## 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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## Bibliographic details
- Published: May 22, 1995

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### 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.*

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## References

- [PRESS CENTER](http://presscenter.imf.org/)
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_Source: https://www.imf.org/en/news/articles/2015/09/28/04/53/spmds9508_