Sofia Condés
Title: A comparison of the Mexican (1994) and
Argentinian (2001) crises: similarities, differences and
policy lessons.
Relevance of these crises
The Mexican and Argentinian crises shocked the international community. In both
cases they represented an end to high expectations on Latin American economies
after structural reforms. In both cases shortly before the crisis the countries were
cited as examples of successful development models. One of the recurrent
arguments was that these crises showed 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. For these reasons we can argue that these
crises present good examples of “21st century economic crisis” and therefore have
several policies to be learnt for they represent examples of crisis in the context of
globalization and more precisely 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 Pre-Crisis context of the Mexican economy has to be understood as one of the
most intensive cases of structural reforms mainly focused on fiscal consolidation,
deregulation and privatization. The reforms started in the 1980’s and put an end to
years of an import-substitution strategy. These policies led to a dramatic increase in
foreign investment attracted by the decrease in restrictions to capital inflows and by
comparatively low interest rates in the U.S. The reforms included a substantial
liberalization of the financial sector, which encouraged an important increase in the
supply of credit. So internally and externally the expectations on the Mexican
economy were very high, not only was the economy booming, credit was abundant,
and foreigners were loving investing in it. During the period 1988-1994 GDP and
private consumption rose by about 30%, while investment grew more than 70%.
In 1987, as part of the macroeconomic reforms the government decided to adopt an
exchange-rate stabilization plan. The plan introduced a currency that was semipegged since it was fixed to an adjustable narrow band. During the booming first
years of the 1990’s the real exchange appreciated and the external balances
widened. Mexico was booming but was running deficits due to an overvalued
currency. It was becoming cheaper for Mexicans to buy American goods rather than
buying national ones and exports were falling. Many authors agree that the peso
was overvalued by at least 20% and that a once and for all devaluation before things
got slippery would have prevented the worse to come.
By 1994 the trade balance showed record deficits of 1.5 billion a month. However
the possibility of devaluating the exchange rate was not really an option for the
government considering the amount of short-term dollar denominated debt it had
emitted, the so-called Tesobonos.
Many causes have been mentioned as being fundamental for the crisis to take place
and we could probably say it was mostly a combination of all of them. Those most
significant according to scholars are the combination of the exchange rate regime
with a rapid expansion of poor quality credit and the important amount of shortterm debt held by foreigners.
As for the immediate causes we can mention a series of unfortunate events that
acted as a trigger for the accumulated fragilities. In the beginning of 1994 Mexico
received several political shocks that scared away investors and caused a run on the
Tesobonos. The shocks included an armed uprising in the southern part of the
country and several political assassinations. These events heightened fears of
political instability and set off financial panic. For these reasons the government had
to intervene heavily to maintain the value of the peso which was already at the top
of its target band. To do so the central bank lost many reserves. The substantial
amount of foreign purchase of short-term Mexican bonds posed the greatest danger
to the exchange rate peg. Foreign investors could take their money out of the
country very easily in a very short time (most of the bonds matured in 3 months). As
political and financial instability increased and the U.S interest rates became more
attractive this is exactly what happened. Moreover, it was not only foreigners
pulling their money out of Mexico but locals as well. Mexicans where also holding
important amounts that could be changed to dollars in a matter of weeks. The
pressure on the government’s reserves increased sharply during December 1994
putting the government in a no option zone. By December 22 the reserves reached
an all time low of 6 billion and the government was forced to abandon the exchange
rate target band and to let the peso float. What followed was very negative. The peso
plunged, interest rates soared and Mexican and foreign investors pulled funds out of
Mexico.
Although the currency had depreciated more than 30% in a matter of days there
was still the issue of the Tesobonos that were worth over 10 billion while Mexican
reserves were less than 6 billion .It became clear that without help Mexico was
going to default in its dollar denominated-debt. As the crisis deepened Mexico had
to arrange a 40 billion package of aid with the help of the United States and the IMF.
Still so, the currency ended up loosing most of its value, some commercial banks
collapsed and many people lost their assets. Most of all Mexico lost its good
reputation and had to engage in major restorations to bring back some although
never the same investor confidence.
The Argentine Crisis of 2001
To understand the Argentine crisis one has to go back to events that took place in
the late 80’s, early 1990’s. During the 1980’s Argentina was collapsed by chronic
hyperinflation. In order to solve the problem of inflation the government adopted a
currency board. A currency board is defined as a monetary arrangement where “a
country keeps its own currency but the central bank cedes all of its power to alter
interest rates, and monetary policy is tied to the policy of a foreign country.” In the
case of Argentina, for every peso of currency in circulation the Argentine currency
board held one dollar-denominated asset, and was forbidden from buying and
selling domestic assets. This type of monetary agreement is considered a “hard-peg”.
Apart from the fixed currency to control inflation the government adopted a series
of radical market-oriented reforms. The reforms led to a period (throughout the
beginning of the 1990’s) of low inflation and strong growth. The reforms also
attracted an increase in foreign investment; the sun was shining on Argentina.
In 1995 the Mexican crisis had an impact in all foreign investments on Latin America
(known as the tequila effect). Financial flows from abroad decreased but the
economy was able to avoid the collapse of Mexico and weather the storm mainly by
rebounding with growth through exports. Moreover, the Argentinians learned from
the Mexican experience and lengthened the maturity of public debt and upgraded
banking regulation.
However several other external shocks came up too close and too soon after.
Authors mention the Asian crisis of 1997, the Russian crisis in 1998 and mostly the
Brazilian devaluation of January 1999. After these experiences the investor’s
interest in emerging economies had definitely collapsed. Output and investment
declined and export volumes stagnated. However other countries such as Brazil,
Chile and Mexico were able to overcome this decline in investments by continuing
exporting. Argentina on the other hand was loosing competitiveness due to its fixed
exchange. The exchange rate had moved negatively for Argentina because the dollar
was strengthening and the Brazilian real (competitor of Argentina in the meat and
commodity market) had weakened. As a last external blow the world entered into
recession in 2001 (after the internet bubble) creating increased turmoil in financial
markets.
It ‘s important to add a key factor to the story, which is the increasing of the
country’s public debt throughout the 1990’s. Scholars debate on the causes of the
high debt and signal corruption and inefficient fiscal policies. This results in
Argentina depending on borrowed money, not recovering enough taxes and using
the money ineffectively. When exports where booming fears there were no fears on
payment of the debt but as soon as the problems started in 1999 the huge amount of
debt accumulated was becoming a major issue. The IMF had been lending huge
amounts of money to the country as long as it complied with its reforms.
Unsustainable debt dynamics were left unattained for too long and exploded right at
the worst moment. “Argentina became caught in a vicious cycle of weak activity,
overvaluation and mounting debt” (Krueger, p.8).
As it is now known a hard peg is difficult to defend infinitely and most scholars
argue that Argentina should have left the peg at the latest in 1997 when it was
experiencing the “boom years” and even then to do so would have required
significant structural reforms and institution building. Other scholars mentioned
that the best option would have been to leave the peg as soon as the monetary
strategy had been established. In any case it was never a good idea to maintain it as
long as Argentina did and after 1997 a successful change of the exchange rate
regime was resulting highly improbable.
By late 1999 Argentina had a debt of 50% of its GDP and no means to pay it.
Surprisingly the IMF still accepted to negotiate a 40 billion lending package with the
government as long as it made drastic fiscal reforms and spending cuts. Although
the loans were passed and reforms put into place they were unable to have
immediate effects. The political and economic situation was deteriorating sharply
throughout the year 2000 and 2001. The lowest point arrived at the end of 2001
when the IMF denied releasing a portion of the loan. With the combination of events
social unrest increased and scared investors rushed into banks to take out their
deposits. What followed in the last months of 2001 and the first months of 2002 was
a pure 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.
Commonalities
-Both countries had experienced substantial reforms of their economies, had
engaged in global financial integration, attracted important amounts of foreign
investment and had experienced a boom before the problems arises.
-Both countries had seen a credit expansion. In the case of Mexico it accumulated
high levels of public and private debt. In the case of Argentina it had borrowed
mainly from abroad.
-Both balance of payments crisis involving the devaluation of their currency caused
by balance-of-payments deficits.
-In both cases the countries were running deficits that were influences by an overappreciation of the real exchange rate and therefore loss of competitiveness. This is
a direct cause of the fixed exchange rate regime. Both countries were unable to leave
the peg on time.
-The severity of both crises was unprecedented as were their social costs.
Differences
-The biggest problem in Mexico was the short-term dollar denominated debt. In this
issue Argentina learned the lesson and prolonged it’s 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 was able to maintain relative political
stability while Argentina was forced to change of president. Also Mexico was able to
manage to avoid major scale bank runs while Argentina wasn’t.
-Mexico depleted its reserves while Argentina’s reserves remained stable (thanks to
the currency board).
Lessons
-The financial community learned that even if a country is supposedly doing
“everything right” in surface the closer picture might show that its economic
fundamentals are still not stable. The path to financial integration takes time to
consolidate and in periods of adjustment emerging economies are very fragile. (Also
proven on the Asian crisis of 1997). So they are good examples of how financial
liberalization can go astray despite important economic achievements.
-As in most crises these examples show that the root causes of crises are planted in
the “good times” mainly by lack of prevention and imprudent behavior. The
consequences of the irresponsibility of “the good times” only show when pressures
arrive. (Applicable also to subprime crisis). In the case of Mexico the irresponsibility
was visible in the unregulated credit boom, overdependence on foreign investors
and the sustained emission of dollar denominated debt. In the case of Argentina, we
can mention the irresponsibility of borrowing large amounts while having a weak
fiscal system and dependence on exports.
-With globalization what happens in other countries will affect your country. Mexico
and Argentina learned this and recently other economic crises are confirming it.
Countries are subject to both internal and external shocks. Emerging countries are
vulnerable to major capital inflows but also to major capital outflows.
-The need to follow the behavior of credit aggregates became evident.
Several lessons concerning a fixed exchange regime:
-The tension between the convenience of adopting a fixed exchange rate regime and
the option of having a floating exchange with the challenges it implies in a world
economy characterized by highly volatile currencies.
-Yes pegging the exchange rate holds down the domestic rate of inflation but this
might cause the economy to run continuous current account deficits that deplete
foreign exchange reserves.
-Another lesson: 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. In times of recent integration to financial markets, especially in the
cases of developing countries governments should assure their competitiveness.
-A currency board helps constrain the monetary authority but doesn’t guarantee
that other entities such as private banks and the government will not get into
illiquid positions.
-No you can’t have it all, either you have control over your exchange rate or you
have control over your monetary policy. Both cases highlight the severe constraints
that can arise in terms of monetary policy.
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