The Mexican & Argentine Crisis
Embed Size (px)
Transcript of The Mexican & Argentine Crisis
Mexican & Argentine Crisis
The Mexican & Argentine Crisis
Submitted To Professor D.N.PandeyMSC IBM - FORE School Management
Smita Swarup Kapur
This report on the The Mexican and Argntine Crisis has been prepared with the support provided by Professor D.N. Pandey, International Financial Markets and Instruments. We are thankful to him for providing us his guidance without which this report would not have been possible.
2) Research Methodology
3) Mexican Crisis
Mexican Crisis and the International Monetary Fund
Current Scenario of the Mexican Economy
Argentina and International Fund
The main objectives of this project are as follows:-
1) To study the causes and effects of Mexican and Argentine currency crisis in detail.
2) To highlight the lessons that can be learnt by other developing nations from these crises.
3) To study the role of the International Monetary Fund in these crisis.
All the data gathered for the purpose of this project is secondary data.
The Secondary Data has been gathered from websites, books and magazines. The magazines used were The Economist, The Business Week.
No primary research has been done.
BACKGROUND OF THE MEXICAN CRISIS
Mexican crisis has been described as the first crisis of the 21st century, meaning the first major financial crisis to hit an emerging market economy in the new world of globalized financial markets. Mexico has witnessed two major currency crisis the first one in 1982 and the more recent one in 1994-95. A currency crisis essentially means that international investors "lose confidence" in the value of a currency. This loss of confidence causes them to refuse to lend more to the country. The reasons highlighting a currency crisis are difficult to pin point. But most of the countries that have faced a currency crisis till now have had pegged exchange rates to a foreign currency. The Mexican Crisis had such a large impact globally because it was a period of global recession and many other countries were running large debts and financially vulnerable. The Mexican experience weakened banks and investor confidence overall and decreased the amount of funds available to many middle-income countries who were at the time in desperate need of capital. The crisis highlighted the weaknesses of the international financial system.In 1976, massive reserves of oil were discovered and oil quickly became Mexicos top export. In 1979 and 1980, there was an oil hike and Mexico earned huge revenues. Now, the Mexicans assumed that the increase in oil prices were permanent and embarked on ambitious development projects. Government spending rose rapidly and this increased their fiscal deficit to 14.1% of GDP in 1981. There was an increase in aggregate demand due to the rapidly rising government spending, which in turn was fueled by rising oil exports, and this drove Mexican inflation up. Given the fixed nominal exchange rate, the Mexican real exchange rate appreciated, increasing the relative price of Mexican goods and services. The real price of the peso was about 15 percent higher in 1982 compared to 1980. The trade and current account deficits increased. The rise in the current account deficit resulted in need for borrowing from international capital market. The banks in Europe and US had funds mainly invested from Middle East countries and were willing to lend. Many of these banks viewed oil rich Mexico as a particularly good lending risk, and they believed that the high export revenues Mexico earned from oil assures their future repayment. Thus, the Mexican government and the state owned enterprises in Mexico had no trouble borrowing on international capital markets.
By mid-1981, oil prices were falling, reducing Mexican export revenues. For a while the Mexican government was able to continue financing its burgeoning current account deficit with increasingly short-term bank loans (full repayment in less than one year). But the dithering by Mexican policymakers and the continued need for borrowing began to concern developed country banks and other investors. The investors and banks were mainly concerned because if there is too much accumulation of foreign debt and Mexico is unable to repay, then the Mexican government would have to devalue its currency. In August of 1982, the Mexican government announced a 90-day suspension of payments of principle on its loans from foreign banks, as Mexicos Foreign Exchange reserves had begun to run out.
In quick succession governments in Brazil, Argentina, and several other countries announced they could not repay loans from U.S. and European banks. Developed country governments, like the U.S., feared that some of the debtor countries would default on the debts they owed the banks, which could have made several large U.S. and European banks insolvent and endangered the world financial system. To avert disaster and help the debtor countries, the developed country governments, the commercial banks, and the international lending agencies (principally the IMF and the World Bank) put together packages of relief. These packages included debt rescheduling (delaying principle repayments) and new lending. In return, the debtor countries like Mexico had to revamp their economic policies to reduce their government and current account deficits. These usually involved some combination of higher taxes, lower government spending, tight monetary policy, and devaluation of the domestic currency.
Mexico, like other debtor countries experienced six years of slow growth, low employment and occasional bursts of high inflation because it had to pursue policies and reforms as recommended by international creditors, as it needed Foreign exchange reserves.
In late 1987, after inflation had again accelerated, the Mexican government and formal representatives of labor, agricultural producers, and the business sector agreed to cooperate to reduce inflation and stabilize the economy. The government fixed the exchange value of peso in terms of dollars so that it would be forced to pursue a tight monetary policy to bring inflation down. They also were privatizing many government-owned enterprises, lifting the restrictions on businesses, moving toward free international trade, and allowing more foreign direct investment. Three months after nationalization of banks, people had become upset, jobs were disappearing, shops were closing, people were restive. The next years were very difficult indeed for ordinary people in Mexico, as indexed by the fact that their wages were reduced by an average 50 percent in six years, according to the report of the President. In 1988,economist reported that Mexico's financial deficit had reached 18.5 percent of GDP, surpassing 1982's record 17.2 percent, inflation had reached 150 percent and GNP growth had only managed 1 percent , even though Mexican labor had suffered a pay cut in five years of the last six.
In a climate of uncertainty, potential new lenders were reluctant to provide new financing for fear that it would end up in old creditors pockets. Mexico, along with other Latin American countries lost access to international capital markets. In 1988, Nicholas Brady, former secretary of the U.S., brought together the main creditors, governments of the countries of the major banks involved, and debtors. After negotiations, it was agreed that the old debt would be exchanged for new long-term debt with lower nominal value. Multilateral Institutions and industrial countries guaranteed the new bonds with $30bn. The main points of the Brady Plan were the following: -
Partial write off and recognition. Creditors agreed to write-off a percentage of the nominal value of the loans according to the value of the outstanding debt in the secondary market.
Commitment by debtor countries to improve macroeconomic policies and engage in serious reform policies. The main purpose was to permit countries engaged in macroeconomic reforms to achieve long term economic growth and also to allow them to borrow again in the international capital markets and relieve them from the extremely high interest payments. At the same time, special prov)sions were included in the debt reduction packages to allow these countries to borrow in the transition period while the stabilization efforts took place.
Securitization of existing debt the outstanding debt was already trading in informal secondary markets but they were illiquid.
In 1989, the new reform program was pushed by president Salinas and had four basic components:
1. Opening up of the economy
3. Stabilization program centered on a predetermined nominal exchange rate and supported by restrictive fiscal and monetary policies
4. A broad social and economic agreement between private and government sector and labour unions called Pacto.
In 1989, the exchange rate system changed to a system based on a preannounced rate of devaluation- where the rate of devaluation was set below the (actual and expected) rate of inflation, but later in 1991 it further changed to a (narrow) exchange rate band with a sliding ceiling. The rate of inflation fell drastically in the first eighteen months of the program, but from then, the pace of disinflation became slow. At this point