Mini Case International Financial Management Fifth Edition Mexicos Balance of Payments Problem Mexico experienced larger scale

trade deficits, depletion of foreign reserve holdings, and a major currency devaluation in December 1994, followed by the decision to freely float the peso. These events also brought about a severe recession and higher unemployment in Mexico. Since the devaluation, however, the trade balance has improved. Investigate the Mexican experiences in detail and write a report on the subject. Mexicos key economic indicators; BOP, the exchange rate, and foreign reserve holdings, during the period 1994-1995 Causes of Mexicos balance of payments difficulties prior to the peso devaluation Policy actions for prevent and mitigate the balance of payment problem and the subsequent collapse of the peso Lesson from the Mexican experience that may be useful for other developing countries

Key economic indicators document:

Cause of Mexicos balance of payments difficulties prior to the peso devaluation.

Floating of the peso according to the peso fell against USD as much as 40%. The decision was made by Mexican government to devalue the peso against dollar to 14% that touched off a stampede to sell pesos as well as Mexican stocks and bonds.

Decline in investor confidence is the one of Mexico BOP problem, decline in investor caused by the deficit of current account and the overvalued money. This condition getting worst with the political condition in that country, beginning with the Chiapas uprising at the beginning of the year and culminating with the assassination of the PRIs presidential candidate in March, its make breakdown trust by investor.

Policy action might have prevented the balance of payments problem and the subsequent collapse of the peso: Limiting High and Low Frequency Fluctuations in the Nominal Exchange Rate After the 1994-1995 crisis Mexico opted for floating its exchange rate. While the experience has been largely successful, when combined with its fiscal fragility, it has left Mexico with volatile interest rates, inflation, and nominal exchange rates. Partly as a result of the latter, Mexico has had to develop future markets for its exchange, which have brought additional volatility problems. In order to deal with these issues Improving Links with International Financial Markets By now, there is widespread consensus on a series of general recommendations to improve these links, which can be found in most international financial architecture pamphlets. These include norms of transparency and accountability, banks sound practices for supervision, settlement, accounting and disclosure, aggregate risk management, and a series of related measures and practices aimed at improving the countrys contractual environment and corporate governance. Taking Stock and Policy Recommendations The diagnostic contains four basic elements: (i) limited and fragile links with international financial markets, coupled with strong dependence on external conditions; (ii) domestic financial underdevelopment and chronic credit crunches; (iii) a weak fiscal

situation due to vulnerability to external and internal factors (primarily bailouts); and (iv) lack of credibility in monetary policy aspects. Reflecting these elements, the general policy recommendations highlighted in the introduction were grouped into four categories as well: (i) improve external financial links and their use during crises and reduce direct exposure to external shocks; (ii) accelerate the development of domestic financial markets and intermediation; (iii) reduce public accounts exposure to internal and external shocks; and (iv) stabilize very high and low frequency movements in nominal exchange rates. While at a general level the connection between recommendations and diagnostic is apparent, there are specific aspects that are worth developing further.

There are several reasons that can be derived from peso crisis, are: First, it is punctual to have a multinational safety net in place to safeguard the world financial system from the peso-type crisis. No single country or institution can handle potentially global crisis alone. In addition, in the face of rapidly changing market conditions, usually slow and parochial political processes cannot cope with rapidly changing market conditions. Second, Mexico excessively depends on foreign portfolio capital to finance its economic development. In hindsight, the country should have saved more domestically and depended more on long-term rather than short-term foreign capital investments. Third, the lack of reliable economic information was another contributing factor to the peso crisis. The Salinas administration was reluctant to fully disclose the true state of the Mexican economy. If investors had known that Mexico was experiencing serious trade deficits and rapid depletion of foreign exchange reserves, the peso might have been gradually depreciating, rather than suddenly collapsed as it did. The transparent disclosure of economic data can help prevent the peso-type crisis. Fourth, Mexico depended too much on short-term foreign portfolio capital (which is easily reversible) for its economic growth. The country perhaps should have saved more domestically

and depended more on long-term foreign capital. This can be a valuable lesson for many developing countries.