of Mexico is not enough to stabilize the exchange rate 2.1 Weaknesses in the Mexican economy The process of reforming and opening up Mexico's economy has created a series of challenges for the Salinas government In particular, the increase in the trade balance deficit that became difficult should be more prominent than ever, accompanied by a reduction in the private sector's savings rate core Nationalization also left Mexico's banking system vulnerable and fragile, which limits the use of monetary policy to support pesos and to reduce the current account deficit 2.1.1 Prolonged trade deficit The Salinas government has moved to stimulate economic growth and increase competitiveness completely by encouraging international trade and investment To be more specific, the export of goods in Mexico has nearly doubled, from $31 million in 1986 to $61 million during the year 1994 Mexico has also attracted very important foreign investments According to the Central Bank of Mexico, the amount of foreign investment capital attracted is $102.8 million, of which $30.2 million is foreign direct investment This huge level of investment has created significant investment capital accumulation in the Mexican economy During this time, foreign currency reserves increased from $6.4 million to $24.5 million However, this reform also requires market opening to foreign products In 1990, the total value of Mexico's imports exceeded its exports From 1990 to 1994, Mexico's trade deficit increased from $1 million to $18.5 million It can be said, mainstream foreign investment has increased private consumption of imported goods As a result, Mexico's current account deficit increased from 1.4% of GDP during the year 1988 to 7.7% of GDP in 1994 2.1.2 Reduced savings in the private sector As economic reforms took hold in the early 1990s, Mexicans began shifting more of their income from savings to consumption According to data from the Central Bank of Mexico, the private sector savings rate in 1989 was approximately 16%, by 1992 it had decreased to less than 9% and by 1994 it had only increased to about 12% The explanation for this shift from saving to consuming is pent-up demand after years of hardship during most of the 1980s 17 and the appeal of cheaper foreign products appearing in Mexico when the country opens its market The decline in domestic savings is also reflected in the increased demand for imports This has put more pressure on the current account deficit Furthermore, imports are largely geared toward consumption rather than investment, making the current account deficit less sustainable because there is less money to invest for longer-term development 2.1.3 The Peso’s appreciation From 1988 to 1994, the Mexican government pegged the peso exchange rate to the US dollar This pegged exchange rate has contributed to stabilizing the economy, attracting foreign investment, and curbing inflation However, a long-term peg will lead to an appreciation of the peso, which will harm export activities and reduce the growth rate of the economy One of the reasons for the overvaluation of the peso is that the nominal depreciation allowed by the Mexican government during this period did not reach the level of the inflation differential broadcast between the US and Mexico Although Mexico's inflation rate decreased during these years, it was still higher than the US inflation rate As a result, the peso's exchange rate against the dollar has gradually increased in real terms even though the peso has nominally depreciated With the peso overvalued, Mexicans demand more imports than they can afford to pay Meanwhile, export growth is limited due to this high valuation Thus, the constant appreciation and overvaluation of the peso during this period led to the worsening of the current account deficit In mid-1994, two economists argued that Mexico needed to act to adjust its exchange rate to compensate for the overvaluation of the peso An amount of 20% exchange rate devaluation could reduce the current account deficit to a more manageable level However, according to finance ministry officials, this view is not supported by many private sector economists because they believe that only a small adjustment in the exchange rate is needed Mexican finance officials explained they were not convinced the peso was overvalued at the time They cite Mexico's strong exports and rising productivity as evidence So the Mexican government was not willing to consider calling for currency devaluation 18 2.1.4 Mexico's relatively young banking system Since the nationalization of a series of banks in 1982, the Mexican banking system has revealed many weaknesses The first thing to mention is that the nationalization of several banks has reduced competition in the banking and finance sector Furthermore, Mexican banks not yet have a system of criteria to evaluate customers' creditworthiness when providing loans Especially with the consumer credit boom since 1989, this credit rating problem has led to a pile-up of overdue consumer credit The overdue debt rate of banks continuously increased from December 1991 to March 1994 from 3.5% to 8.5% (IMF data) This increase in overdue debts has made the balance sheet situation of banks increasingly worse And a banking system that exhibits many such weaknesses is a factor that hinders the effective implementation of the Central Bank's monetary policy, aimed at reducing the trade deficit 2.2 Contradictions in Mexico's macroeconomic policies With the policies implemented following the assassination of presidential candidate Colosio, the Mexican government hardly realized that the fundamental weakness of the economy was the current account imbalance During the run-up to the presidential election in August, Mexican authorities increased pressure on the current account deficit in an attempt to sustain economic growth Furthermore, it is becoming increasingly clear that monetary, financial, and exchange rate policies are incompatible 2.2.1 Pegged exchange rate and the overvaluation of the currency Numerous observers claim that by adjusting the exchange rate in 1994, Mexican authorities were able to lower the country's current account deficit According to analysts, Mexico's overvaluation of its currency has caused the country to lose competitiveness even with its increasing manufacturing capacity Mexico's central bank intervened in the foreign exchange market to maintain a fixed exchange rate of the Mexican peso to the US dollar by issuing dollar-denominated public debt to buy pesos A stronger peso increases import demand in Mexico, leading to a trade deficit Speculators realized the peso was overvalued and capital began to flow out of Mexico to the United States, increasing bearish market pressure on the peso In response to election 19