Mexican Peso Crisis: Restructuring and Forgiveness

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Introduction

By the middle of the 1990s, Mexico seemed to be a prime example of economic liberalization. The country managed to attract a significant inflow of foreign investments. However, the success was short-lived since the political instability led to a drastic deterioration of the investment climate. The situation worsened because Mexican banks debt to foreign creditors increased from $8 billion n 1991 to $16.5 billion in 1994 (Graf, 1999, as cited in León Hoyos, 2021, p. 478). As the fears of turmoil siphoned foreign capital from Mexico, the Mexican authorities faced a problem paying the countrys sovereign debt. Since the Mexican international reserves dwindled at an alarming rate, the government decided to devalue the peso, letting it float freely against the U.S. dollar. By January 1995, the national currency depreciated to almost 6 pesos per USD from approximately 3.5 pesos per USD in November 1994 (León Hoyos, 2021). However, the rapid devaluation was insufficient to avoid the impending threat of default on sovereign debt. As a result, the Mexican authorities implemented two emergency solutions in order to resolve the crisis  a bailout and a recapitalization of the national banking sector.

A Bailout

The emergency was too significant to be resolved with fiscal measures  the national economy needed an immediate rescue. In addition, the Mexican government strived to prevent further peso depreciation (Meza, 2019). As such, emitting extra currency to meet the obligations on sovereign debt was not feasible. Mexico engaged in negotiations with the United States and the International Monetary Fund (IMF) to acquire the necessary funds. The collective bailout of the struggling Mexican economy was arranged in February 1995. The experts estimated that Mexico would need at least $50 billion to prevent a total economic collapse (Schneider & Tobin, 2020). The IMF provided $17.8 billion, while the United States committed an additional $20 billion (McNamara et al., 2020). Additionally, the Bank for International Settlements (BIS) contributed $10 billion to the bailout program, while the rest came from multiple bilateral and multilateral agreements (León Hoyos, 2021). In this regard, one can see that the urgency and severity of the crisis forced the Mexican government to implement radical monetary measures.

Intended Impact

The Mexican authorities intended to achieve several vital goals via the bailout policy. Firstly, the government strived to increase economic stability and avoid default on sovereign debt. The second goal was to reverse the capital outflow that had a crippling effect on the national economy. Lastly, the increasing economic stability was intended to prevent the further weakening of the peso (McNamara et al., 2020). Overall, the loans from IMF, BIS, and the USA were supposed to reinforce the crumbling Mexican economy with much-needed foreign capital in a short time.

Actual Impact

In the end, the bailout plan worked reasonably well, as Mexico managed to prevent the default and stabilize the national currency. However, the initial impact was relatively weak, as the peso continued to depreciate, falling to a 7.5 peso per USD rate in March 1995 (McNamara et al., 2020). While the funds from the USA, IMF, and BIS saved the Mexican economy from an immediate collapse, the price of the rescue was quite high. In accordance with the bailout terms, Mexico had to implement strict monetary controls and fiscal policies, which led to a severe economic recession after the crisis (Sablik, 2017). Therefore, one can consider the bailout a successful yet painful crisis resolution policy.

Banking Sector Recapitalization

Once the bailout program was successfully arranged, the Mexican government launched an internal monetary intervention policy aimed at stabilizing the national banking system. The Bank of Mexico, the Ministry of Finance, the National Banking and Securities Commission (CNVB), and the Bank Fund for Savings Protection (FOBAPROA) were tasked to oversee the preservation of the banking sector. The FOBAPROA played a critical role in this effort, as it was responsible for deposit insurance and blanket guarantees of all unsubordinated liabilities of Mexican commercial banks (León Hoyos, 2021). Under the FOBAPROA guidance, the Temporary Recapitalization Program (PROCAPTE) was launched to temporarily recapitalize banks using the international loans distributed by the Bank of Mexico. By March 31, 1995, six banks, including Servin, Inverlat, and Bital, the third-, fourth-, and fifth-largest Mexican commercial banks, joined PROCAPTE and received $950 million for recapitalization purposes. The funding for PROCAPTE was obtained via a $3.25 billion loan from the Inter-American Development Bank and the World Bank (León Hoyos, 2021). Given these facts, one can see that the Mexican government prioritized saving the banking sector once the necessary international loans were secured.

Intended Impact

The PROCAPTE policy designed to support the Mexican banking sector pursued two primary goals. Firstly, the government strived to prevent the escalation of internal instability, which would have likely occurred if the Mexicans had lost their savings. Secondly, the Mexican authorities tried to show their strong commitment to supporting the banking system (León Hoyos, 2021). Without such a policy as PROCAPTE, the remaining foreign investors could withdraw their capital from the country, reducing the time left for anti-crisis measures. In this regard, PROCAPTE was supposed to play an instrumental role in reversing the negative trends in the Mexican economy. Overall, the policymakers intended to protect the Mexican governments credibility and improve the disposition of foreign investors and the Mexican nation.

Actual Impact

One can claim that PROCAPTE achieved its primary goal since several large Mexican banks were successfully recapitalized. According to Eduardo Fernandez, the former CNVB President, PROCAPTE bought precious time to attract new investments (León Hoyos, 2021). In addition, PROCAPTE succeeded at sending a clear message that the Mexican government would support commercial banks facing a lack of capital (Mackey, 1999, as cited in León Hoyos, 2021, p. 492). Therefore, one can argue that PROCAPTE was effective since it prevented potential panic among foreign investors and domestic depositors.

Conclusion

In summary, one can claim that the Mexican government predominantly deployed monetary policies to resolve the peso crisis. The severe capital loss forced Mexico to negotiate a bailout since the countrys reserves were insufficient to stop the further depreciation of the national currency. In the end, the bailout plan allowed Mexico to avoid a default on sovereign debt and stabilize the economy at the cost of severe recession and austerity policies. As such, the Mexican government had to implement unpopular measures in order to fix the consequences of overly-ambitious economic growth.

However, the bailout efforts aimed to provide funding for more targeted monetary interventions rather than serve as a standalone solution. In particular, the PROCAPTE policy used loans from international financial institutions to recapitalize the struggling Mexican commercial banks. As a result, the Mexican government managed to uphold its credibility by assuring the public that the Mexican banking sector would not collapse. In this regard, PROCAPTE can be considered an important monetary policy that succeeded in preventing panic among foreign investors and Mexican citizens.

References

Meza, F. (2018). The monetary and fiscal history of Mexico: 1960-2017. University of Chicago, Becker Friedman Institute for Economics, 2018(64), 1-40.

McNamara, C. M., Rhee, J., & Metrick, A. (2020). Restructuring and forgiveness in financial crises A: The Mexican peso crisis of 1994-95. The Journal of Financial Crises, 2(1), 82-95.

León Hoyos, M. (2021). Mexico peso crisis (19941995): PROCAPTE. The Journal of Financial Crises, 3(3), 474-497.

Sablik, T. (2017). The Feds tequila crisis. Federal Reserve Bank of Richmond. Web.

Schneider, C. J., & Tobin, J. L. (2020). The political economy of bilateral bailouts. International Organization, 74(1), 1-29. Web.

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