A comparison of the Mexican (1994) and Argentinian (2001) crises: similarities, differences and policy lessons. 

Presented by Sofia Condés

Relevance of these crises:

• The crises shocked the international community.

• They represented an end to high expectations on Latin American economies after structural reforms.

• The countries were cited as examples of successful development models.

• Show the fragility that can be experienced when developing countries decide engage in the globalized trade model and to participate in global financial integration.

• The patterns of rapid opening, expansion and crash have been repeated in other countries.

• These crises present good examples of “21st century economic crisis”

• have several policies to be learnt for they are examples of crisis in the context of increasing financial integration.

• Throughout the past decade the causes and explanations of these crises have been one of the most debated topics by economic scholars

The Mexican Crisis of 1994: the context 1.

• Intensive structural reforms: fiscal consolidation, deregulation, trade and privatization.

• Increase in foreign investment attracted by comparatively low interest rates in the U.S.

• Liberalization of the financial sector so important increase in the supply of credit.

• So internally and externally the expectations on the Mexican economy were very high,

• Rising GDP and private consumption

The context 2.• Semi-pegged currency.• During the booming first years of the 1990’s the

real exchange appreciated • The external balances widened. • Mexico was booming but was running deficits

due to an overvalued currency. • Exports were falling. • The peso was overvalued by at least 20% • Possibility of not really an option due to the the

so-called Tesobonos

Fundamental causes

• The combination of the exchange rate regime with a rapid expansion of poor quality credit.

• An overvalued peso• Impossibility to leave the peg.• Low interest rates in the US that later

increased.• The important amount of short-term debt

denominated in dollars

The immediate causesA series of unfortunate events that acted as a trigger for the accumulated fragilities: Several political shocks that scared away

investors and caused a run on the Tesobonos. Shocks include an armed uprising in the

southern part of the country and several political assassinations.

U.S interest rates became more attractive

The crisis 1.• Fears of political instability and set off

financial panic. • Government had to intervene heavily to

maintain the value of the peso , loosing reserves.

• Foreigners AND locals pulling their money out of Mexico

• Reserves reached an all time low of 6 billion.• Government was forced to abandon the

exchange rate target band and to let the peso float.

dec jan febmarc

hap

ril may junejuly

augu

st

septem

ber

october

november

december

0

5

10

15

20

25

30

35

Reserves 1994-1995

Billions of dollars

Source: International Monetary Fund (IMF), International Financial Statistics .

The Crisis 2.• What followed was very negative. • The peso plunged, interest rates soared and

Mexican and foreign investors pulled funds out of Mexico.

• Currency depreciated more than 30% in a matter of days

• But still… the problem of Tesobonos. 10 billion worth to pay and only 6 million in reserves.

• Cry for help• Lost reputation

The Argentine Crisis Context

• During the 1980’s Argentina was collapsed by chronic hyperinflation.

• Adopted a currency board . • For every peso of currency in circulation the

Argentine currency board held one dollar-denominated asset.

• Radical market-oriented reforms. • Results: low inflation, strong growth and an

increase in foreign investment.• Mexican crisis had an impact but Argentina was

able to overcome it.

Development • Several external shocks came up too close and

too soon after the Mexican crisis.• The Asian crisis of 1997, the Russian crisis in

1998 and mostly the Brazilian devaluation of January 1999.

• Investor’s interest in emerging economies had definitely collapsed

• Output and investment declined and export volumes stagnated. .

• But.. Other countries survived!

Development 2. • Dollar appreciated and real depreciated. • Key factor: over the past decade Argentina had

accumulated huge a debt. • It wasn’t relevant when exports where high but

now it was becoming very problematic. • Argentina became caught in a vicious cycle of

weak activity, overvaluation and mounting debt .

• And the IMF was still lending!• Plus a hard peg it was unable to leave. After

1997 a successful change of the exchange rate regime was resulting highly improbable.

The Crisis • By late 1999 Argentina had a debt of 50% of

its GDP and no means to pay it. • Still…the IMF still accepted to negotiate a 40

billion lending package.• The political and economic situation was

deteriorating sharply throughout the year 2000 and 2001

• Combination of events and social unrest increased causing scared investors to rush into banks to take out their deposits.

The meltdown• fiscal and financial crisis,• default on foreign and domestic debt,• collapse of the exchange rate system,• collapse of domestic banks • and downfall of a president. • PLUS: the most feared evil for Argentinians :

skyrocketing inflation!

Exchange rate/inflation

Source: Charles Wyplosz website

Commonalities:

• Both countries had experienced substantial reforms, engaged in global financial integration, attracted important amounts of foreign investment and had experienced a boom before the problems.

• Both countries had seen a credit expansion. • Both balance of payments crisis involving the

devaluation of their currency caused by balance-of-payments deficits.

• Deficits that were influences by an over-appreciation of the real exchange rate

Differences

• The biggest problem in Mexico was the short-term dollar denominated debt. Argentina had learned the lesson and prolonged its debt. However it still had unsustainable debt dynamics.

• Mexico had relied irresponsibly on foreign investment while Argentina had relied irresponsibly on foreign loans.

• The development of the crises differ • Mexico depleted its reserves while Argentina’s

reserves remained stable • Hyperinflation in Argentina not in México

Lessons

• Even if it seems like a country is doing everything right.. It could be they’re not!

• Path to financial integration takes time to consolidate.

• As in most crises these examples show that the root causes of crises are planted in the “good times”

Lessons 2. • With globalization what happens in other

countries will affect your country (ie: interest rate of the U.S)

• Need to follow the behavior of credit aggregates

• Shifts in foreign capital flows may produce large imbalances between stocks of financial assets and foreign reserves (lesson learned Mexico 2008).

Lessons regarding a fixed-exchange rate:

• Yes pegging the exchange rate holds down the domestic rate of inflation but it’s not a miracle solution or an everlasting one.

• Once a peg is installed it is difficult to find the way to leave it at the right time without creating major damage.

• Fixed exchange rates may bring stability in some areas but decrease competitiveness.

• A currency board helps constrain the monetary authority but doesn’t guarantee that other entities will become illiquid .

• No you can’t have it all