Case Study Mexico And Thailand Crisis Example For Free - Free Essay Example

In this section a case study approach will be used to explain the financial economic crisis in Mexico 1994 and Thailand 1997. In this way I want to explain the reasons why both countries came under the guidance of the IMF. 3.1 Mexico Tequila Crisis To find out what happened in Mexico during the 90s, I first have to explain the economic reforms in the 80s. In the 80s there was in Mexico a stagnant economy and high inflation. The Mexican government intervened and liberalized the trade sector in 1985 and adopted a plan with intentions to ensure economic stability and introduced market-oriented institutions (Gil-Diaz, 1998). To fulfill this task a reform process was started that included i.e. deregulation of economic activity, financial reforms, and signing of the North America Free Trade Agreement (NAFTA) (Buira, 1996). The intervention of the government led to a resumption of economic growth with an average of 3.1 percent per year between 1989 and 1994. The reforms ensured for a reduce in the inflation rate, for the first time in more than twenty years the inflation was brought down to normal and accepted level (Buira, 1996). The financial performance of Mexico remained not unnoticed for other countries and investors, and th ey suggested that Mexico was ready to make advantages of their economic growth. The economic reforms together with the recovery of the economy brought Mexico in a perfect attractive position for investors and attracted an unprecedented capital flow; between 1990 and 1994 US$104 billion was invested. Foreign investments were mainly due to the low interest rates in the U.S. and the lack of major restrictions on capital flows in Mexico. There became in this way a large capital inflow in the 1990s when there was a foreign-debt renegotiation was formalized. The financial sector in Mexico also underwent liberalization and the government encouraged an increase in the supply of credit. In a short time the credit increased enormously and the (weak) supervisors came into trouble and this resulted in some cases in a scant of capital for some banks, and even borrowers (Gil-Diaz, 1998). Factors that influence the increase of credit were: (1) positive economic expectations; (2) reduction of pu blic debt; (3) availability of various debt instruments; (Hale, 1995) (4) and a boom in real estate and stock market. In the end of 1993 to end of 1994, credit from commercial banks to the private sector rose with 25 percent per year. The credit card liabilities increased with 31 percent per year, direct credit to and for consumers increased with a yearly rate of 67 percent, and mortgage loans increased with an annual rate of 47 percent (Gil-Diaz, 1998). The external credit flow to the private sector went from $193 million in 1998 to $23.2 billion in 1993. In this way there became overindulgence in credit. The share over government securities held by foreign investors during 1990-93 rose from 8% at the end of 1990 to 57% at the end of 1993 (Griffith-Jones, 1997). 3.1.2 Arise of problems In 1994 there rose some problems for Mexico. In February, the Federal Reserve (FED) began to raise the US interest rates from 3% to 3.25%. Further rises of the interest rate were expected to slow down the rapid pace of the US economy (Griffith-Jones, 1997). In 1994 the US interest rate increased in his total six times to a value of 5.6% (Griffith-Jones, 1997). Furthermore, in 1994 there were some political and also criminal events in Mexico such as kidnapping of prominent businessmen and some armed conflicts in the town Chiapas. The unrest caused an enormous amount of uncertainty, and pushing the exchange rate down to the levels close to the band of ceiling (Banco de Mexico, 2009). In March, President candidate Luis Donaldo was assassinated. The crime itself and the unrest as well the uncertainty which occurred took a caused widespread concern. The reserves of Banco de Mexico, were amounted on US$28.321 billion dollars at the day of the assassinated, the following month the rese rves decreased with US$11 billion (Banco de Mexico, 2009). More huge political events triggered the uncertainty and disquiet even more. Deputy Attorney General Mario Ruiz Massieu had his doubts about the stability of the political system (Banco de Mexico, 2009). Because of the disquiet there was much volatility in the international market, investors were wondering of the government of Mexico could financing its current account deficit of 1995 and this triggered a massive attack on the peso (Banco de Mexico, 2009). On 19 December 1994, the Foreign Exchange Commission came to the conclusion that the current exchange rate regime at that moment, exchange rate band slippage regime, should be replaced with a floating rate regime (Banco de Mexico, 2009). The Mexican authorities devalued the peso with 20% but the market forces a larger devaluation of more than 50% of the peso (de Jong, 2009). Mexicos devaluation of the peso precipitated a crisis for financial institutions and markets tha t continued into 1995 (GAO, 1996). Investors confidence collapsed and provided a large financial balance of payment crisis for Mexico and put an abrupt end of capital flows. External credit flows decreased from $23.2 billion in 1993 to $8.9 billion in 1994 (Gill-Diaz, 1998). 3.1.3 Measures IMF In 1995 the financial crisis in Mexico led to a large financial assistance packed from various parties. The IMF gave Mexico $17.8 billion in financial assistance. This financial assistance over a period of years was in the form of a standby arrangement and was designed to support international reserves and reducing its current account deficit and inflation rate, and reinforcing of its fiscal policy. The IMF wanted that Mexico adopted the next measures: Limited growth of for Mexico, 1.4 percent in 1995 and 4.0 percent in 1996; Bringing down inflation to 19 percent (inflation rate was at a moment 48.46 percent); Wages increases should be limited. Structural reform in industries such as; privatizations in transportation, telecommunications, banking and finance, railways and petrochemical industries. Source: Griffith-Jones, 1997 In response of the financial crisis in Mexico, the US organized also a financial assistance package. The economies of the U.S. and Mexico have been closely integrated. In 1994, the U.S. exported 69% of Mexicos imports and imported about 85 percent of its export. U.S. investors had invested a substantial share of foreign investment in Mexico and have numerous manufacturing facilities in Mexico (GAO, 1996). The U.S. rescue package for Mexico was expand to US$20 billion, including US$6-9 billion of the U.S. swap facility, US$10 billion though the Bank of International Settlements (BIS), C$1 billion from Canada and another $3 billion from commercial banks (Lustig, 1995). The total rescue package was in the end of January 1995 around the US$ 50 billion. The intention of the assistance package was to help Mexico and to avoid defaulting on its debt obligations, overcome a short-term liquidity crisis, and to prevent contagion of the crisis to other countries/emerging economies (GAO, 1996). The package stopped the panic but did not cause its reliability back into Mexico and the market. This was because the funds were not directly available (Lustig, 1995). 3.2 Thailand Currency Crisis The financial crisis in Thailand of 1997 was not the first crisis that the country had to endure. In the early 80s it went through a serious financial crisis and the government was forced to give a large financial injection together with a devaluation of 25% on its currency, the baht (Lauridsen, 1998). Through this crisis, fifteen finance companies collapsed and thirty-two companies were helped by liquidity injections. By an export driven boost Thailand came out of his recession and her financial problems in the year 1986. The export boost was due to the cheap baht and the appreciation of currencies in other East Asian countries (Lauridsen, 1998). There became a massive inflow of direct investments (FDI) from neighboring countries like, Japan, Taiwan and South Korea (Lauridsen, 1998). A speculation on real estate and the stock market led to a doubling of assets during the period of 1986-1990. Interestingly, the focus of the government was not lying on control and regulation of the market, but was more focused on deregulation and competition. From 1989-1993, there was a reform process in the financial sector. The government encouraged domestic savings and the inflow of capital because it wanted to improve the financial sector so that it could compete internationally, by establishing The Bangkok International Banking Facility (BIBF). The Thai government wanted to improve the capability of the financial sector to compete worldwide and wanted to develop Thailand into a financial center for SouthÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ East Asia. 3.2.2 Booming Years The Thai economy increased enormously in the late 1980s and in the beginning of the 1990s. During the 90s the growth numbers of the economy increased, the numbers were around 10% per year, this ensured that Thailand could be seen as one of the Asia Tigers. The boost in the economy of Thailand was largely caused by high investments. In the period 1990ÃÆ' ¢Ãƒ ¢Ã¢â‚¬Å¡Ã‚ ¬Ãƒâ€šÃ‚ 96 the investment ratio (gross domestic investment as a percentage of GDP) was between 40% and 44%, compared to the 1980s were it fluctuated between 25% and 30 % (Lauridsen 1998). The investments were financed with money that was borrowed from abroad. The interest rate in Thailand was at that time high, higher than in the U.S. The bath was pegged to the U.S. dollar; so there was a large inflow of foreign capital. Investors could borrow in dollars and invest in higher yielding assets denominated in other currencies such as the Bath. Investors will always look for high returns and because of the high int erest rates in Thailand; they could get a higher return on their loans with minimum risk. The net capital inflow in the Thai economy increased from 8% of the GDP in 1990 to 14% of GDP in 1995. The Thai economy experienced in this way a large inflow of foreign capital. The large amount of inflowing capital increased the total debt from US$ 28 billion in 1990 to US$ 93 billion in March 1997 (Sussangkarn, 1998). The outstanding debt as a share of GDP increased from 33.75% in 1990 to 50.94% in 1996. Of the total debt was 36% short term and matured within 12 months (Sussangkarn, 1998). In 1997 the Bank of Thailand revealed that the foreign debt was US$ 90 billion and that 20 billion was due at the end of the year (Lauridsen 1998). Normally, a huge inflow of capital would result in an appreciation of the value of the baht, since 1963 the baht was tied closely to the dollar. During the 1980s the bath was a couple of times devalued and was linked to a basket of currencies, the most impor tant linked currency was the U.S. dollar. Monetary policies kept the baht on a stable level. Before the increase of capital inflows, the Thai public sector had an effective management system (Sussangkarn, 1998). Within this system the authorities could control the size and maturity of public debt (Sussangkarn, 1998). When private debt increased; the government didnt followed an effective management system anymore and there became a lack an effective management mechanism and supervision. The private sector had no strict rules or restrictions and therefore