Drawing Lessons from the Mexican Crisis: Preventing and Resolving Financial Crises--the Role of the IMF -- Address by Michel Camdessus

IMF News, May 22, 1995

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Drawing Lessons from the Mexican Crisis: Preventing and Resolving Financial Crises--the Role of the IMF -- Address by Michel Camdessus

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Bibliographic details

• Published: May 22, 1995

Overview and context

• Speech given at the 25th Washington Conference of the Council of the Americas on "Staying the Course: Forging a Free Trade Area in the Americas", Washington, D.C., May 22, 1995.
• Mexico (1988–1993) pursued macroeconomic stabilization and structural transformation with IMF support:
  • Tight financial policies and use of the exchange rate as a nominal anchor.
  • Comprehensive structural reforms, including privatization and trade and exchange liberalization.
  • Major restructuring of external debt.
• Key outcomes prior to the crisis:
  • Inflation reduced from 160 percent in 1987 to 8 percent in 1993.
  • Economic growth recovered from an average not much higher than zero in 1985-88 to 3 percent in 1989-93.
  • Large increase in international reserves and resumption of access to international financial markets.

How the crisis arose

• Pre-existing vulnerabilities at start of 1994:
  • External current account deficit running at 6 1/2 percent of GDP in 1993, financed largely by short-term capital inflows.
  • Steep real appreciation of the peso and deterioration in private sector saving performance.
  • IMF in February 1994 "stressed the need to lower the external current account deficit...to reduce the economy's vulnerability to a sudden reversal in capital flows."
• Adverse developments in 1994:
  • Domestic: uprising in Chiapas and a political hiatus following elections in August that delayed decisive policy response.
  • External: substantial rise in world interest rates prompting reassessment of emerging market exposures.
• Policy choices that increased vulnerability:
  • Allowing the peso to depreciate within its band while replacing peso-denominated government debt with Tesobonos (instruments indexed to the U.S. dollar).
  • Current account deficit widened further to 8 percent of GDP for 1994 as a whole.
• Crisis eruption in December 1994.

How the crisis was resolved: program and financial package

• Confidence was not restored by the December 20 devaluation or the subsequent float; resolution required two components:

1. A stringent adjustment program designed in close collaboration with the IMF. 2. A large-scale international financial rescue package supporting that program.

• Rescue package components:
  • IMF approved on February 1 an 18-month stand-by credit of $17.8 billion in support of Mexico's program for 1995-96, of which $7.8 billion was made available immediately.
  • $20 billion in swaps and guarantees from the U.S. Exchange Stabilization Fund (dependent on Mexico's IMF arrangement).
  • $10 billion of short-term support from the G-10 central banks through the BIS (Bank for International Settlements) (dependent on Mexico's IMF arrangement).
• Rationale for exceptional support:
  • IMF mandate per Article I to make resources temporarily available under safeguards to correct balance-of-payments maladjustments without resorting to measures destructive of prosperity.
  • Risk of systemic repercussions and immediate spillovers to equity and currency markets in Latin America and other emerging markets.
• Program objectives and early indicators:
  • Aim to cut the external current account deficit to less than 1 percent of GDP in 1995 and contain inflationary effects of the peso depreciation.
  • Program centered on further tightening the fiscal position and a strong monetary policy.
  • Continued privatization and liberalization, plus measures to protect the poorest from short-term adverse effects.
  • Early signs: trade balance in surplus in the first quarter (contrast with a $4.3 billion deficit in the same quarter of 1994); peso recovered from a low of 8.1 per dollar in early March to less than 6; easing of domestic interest rates indicating stabilizing financial situation.

Lessons for economic policy (four emphasized lessons)

• Lesson 1: Openness to international financial markets imposes an obligation of unfailing discipline on economic policy.
  • Vigilance and discipline deter and defend against financial market setbacks.
  • Costly consequences when a country “lowers its guard.”
  • Example: Argentina's quick reaction to its problems helped contain systemic risk.
• Lesson 2: Large external current account deficits are dangerous, especially when financed by short-term capital inflows and supporting domestic consumption.
  • Applies even when fiscal position appears strong and deficits reflect weak private saving.
  • Mexico’s fiscal position should have been even stronger to reduce dependence on reversible capital inflows.
  • Observation: during 1989-93 the United States, Canada, and Mexico were three of the four largest users of foreign capital in the world.
• Lesson 3: Adjusting a pegged exchange rate is inherently difficult; sound and credible accompanying macroeconomic measures are essential to make a new exchange rate sustainable.
• Lesson 4: Failure to publish timely information about key economic indicators increases crisis costs.
  • Lack of frequent publication on international reserves and other key variables contributed to markets being surprised at the devaluation.

Lessons for the IMF and surveillance enhancements

• Fundamental task: strengthen IMF capacity to prevent and resolve crises in a globalized financial environment.
• Surveillance role: annual consultations, Executive Board discussions on world economic outlook and global financial market developments.
• Identified adaptations to make surveillance more effective:
  • First, data:
  • Stricter requirements for the regular and timely communication by countries to the IMF of data on key economic indicators.
  • Greater use of financial market data in monitoring developments.
  • Work toward establishment of standards for timely publication of economic data by members.
  • Second, more continuous policy dialogue:
  • Countries must keep the IMF informed and seek its opinion; IMF internal procedures must foster dialogue between regular consultations, especially after program completion.
  • Third, better focused surveillance:
  • Given limited resources, focus on countries at risk and those where financial tensions have spillover effects; focus more carefully on financial flows and their sustainability.
  • Fourth, more pointed and candid surveillance:
  • Fund must be prepared to be more critical and demanding in policy dialogue with members.
• Challenges:
  • Political resistance: countries prefer surveillance over others more than over themselves.
  • Critical challenge for international policy cooperation and the IMF.

IMF financing capacity agenda and policy proposals

• Current and near-term liquidity:
  • Recent large Fund arrangements (Mexico, Argentina, Russia, Ukraine) mean the Fund's liquidity, adequate at present, is projected to weaken considerably over the next two years.
  • Fund resources are probably sufficient for normal business during this period; the General Arrangements to Borrow (GAB) can be activated if emergencies call for it.
• Longer-term proposals under consideration:
  • Eleventh General Review of Quotas:
  • Priority to initiate expeditiously; conclude by March 1998 at the latest, ideally before end of 1996.
  • Assessment: this quota review should in my assessment lead roughly to a doubling in quotas to keep pace with world economic growth since 1990 and increased scale of international financial flows.
  • Review role of the General Arrangements to Borrow and explore ways to increase potential resources available through borrowing from members.
  • Consider how the SDR could be instrumental in safety-net arrangements:
  • SDRs could be issued on a temporary basis or lent to countries in support of strong policy programs in a liquidity crisis.
  • Suggestion: consider the SDR idea with particular attention together with, but hopefully before, a wide-ranging review of the role and function of the SDR.
  • Ensure continued availability of concessional balance of payments assistance to low-income countries following expiration of ESAF:
  • One possibility: sale of a modest part of the Fund's gold holdings and use of earnings from invested profits of such sales, combined with bilateral contributions, to provide the needed subsidy element.
  • Explore arrangements for more orderly international debt adjustment, informed by experience with debt reorganization under national laws (work still exploratory).
• Institutional and political context:
  • Interim Committee agreed on the need to strengthen resources; further consideration and action to follow.
  • Expectation that upcoming international meetings (Interim Committee guidance, G-7 Summit in Halifax) will give impetus and count on support of the United States.

Broader implications and concluding points

• Financial globalization has increased benefits (efficient allocation of global savings, higher investment and growth) and risks (heightened vulnerability to shifts in market sentiment; faster transmission of disturbances across countries).
• The Mexican crisis illustrates that crises can hit even successful, open economies integrated into global markets.
• Reverting to closed systems with exchange controls would forgo benefits of globalization and is not the recommended response.
• Global cooperation is essential in both trade and international monetary relations; regional cooperation is important but not sufficient.
• The next major crisis of the 21st century will be of global significance; the IMF must be strengthened to match the needs of the global economy.

Source: Address by Michel Camdessus, Managing Director of the International Monetary Fund, 95/8, May 22, 1995.

References

• PRESS CENTER
• https://www.imf.org/en/home