Mexican Currency Crisis

What factors led to the Mexican currency crisis and peso devaluation in 1994?

Politics was the major factor in the devaluation of the peso in 1994. A couple of Mexico's major political players were killed right before an election in 1994 [ (Whitt, 1996) ]. The politicians' assassination caused political unrest and the escalated political troubles eventually devalued the peso [ (Whitt, 1996) ]. One author also listed the following factors that contributed to the peso's devaluation:

1. The financial sector was liberalized; lending and borrowing rates were freed, bank reserve requirements were eliminated.

2. Banks were hastily privatized

3. Several banks were purchased without their owners proceeding to their proper capitalization.

4. The expropriation of the commercial banks in 1982 contributed to their loss of a substantial amount of human capital during the years in which they were under the government.

5. Moral hazard was increased by the unlimited backing of bank liabilities.

6. There were no capitalization rules based on market risk. This encouraged asset-liability mismatches that turn led to a highly liquid liability structure.

7. Banking supervision capacity was weak to begin with, and it became overwhelmed by the great increase in the portfolios of banks.

8. There was a substantial expansion of credit from the development banks.

9. From December 1990 on, foreigners were allowed to purchase short-term government debt.--

10. Short-term, dollar-indexed, peso-denominated Mexican government securities [ (Gil-Diaz, 1996) ].

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