At the end of 1994 Mexico was hit by one of the worst economic crisis in its history, which is called "The Peso crisis" or "Tequila Crisis" and is considered one of the first ones that had global effects. After only three weeks in charge, the newly elected President Ernesto Zedillo Ponce de León was forced to lift the upper band of the exchange rate by 15%, devaluating de facto the Mexican currency. In fact, the Central Bank of Mexico had insufficient international reserves to keep the fixed exchange rate with the US dollar. This triggered panic among Mexicans, who started buying dollars because they were fearing that further and more serious devaluations would occur. This contributed to exacerbate the situation even more.
The crisis was very harsh, but thanks to a US$50b rescue package from USA, the IMF, the Bank for International Settlements and private commercial banks, Mexico was able to roll over its short term dollar denominated debt and did not default on its short term securities. As it results from the following data, Mexico managed to recover very quickly: * The GDP decreased by 5.8% in 1995, but in 1996 and in 1997 it grew by 5.9% and 7.0% respectively * Household final consumption expenditure contracted by 11.5% in 1995, but in 1997 it went back again to 1994 level * Foreign direct investments decreased by 13% in 1995 and by 4% in 1996, but they grew by 40% in 1997 to a level 16% higher than in 1994 * Unemployment rate grew by almost 3 percentage points, but in 1997 it was lower than in 1994 * Inflation rate skyrocketed to 35% from 7% and, in this case, it took seven years to have a pre-crisis level, achieved in 2001 with a 6.4% rate * Interest rate grew to 59.4% in 1995 from 19.3% in 1994. In 1997 the situation stabilized again with an interest rate of 22.1% * The official exchange rate (Peso per US$) almost doubled to 6.4 from 3.4 because the government decided to move from a fixed exchange rate to a floating exchange rate. From this year onward, the exchange rate increased constantly and in the last five years it had an average of 12.9
Economists have identified many different causes of the crisis, but the following ones are those which there is a strong consensus on: 1. Peso overvaluation
In the years previous the crisis, the government maintained the peso within a band against the US dollar with the main objective to bring down the double-digit inflation to a single-digit one. This policy was achieving its goal, but, due to the substantial difference in inflation rates between Mexico and USA, the peso was appreciating in real terms. In the period 1988-1994 the peso was overvalued by 38%. This can be well explained by using the exchange rate equation R= P/(P*E), where "R" is the real exchange rate, "P" is the domestic price level (Mexico in this case), "P*" is the foreign price level (USA in this case) and "E" is the nominal market exchange rate. Since the government kept a fixed exchange rate and the inflation in Mexico was much higher than in USA, the real exchange rate, as a consequence, was growing. The Mexican crawling peg exchange rate system forced the government to intervene heavily when the country was hit by two severe political shocks (discussed afterward) during the first months of 1994. In fact, from February 1994 to April 1994, the international reserves declined by almost US$15b, which represented almost half of the total reserves. After these two political unrest periods, the government had to face two speculative attacks in June and December, which obliged the Central Bank to sell other US$10b of its international reserves. In one year, the international reserves declined by 80%. 2. Current Account Deficit
The constant overvaluation of the peso had as consequence a growing current account deficit, which started in 1988 (-1.4% of GDP) and reached its peak in 1994 (-7.7% of GDP). At that time, this huge current account deficit was not seen as an issue by the government because it was almost entirely caused by an excess of private investments over private savings, while the government spending was recording surpluses. This excess of private investments was considered a positive effect of the improved macroeconomic situation and contributed to foster the euphoria throughout the country. In fact, before the crisis, the country had started opening its economy through the privatization of government-owned enterprises, the deregulation of industries, the reduction of restrictions on foreign investments in many sectors and the lessening of trade barriers. Concerning this last point, at the beginning of 1994, Mexico culminated its new golden era through the signing of the NAFTA together with USA and Canada. Nevertheless, more than the huge amount of the deficit, the composition of it had a great impact on the crisis. In fact, the largest part of the capital inflows did not finance long term investments, such as factories or equipments, but went into short term financial investments, such as equity and government bonds (as shown in the graph below), which are easier and quicker to divest. Most of government bonds were Cetes, short-term, peso denominated securities, similar to US Treasury bills, that were sold on a regular basis. These bonds had a much higher (ten percentage points) return than US Treasury bills. Their level of attractiveness for foreign investors was obviously very high and, therefore, directly proportional to their level of speculation. In December 1993, almost 75% of foreign holdings of Mexican government securities took this form. Moreover, as described above, the exchange rate went under pressure as a consequence of two political unrest periods. For this reason, the government decided to issue a different type of short-term securities, the Tesobonos, which were dollar denominated to guarantee against the peso depreciation. These new securities had a potential cost linked to the peso devaluation, which eventually, at the end of 1994, the country had to pay, amplifying the crisis. 3. Financial Liberalization
In the years before the crisis, the government decided to deregulate the financial sector to make it more competitive and attractive to foreign capitals. Different measures were taken, but the ones that affected the most the financial sector were: * The breakup of "selected credit boxes": banks were not obliged anymore to give priority to some sectors in using their resources * The liberalization of interest rate: banks were given the freedom to determine their passive and active interest rates and the period of time associated to them * The elimination of reserves requirement: banks were not obliged anymore to use their resources to buy governmental bonds and to keep liquidity at the Central Bank. Instead, the government substituted these measures with a liquidity coefficient of 30% of the money collected
These three measures contributed to expand the private credit to unsustainable levels in the long term and left the financial sector with weak regulations. 4. Banks privatization
In 1992, 18 financial institutions were privatized, putting to an end the monopoly the State had over bank services. The way this process was managed had a deep impact on the crisis. First of all, the financial institutions were sold to people with poor knowledge of the banking system. Secondly, the main criteria used in the assignation auctions was merely monetary, without any strategic consideration of the importance of banks for the macroeconomic equilibrium. Finally, the financial institutions were sold at a very high price. For this reason, the newly privatized banks started expanding the credit as much as possible and had no capital for future capitalization. These two consequences played an important role in the burst of the crisis. 5. Political Instability
The 1994, with the entry into force of the NAFTA, seemed to be a brilliant year for Mexico. International independent institutions, foreign governments and Mexican politicians and people were confident that Mexico was ready for a golden age. Nevertheless, the following political unrests happened in 1994 * On January 1st, a group of radical activists started a rebellion in the southern region of Chiapas to protest against the Central Government * On March 23rd, Luis Donaldo Colosio, the PRI (Institutional Revolutionary Party) presidential candidate for the August election was assassinated * On September 28th, José Francisco Ruiz Massieu, the secretary-general of the PRI was murdered
These events contributed to increase the political instability's image of Mexico and to foster the outflow of capital, which were looking for a safer macro environment.
The Peso crisis has a lot of similarities with the Asian financial crisis in 1997-1998. In fact, the five most affected countries (Indonesia, Malaysia, Philippines, South Korea and Thailand) in that region experienced similar economic conditions before being hit by the crisis: * Currency overvaluation: as mentioned above, in the period 1988-1994 the Peso was overvalued by 38%. In the five East Asian countries, in the period 1990-1997, the overvaluation was as it follows: * Indonesia: 25% * Malaysia: 28% * Philippines: 47% * South Korea: 12% * Thailand: 25%

* Current account deficit: in Mexico, the current account deficit grew constantly from 1988 to 1994. A similar pattern is observed in the five East Asian countries. It is interesting to highlight that the deficit did not grew constantly like in Mexico, but had ups and downs, showing that governments were aware to some extent that the deficit would be an issue for the sustainability of their countries

These two factors mentioned are the ones that had the highest impact on both crisis. Nevertheless, there are other factors that were observed in both crisis: * Financial liberalization * Credit expansion * Increased of liabilities in dollars * Vulnerabilities of banks
The crisis in 1994 was not a new event in the Mexican history, since the country had experienced another one a decade before, in 1982. This time it was a debt crisis since the country was not able to pay back its obligations and it arrived after a period of economic bonanza. In fact, in the period 1978-1981, the GDP grew by 8.4% per annum on average.
Even if less harsh than the "Peso crisis", it had a longer impact. In fact, the years following the 1982 are called "The Lost Decade". The following data show the gravity and the length of the debt crisis, especially if compared with the data after the 1994 crisis: * The GDP decreased by 0.6% in 1982 and by 4.2% in 1983. Only in 1988 the GDP recovered to pre-crisis level of 1981 * Household final consumption expenditure contracted by 2.4% in 1982, by 4.7% in 1983 and again by 2.1% in 1986. The first year the household final consumption expenditure overcame the pre-crisis level was 1989 * Foreign direct investments plummeted by 38% in 1982, by 30% in 1984, by 42% in 1987 and by 8% in 1990. In the years not mentioned, investments recorded positive changes, but only in 1991 Mexico went back to the pre-crisis level * Unemployment rate grew to 4.2% in 1982 from 0.9% in 1981. The rate kept growing in the following years: 6.1% in 1983, 5.6% in 1984, 4.4% in 1985 and 4.3% in 1986. The rate went below 4% only in 1987 * Inflation rate more than doubled in 1982 to 59 % from 28% and skyrocketed in 1983 to 102%. The level remained high during the following five years, with peaks in 1987 and 1988, with rates of 132% and 114% respectively * Interest rate grew to 44.1% and 58.7% in 1982 and 1983 and kept growing in the following years, reaching a peak in 1987 with a 96% rate. The rate went back to pre-crisis level in 1991, with a rate of 19.3% * The official exchange rate (Peso per US$) more than doubled to 0.056 in 1982 from 0.025 in 1981 due to three devaluations made during 1982. In the following years, the peso was losing value year after year. For example, in 1985, the exchange rate was 948% higher than in 1981
The causes that contributed the most to the 1982 crisis are the following ones: 1. Huge Public External Debt
The causes that led Mexico to have a very high external debt are both domestic and international. On the first side, the government of José Lopez Portillo (1976-1982) increased a lot the government spending, pushed by an over optimism about the revenues coming from the new petroleum reserves. The government was claiming that the external debt was used to finance strategic projects to increase productivity, create jobs and foster high value exports. But this never happened. On the other side, first of all, the developed countries suffered a recession and, therefore, imported less goods from foreign countries, Mexico included, which saw decreasing its revenues from exports. Secondly, the price of petroleum started declining at the beginning of '80s and, therefore, the revenues could not cover all the state expenses. Finally, the USA decided to increase the interest rate to contain inflation and, therefore, Mexico had to pay highest interests. To give an order of magnitude, with an 1% increase of interest rate, Mexico had to pay US$323m more. In only 12 years, from 1970 to 1982, the debt passed from US$4b to US$80b. Total loans (private + public) came mainly from Western banks (70%) and 75% of them were lent to public sector. 2. Current Account Deficit
The current account deficit started growing steadily from 1978 (US$ 2.7b) and reached its peak in 1981 (US$ 16.1b). This was due mainly because the imports increased 30% more than exports during this period. This was eased by the fact that the Peso was overvalued because of an higher inflation rate than in USA, in presence of a fixed nominal exchange rate. This will be further explained in the point later in this report. 3. Oil Dependence
Mexico found new big oil fields between 1975 and 1977 and its proved reserves moved from 5.8m of barrels in 1975 to 11.2m in 1976 to 72m of barrels in 1981. At the same time, the international oil price grew from US$ 12.68 in 1976 to US$ 38.5 in 1981. The weight of hydrocarbons for the export sector grew from 13% in 1976 to 72% in 1981. At the same time, since the domestic industry was not able to keep the pace of PEMEX's (the national oil company) expansion, the company had to buy the technology and the equipment needed abroad. For this reason, the percentage of imports for the oil sector increased by seven percentage points between 1976 and 1981. Moreover, 21% of the government spending were addressed to the oil sector. When the price of oil started declining in 1981 Mexico found itself in a difficult position. 4. Peso overvaluation
Since 1976, the currency began overvaulting, subsidizing in an effective way the purchase of dollars with foreign currencies revenues coming from oil exports together with associated loans. Moreover, the inflation rate in Mexico was steadily higher than in USA, which resulted in a 30% over evaluation. For this reason, Mexican no-oil exports were negatively affected, while imports became cheaper, having an impact on the current deficit account. At the beginning of the '80s, the inflation started growing more than normal, the no-oil exports declined for the crisis in the developed countries, imports accelerated the growth due to government spending and improved living standards, the interest rates rose and capital started to exit the country. Each of these factors contributed to increase the demand for dollars to a level higher than the Central Bank could cover. Moreover, USA rose the interest rate, obliging Mexico to pay more interests on its debt, and, at the same time, the price of oil decreased, generating the entry of less foreign currencies. On one side there was an higher demand for US dollars and, on the other, there was a scarcity of dollars at the Central Bank. For these reasons, on 17th February 1982 the Central Bank announced to leave the exchange rate to float. This triggered a huge devaluation during that month, following by other two in August and December of the same year. 5. Recession in developed countries
After the crisis in the period 1974-1975, following the oil shock in 1973, developed countries entered recession at the beginning of 1980 until 1982. The industrial production decreased, the unemployment grew tremendously (in 1982, in USA, in only one month 0.5m unemployed people were officially recorded) and for the first time since the end of the second world war the international trade decreased for two consecutive years. Companies bankrupted and entire production areas disappeared. At the same time, it was recorded such a big over production of agricultural goods that governments stopped giving financial aids to the sector. This caused the impoverishment of country people. All this factors had, as major outcomes, the fact that developed economies decreased their imports and the price of commodities declined, affecting mainly the emerging economies like Mexico.
The two crisis have some similarities, but they are different for an important reason. In fact, the crisis of 1982 was mainly due to external factors and, in fact, the debt crisis not only hit Mexico but the majority of countries in Latin America. On the contrary, the crisis in 1994 was caused by wrong internal economic policies. Another difference is that the crisis of 1982 had lasting effects on the country, while in 1994 the effect was limited in the time thanks to a US$50b rescue package.
From the analysis above, it is evident that two are the causes that are persistent in both crisis: the currency overvaluation and the current account deficit. Concerning the first point, the graph below shows that every time the peso was too over evaluated, a period of abrupt devaluation followed

The overvaluation of the Peso occurred mainly because of differential in inflation rates between Mexico and USA. In fact, even if from 1976 the fixed exchange rate was abolished, the new regime was a managed floating exchange rate, which, even if it gave more freedom and flexibility, was managed to maintain stable conditions. As anticipated, it can be noticed that the depreciation of peso after 1982 lasted for seven years, until 1990, while, in the crisis of 1994, the depreciation lasted for half of the time.
The other persistent cause is the current account deficit. Per se, the current account deficit cannot be considered positive or negative. In fact, according to the academic definition, the current account deficit is "a measurement of a country's trade in which the value of goods and services it imports exceeds the value of goods and services it exports". What it is important is the use done of the external debt generated by the current account deficit. "If a country uses external debt to finance investments that have a higher return than the interest rate on the debt, it can remain solvent while running a current account deficit. If a country is unlikely to cover current debt levels with future revenue streams, it may become insolvent". In fact, there are countries, such as Australia and New Zealand, that "have been able to maintain current account deficits averaging about 4 1/2 to 5 percent of GDP for several decades". On the contrary, Mexico in both crisis "experienced sharp reversals of their current account deficits after private financing withdrew during the financial crisis".
A big difference between the two crisis has been the different nature of no-economic factors that had a huge contribution in the crisis. In the crisis of 1982, the main economic factors were two: the recession in the developed countries and the decrease of oil prices. Both factors are external and this consideration is very important because it suggests that Mexico was a country too dependent on others economies and on sole one sector. Structural reforms were needed in order to give the country more stability. For this reason, the adjustment the country had to make took a lot of time. On the contrary, the crisis of 1994 was caused by wrong and precipitated internal economic and financial policies. In fact, Mexico privatized the banks and liberalized the financial sector too quickly, without a long term strategy. As mentioned above, the main criteria used in implementing these policies was making as much money as possible.
In conclusion, the analysis of the two crisis and the comparison with the Asian financial crisis in 1997 clearly shows that there are some persistent mechanisms that anticipate crisis. The first one is the overvaluation of the local currency and the other one is the current account deficit. I would like to underline that the financial liberalization is another factor that can be considered persistent, but this is not recorded in the 1982 crisis because the globalization and the integration of financial markets were not completely developed. These persistent factors should be taken into consideration by all governments to prevent financial crisis. As an example, the current account deficit Spain experienced before the 2008 has been one of the main reasons that caused a fiercer recession than other countries in the Eurozone.

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