Restructuring and Forgiveness in Financial Crises A: The Mexican Peso Crisis of 1994-1995

Abstract

Following a year in which repeated political turmoil sapped investor confidence in Mexico, putting pressure on the peso and draining the country’s foreign exchange reserves, on December 22, 1994 the Mexican government sparked a financial crisis by unexpectedly abandoning its policy of anchoring the peso to the US dollar and instead allowing it to float freely. The resulting collapse of the peso left Mexico with $40 billion to $50 billion in external debt (much of it dollar-indexed) coming due in the near term and almost no foreign exchange reserves. Faced with the prospect that Mexico would either default on its obligations or impose exchange controls (with either scenario being seen by many as likely to result in contagion), officials from both the US and abroad scrambled to craft a response to what had been dubbed “the first financial crisis of the twenty-first century” because of its origins in an emerging market economy within globalized financial markets. On January 31, 1995, an assistance package comprised primarily of funds from the US and the IMF was announced. Backed by $20 billion from the US Treasury’s Exchange Stabilization Fund (ESF) and a $17.8 billion stand-by arrangement from the IMF, Mexico met its immediate obligations, restructured short-term debt into longer-term debt and implemented a strict economic reform plan. While the country experienced significant economic hardship in the immediate aftermath of the crisis, by 1996-1997 the economy had rebounded and by 2000 Mexico had paid back all outstanding obligations under the assistance package.