mexico’s financial crisis

29
Mexico’s Financial Crisis of 1994-1995

Upload: boicha

Post on 16-Apr-2017

446 views

Category:

Economy & Finance


1 download

TRANSCRIPT

Page 1: Mexico’s financial crisis

Mexico’s Financial Crisisof

1994-1995

Page 2: Mexico’s financial crisis

Presented by:OKomal RanaOLaishram Boicha

SinghOSanchi AgarwalOSimran AgarwalONikita SharmaOArbind KumarOAashish Tiwari

Page 3: Mexico’s financial crisis

Originsof

the crisis

Page 4: Mexico’s financial 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

Page 5: Mexico’s financial crisis

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

Page 6: Mexico’s financial crisis
Page 7: Mexico’s financial crisis

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.

Page 8: Mexico’s financial crisis

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

Page 9: Mexico’s financial crisis

Mexico’s bank privatizationOLargest private banks

privatized in stages, by 1992, most commercial banks privatized

O Immediate boom in credit

Page 10: Mexico’s financial crisis

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

Page 11: Mexico’s financial crisis

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.

Page 12: Mexico’s financial crisis

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.

Page 13: Mexico’s financial crisis

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.

Page 14: Mexico’s financial crisis

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.

Page 15: Mexico’s financial crisis
Page 16: Mexico’s financial crisis

The system under stress in 1994

Page 17: Mexico’s financial crisis

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.

Page 18: Mexico’s financial crisis

Mexico’s macroeconomic indicators

Page 19: Mexico’s financial crisis

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.

Page 20: Mexico’s financial crisis

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.

Page 21: Mexico’s financial crisis

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.

Page 22: Mexico’s financial crisis

Total non-performing loans as a percentage of total loans in the Mexican Banking System, 1991-2003

Page 23: Mexico’s financial crisis

Crisisand

The US Bailout

Page 24: Mexico’s financial crisis

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.

Page 25: Mexico’s financial crisis

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.

Page 26: Mexico’s financial crisis

What did Mexico gain in the long term ?

Page 27: Mexico’s financial crisis

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.

Page 28: Mexico’s financial crisis

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.

Page 29: Mexico’s financial crisis