Mexico Peso Analysis

Case Study: Mexican Peso Crisis, 1994

From 1954 to 1976, Mexico had maintained a fixed exchange rate of Ps12.50/$. Even after the collapse of the Bretton Woods fixed exchange rate system in 1971/73, Mexico was able to hold this fixed rate.

Although the Mexican economy experienced rapid growth during most of the 1970s, it was progressively undermined by fiscal mismanagement in the form of large government borrowings (both home and abroad) which resulted in high rates of inflation and growing external indebtedness. As the international financial community’s concerns about Mexico grew, capital flight out of the country intensified.

In response to this international crisis, the Mexican government was forced to end its regime of fixed exchange rates. On August 31, 1976, Mexico announced that it was switching to a managed floating exchange rate regime and devalued the peso by 45%. However, under this new arrangement, the Mexican authorities were still committed to intervening when necessary to maintain orderly conditions within a preset trading band for their currency.

Difficulties continued for Mexico into the early 1980s. In the late 1970s, Mexico had borrowed billions of U.S. dollars at extremely high interest rates in anticipation of increased oil revenues. When the oil prices dropped sharply in the early 1980s, Mexico’s oil revenues, and U.S. dollar revenues, plummeted as well. In 1982, Mexico was forced to default on billions of dollars of loans to foreign banks, mostly in the United States.

The lack of confidence in the ability of the Mexican economy to rebound from this financial crisis led to high rates of inflation, a serious flight of capital out of the country, and a dramatic decline in the value of the peso. By 1983, the yearly inflation rate exceeded 110%. In the first six years of the 1980s, the value of the Mexican peso fell from around Ps50/$ to more than Ps1,100/$.

The Mexican economy improved in the late 1980s and early 1990s. A...