TEQUILA CRISIS

1994
ESTADOS UNIDOS MEXICANOS
Economic and Political
background before the Crisis
Unrecorded spending spree.
NAFTAs entry.
Declaration of Waar (Zapista Army of National
Liberation).
Maintained the pesos through an exchange rate
peg to the U.S dollar.
Mitigation of the peso depreciation.
Purchasing of imports.
Central Banks intervention to revalue Peso

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Origin of the crisis:
Mexico undertook large
scale reform and
deregulation of its
economy in the second
half of the 1980s.

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Economic Impact
The countrys GDP declined by 6.2% by the year
1995.
Hyperinflation and extreme poverty resulting in
unemployment and real wages plummeted.
Growing poverty more affected by urban areas than
rural.
Expatriates living abroad increased remittances to
Mexico.
Households lower demand for primary healthcare
led to 7% hike in mortality rates among infants and
children in 1996.

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Bailout
In January 1995, US president Bill Clinton
held a meeting to newly confirmed US
treasury secretary Robert Rubin, US
Federal Reserve Chairman Alan
Greenspan and then under secretary for
the Treasury Larry Summers to discuss an
American Response.
Clinton decided nevertheless to seek
congressional approval for a bailout and
began working with Summers to secure
commitment from congress
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 Clinton administrations
efforts to organize a
bailout for Mexico were
met difficulty.
Criticism from members
of the US congress as well
as scrutiny from the news
media.
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Trade Liberalization
Under the ISI the Mexican government instituted a
series of policies and regulation to protect domestic
industries from international competition.
The country had balance of payment crisis.
Had to devalue its currency in1954, 1976 and
1982.
Federal Reserve Board raise interest rates in the
U.S.
The interest rates increase perversely affected
Mexico and other developing companies.

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Liberalization of Capital
Flows
1989
Foreign Investment Act
1993
Portfolio inflows Increased
considerably

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The Mexican Peg
Policy served at least three purposes:
1. It provided foreign investors with assurance
that their investments would not lose value
under normal circumstances.
2. Fixed exchange rate allowed Mexican Firms
to borrow international markets to finance
expansion in preparation for the opening of
Free Trade with U.S in Jan. 1995.
3. Fixed exchange rate helped the Mexican
Authorities fight domestic inflation by
forcing monetary policy to fluctuate
according to balance of payments
consideration.

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The consequences of
Financial Liberalization
Privatizing and liberalizing the banking
sector led to a major lending boom.
Mexico deregulated finance and
facilitated the entry of foreign capital,
there was a major boom in the
countrys stock market and the large
increased in foreign direct investment
in the country.

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Mexicos Bank
Privatization
In 1982, Lopez Portfolio had just
nationalized most commercial banks.
In 1989, the government of Miguel De La
Madrid started a major privatization of
banking sector.
The administration of De La Madrid and
Salinas had privatized most commercial
banks as immediate boom in credit
followed.
Both the privatization and the boom
credit carried a series of problems.
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Investors Enthusiasm
Interest rate in the United
State fell during the
recession of the early
1990s and foreign
investors began to look for
high yield in other market.

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System under Stress in
1994
The year 1994 is
TURBULENT
YEAR for Mexico.

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Consequences of the
1994 Crisis

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Crisis and the US
Bailout
As the Mexican economy continued to
collapse, there was contagion to other
emerging markets.
The press started to refer to the
contagion of the Mexican crisis to other
emerging markets in 1995 as the tequila
effect.
Orchestrated a large scale standby loan
for Mexico
Mexican government used only
approximately $13 billion from the U.S
Treasury and repaid15the money rather
What did Mexico gain
the long term?
After the recession of 1995 and the
banking crisis of 1995- 1997, the country
ended up with a more stable economy.
Trade with the U.S and other countries
expanded rapidly.
By 2008 foreign banks controlled about
80% of assets of the commercial banking
system, including the largest Mexican
banks.

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Government Response
To support the currency.
To refer to the contagion of the
Mexican crisis.
Implementation de facto restrictive
monetary policy.
Negotiate support package with
international finance institution.
Public savings

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Financial Institution
Response
The government was mainly focused on
maximizing the sales price, with the
restriction that foreign banks could not
participate in the bidding process.
The bidders experience in the banking
sector was not taken into account.
The Mexican government delayed the
implementation of international
banking standards.

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Conclusion:
The Mexican Tequila Crisis was triggered
by a combination of poorly carried out
reforms, a currency peg, current account
deficits, policy rate hikes in the US and
social unrest, and finally led to both a
currency and banking crisis. A sovereign
crisis was just averted, due to financial
assistance of among others the US and the
IMF. The banking sector, which was already
in a bad shape, would have collapsed
without the help of the government.

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Lessons to learn:
This paper gives several important lessons from the Tequila
Crisis of 1994 and 1995 in Mexico. The overriding lesson is
that the dynamics of financial crises in emerging market
countries differ from those in industrialized countries
because institutional features of their debt markets differ.
Several policy lessons for emerging market countries also
emerge from the analysis. Pegged exchange-rate regimes
are extremely dangerous, strong prudential supervision of
the banking system is critical for prevention of financial
crises, financial liberalization must be managed extremely
carefully and different policies are needed to promote
recovery in emerging market countries than those that are
applicable to industrialized countries.

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THANK YOU!

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