Financial Crisis in Latin America & Mexico

1. Financial Crisis in Latin America & Mexico Jessica Hofer Megan Garcia

2. Start of Financial Crisis • In 1979, the US Federal Reserve adopted a tough anti-inflation policy which raised dollar interest rates and helped push the world economy into recession by 1981. • This had a direct negative impact on the developing countries

3. Other Important Factors • Immediate rise in the interest burden that debtor countries had to pay • Substantial rise in the real value of dollar debt burden • Primary commodity prices collapsed, depressing terms of trade of many poor countries

4. What happened next? • Mexico announced in 1982 that its central bank had run out of foreign reserves and could no longer meet payments on foreign debt • Large private lenders cut off new credits and demanded repayment on earlier loans from other Latin American countries • Widespread inability of developing nations to meet prior debt obligations • Sometimes referred to as the “lost decade” of Latin American growth

5. Mexico • Introduces a broad stabilization and reform program in 1987 • Reduction in public-sector deficits and debts • Using exchange rate targeting and wage-price guidelines • Committed to free trade by joining various organizations (GATT, OECD, NAFTA)

6. Mexico’s Exchange Rate • Fixed peso’s exchange rate to the US dollar in 1987 • Moved to a crawling peg in early 1989 and then later to a crawling band in 1991 • Government annually announced a rising limit on the currency’s allowable extent of depreciation, permitting a range of fluctuation • Peso appreciated sharply in real terms and created a large CA deficit • Over 1994, foreign exchange reserves fell to very low levels

7. Cont’d • Government continued to extend credit to banks experiencing loan losses • Mexico rapidly privatized banking without regulatory safeguards • Banks had free access to foreign funds • Banks were confident they would be bailed out if they met trouble

8. New Government in Mexico • In 1994 a new government took over and devalued the peso 15% beyond the limit promised previously • This was attacked by spectators and the government switched to a floating exchange rate • Foreign investors panicked; Mexico was unable to borrow except at penalty interest rates • Experienced similar financial crisis as in 1982, only to be bailed out by a $50 billion emergency loan from the US Treasury and IMF

9. Mexico’s Inflation