Foreign Policy Research Institute A Nation Must Think Before it Acts After Mexico: Emerging Markets, Emerging Crises?

After Mexico: Emerging Markets, Emerging Crises?

In December 1994, Mexico shocked world financial markets with a sharp devaluation of the peso. Huge outflows of capital from Mexico before and after the devaluation seriously depleted its international reserves and threatened default on the country’s foreign-held debt. Five years worth of carefully nurtured international confidence in Mexico’s political leadership and economic management was swept away. Moreover, the Mexican crisis aroused investor concern regarding other emerging markets, raising the specter of a spreading financial calamity.

The Mexican crisis was eventually quelled by a $47.8 billion rescue package provided by the United States, the International Monetary Fund (IMF), and a group of ten central banks working through the Bank for International Settlements (BIS). But the rescue package was arranged only with considerable difficulty, subjecting world financial markets to a six-week period of uncertainty. Mexico showed improvement in subsequent months as the peso stabilized, the inflation rate first rose then declined, and trade deficits were corrected. These positive effects were achieved, however, with an economic austerity program that plunged the country into a severe recession. Should the recession be prolonged, political and social pressures would mount and raise again the question of Mexico’s ability to meet its external debt service.

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