Global Finance - Mexican Peso Crisis

Global Finance
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GLOBAL FINANCE
Introduction
Recently, Mexico has been experiencing depletion of foreign reserve holding, large-scale deficits, and devaluation of the currency in 1994 December. These events were contributed by a severe recession and high rates of unemployment in the region. However, after the devaluation, trade of balance has enriched. Although Mexico has experienced unceasing trade deficits, the currency of the country failed to depreciate because of political instability. Further, Mexico declined peso devaluation before presidential elections were conducted in 1994. The following essay will investigate the experiences of Mexico and write a detailed report on the following;
* Document the trend in Mexico’s key economic indicators, such as the balance of payments, the exchange rate, and foreign reserve holdings, during the period 1994.1 through 1995.12.;
The exports of Mexico = $60,619
Imports of Mexico= $79,335
Trade Balance = -2.95%
(b) Investigate the causes of Mexico's balance of payments difficulties before the peso devaluation;
From the report, it is evident there were certain difficulties in the balance of payment before peso devaluation. First, Peso had certain strengths that cause an increase in demand for exports and this resulted in huge trade deficits. Additionally, the initiation of monetary and fiscal policies in 1994 caused the failure of the balance of payments. Political instability was another cause. In January and February 1994, the capital inflows of Mexico were strong although political uncertainties were associated with the Chiapas Uprising (Griffith-Jones, 1998). Further, high-risk premiums placed in foreign investment and the central bank of Mexico contributed to difficulties in the balance of payments. Some of the changes made on the monetary policy of the United States coincided with unexpected political development in Mexico. These events reduced the attractiveness of Mexico for both domestic and foreign investments. The intervention of the Mexican central bank made things worse. This was because capital had started to flow out of the Mexican economic systems. Additionally, in 1994, Mexico took the step of purchasing Treasury securities so that they could maintain the money supply. This step increased the interest rates. These interest rates increased from 10 % to 17%.
(c) Discuss what policy actions might have prevented or mitigated the balance of payments problem and the subsequent collapse of the peso
To solve the problem of balance of payment, it was important for Mexico to come up with different policy actions. To reduce the balance of payment Mexico needed a deflationary policy. The deflationary policy would assist in reducing the level of aggregate demand and the demand for imports (Griffith-Jones, 1998). Deflating demand means reducing consumer spending in the economy. This can be done through the increment of direct taxes, reducing the availability of credit, or increasing interest rates. Mexico should have also imposed direct controls on imports. For example, they could have crafted barriers for importers and provided help to the exporters. Measures like the use of non-tariff barriers like quotas could have been used. Mexico should have also acquired a loan from the IMF. This is one of the best options for reducing the balance of payment deficit.
(d) Derive lessons from the Mexican experience that may be useful for other developing countries.
Several lessons can be derived from the Mexican experience. These ...