The Mexican Financial Crisis

The Mexican Financial Crisis: Genesis, Impact, and Implications
Author(s): Gary L. Springer and Jorge L. Molina

Source: Journal of Interamerican Studies and World Affairs, Vol. 37, No. 2 (Summer, 1995), pp.
57-81
Published by: Center for Latin American Studies at the University of Miami
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The Mexican Financial Crisis:
Genesis, Impact, and
Implications
Gary L. Springer andJorge L. Molina*
I. INTRODUCTION
HE financial problems faced by Mexico since late December
1994 are the result of a balance of payments crisis which
developed earlier during the year when a number of economic
and political developments came together to disruptits financing
plans. A combination of events - an increase in US interest
rates, political ferment and presidential elections in Mexico,
plus capital flight from Mexico which was prompted, in turn,
by lax monetary policy during the last weeks of the Salinas
administration- all helped contribute to, and culminated in,
a collapse of the peso at the end of 1994. As a result, the
incoming administration of President Ernesto Zedillo found
itself in the position of having to devalue the peso, a move that
Gary L. Springer is Vice-President of Fleishman-Hillard, an interna-

tional communications and public relations firm, at its Latin America
headquarters in Coral Gables (FL). While with the law firm of Shearman &
Sterling, where he was Senior Advisor for LatinAmerica, he was part of the
legal team that served as lead counsel to the Government of Mexico during
negotiations for the North American Free Trade Agreement (NAFTA). A
specialist in Western Hemisphere business and policy affairs,he has directed
work programs for both the Council of the Americas and the Mexico-US
Business Committee and has also been a journalist with Business Latin
America.
Jorge L. Molina is Acting General Manager and Vice-President of
Fleishman-Hillard, Mexico. Dr. Molina is a former member of Mexico's
Secretarfa de ComercioyFomento Industrial (SECOFI),in which capacity he
helped his government in negotiating trade agreements with other countries,
including service on the team that negotiated the North American Free Trade
Agreement (NAFTA).
The views expressed in this article are those of the authors alone.
57
58 STUDIESAND WORLDAFFAIRS
JOURNALOF INTERAMERICAN
sparked severe economic repercussions, including a crisis of

confidence that spread beyond Mexico to affect other emerging
markets as well.
This crisis of confidence was exacerbated by a number of
economic problems, developing in rapid succession, which
added to the many domestic political and social tensions
already in existence. Mexico found itself in the midst of major
internalchanges that were without precedent in recent memory.
Some of the political factors that triggered this process in-
cluded: (a) an unexpected guerrilla uprising in Chiapas in
January 1994; soon followed by (b) the assassination of Luis
Donaldo Colosio, leading presidential contender and candi-
date of the ruling Partido Revolucionario Institucional (PRI)
just three months into the year; both of which took place during
(c) an ongoing liberalization of the economy that was rapidly
altering the status quo, and while (d) a number of governmen-
tal reforms were being carried out that were changing the
political rules of the game to open up new spaces for other
political forces.
At present, conditions in Mexico are such that all actors in
both the economic and political arenas are finding it necessary
to redefine their roles vis-a-vis one another, particularly as
these changes in the system work themselves out under the
Zedillo government.
II. HOW DID IT ALLSTART?

OR most people, 1994 was to be the year when Mexico
would enter a new era whose outlines had been shaped
and guided by the strong hand and capable leadership of
President Carlos Salinas de Gortari(1988-94), whose term was
soon to expire. In less than five years, the Mexican economy
had gone from being one of the most protected in the world
to one of the most open - with clear, transparent rules of the
game and a marked continuity of policy. During that time,
Mexico had (1) negotiated the North American Free Trade
Agreement (NAFTA) with the United States and Canada;
SPRINGER
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CRISIS 59
(2) become an active participant in the Uruguay Round of the

General Agreement on Tariffs and Trade (GATT), even to the
point of chairing the group that negotiated services; and
(3) had become a full-fledged member of such developed-
country associations as the Organization for Economic
Cooperation and Development (OECD) and the forum for
Asian-Pacific Economic Cooperation (APEC).In just that brief
a time, and as a result of its willingness to "join the world,"
Mexico had become one of the world's most attractive
destinations for investment, both direct and portfolio.
The year 1994 was also the time when President Salinas
was slated to step down from the presidency, with a high
probability that, given the stellar nature of his economic
achievements at home, he would go on to become the first
chairman of the World Trade Organization (WTO), the newly-
organized successor to the General Agreement on Tariffs and
Trade (GAT). Not only would Mexico's incoming president
inherit a more democratic regime, but there was every expec-
tation that he would be able to build upon this legacy to
consolidate the economic gains made under the previous two
administrations. Because the new president would not be
captive to the ruling party's "old guard," which had been
largely marginalized by the economic modernization policies
of Salinas, he could also be expected to expand, and deepen,
the nascent process of political reform. Prevailing public
opinion looked forward to a new, improved Mexico: a newly-
industrialized nation, a member of the so-called "firstworld."
In addition, passage of the NAFTA held promise of
sufficient benefits to raise expectations for the country as a
whole, fostering a generally positive image of its government
both at home and abroad. The prevailing optimism created a
"bullish" environment for trade and foreign investment, in
which Mexico became the darling of internationalbrokers and,
in particular, their institutional clients. Despite some reserva-
tions and expressions of concern (the possibility of devaluation
was an ever-present topic of conversation among the knowl-
edgeable, like international economists, financiers and busi-
60 JOURNAL OF INTERAMERICANSTUDIES AND WORLD AFFAIRS
ness executives), investor mood was generally upbeat, particu-

larly as the dark days of the de la Madrid administration
(1982-88), when renegotiating Mexico's foreign debt had been
a crucial concern for participants and observers alike, faded
into memory and became a thing of the past. There had been
some anxious days as the US Congress debated the NAFTAin
the Fall of 1993, but its subsequent passage provoked such
general euphoria that few were prepared for the political shock
that ushered in the new year.
On 1 January 1994, just 43 days after the United States
approved the NAFTA and on the very day that it went into
effect, the Ejercito Zapatista de Liberacion Nacional (EZLN)
leaped into the headlines and dealt a stunning blow to Mexico's
image of stability and progress with (1) its declaration of war
against the Salinas administration and (2) its armed seizure of
a number of key cities in the southern state of Chiapas. The
events of that fateful New Year's Day shook every previously
held perception of the new, "modernized"Mexico. Indeed, not
only did the Chiapas rebellion challenge the country's social
and political institutions, but it called into question Mexico's
new status as a "more-developed" nation as well. And that was
just the beginning. As the year unfolded, both Mexican society
and the world at large were to witness a series of bizarre events,
almost unsettling in their violence, that were to undermine all
the rosy scenarios and optimistic forecasts that had prevailed
at the outset.
* Terror and violence. The
year opened with the EZLN
declaration of war and rebellion in Chiapas on New Year'sDay,
which led to 9 days of fighting between the EZLNand Mexican
Army and left more than a hundred people dead in that state.
Although a truce was declared on 12 January, it was soon
followed by a series of bombings and bomb scares in Mexico
City. Among other unsettling revelations was information that
members of the ETA,a Basque nationalist terroristgroup, had
been operating in Mexico for several years. Indeed, during
1994, more than 200 extortion-related kidnappings were
reported, including those of two prominent Mexican business-
THEMEXICAN
ANDMOUNA:
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FINANCIAL 61
men: Alfredo Harp, Chairmanof Banamex; and Angel Lozada,

the son of the owner of the Gigante chain of department stores.
Initially, the Mexican government described the EZLN,
authors of the Chiapas uprising, as a group of rebels known to
the authorities but who had been believed to pose no threat,
hence no effort had been made to eliminate them. This
revelation was particularlysurprising since it was made by the
Minister of Gobermacin who (1) was in charge of internal
intelligence and security, and (2) had been Governor of
Chiapas only a few months earlier and thus should have been
well aware of the existence of a nascent guerrilla movement in
his area (see below). While the uprising appeared to catch the
government off guard, it also served to underscore the depth
of Mexico's social disaffection and unrest, in part a conse-
quence of the country's uneven social infrastructureas well as
of the industry-oriented policy of the Salinas government.
According to some, that policy had done nothing to alter (and
may even have accentuated) the country's highly skewed
distribution of income, in which more than 90%of the national
wealth rested in the hands of less than 20%of the population.
*
Instability of political institutions. Nor was there any
shortage of political problems in the country, particularly
within the Partido Revolucionario Institucional (PRI), which
had governed Mexico uninterruptedly for 65 years. The extent
to which the Chiapas uprising caught the government unaware
tended to discredit the way in which the Salinas government
had administered the Ministerlo de Gobernaci6n, the depart-
ment of state responsible for internal security. Its oversight in
this area had been demonstrably weak and, indeed, President
Salinas had appointed three different ministers to that post
during his sexenio (6-year term of office). There was also the
open - and uprecedented - dissent of Manuel Camacho
Solis, former mayor of Mexico City and PRI presidential
hopeful, who went from the latter position to that of party
dissident, to Secretary of Foreign Relations and, finally, to
peace commissioner in Chiapas in a matter of weeks, in late
1993/early 1994. The possibility that Camacho might become
62 JOURNALOF INTERAMERICAN
STUDIESAND WORLDAFFAIRS
the candidate of another party remained a threat for much of

the 1994 presidential campaign season, and his continuing
dissent into 1995 serves as a constant reminder of the cracks
that exist in the armor of the ruling party. All this despite a
burgeoning political reform and clear political "opening"
during 1993-94.
*
High-level political assassinations. Even though
presidential campaign years in Mexico are usually marked by
considerable tension and uncertainty in every way (financially,
socially, and politically), 1994 stood out as one of the more
unusual years in modern Mexican history. The assassinations
of two major political figures in particular - Luis Donaldo
Colosio, the PRI'soriginal presidential candidate and, later in
the year, of Jose Francisco Ruiz Massieu, who was slated to
become the leader of the PRIin the Chamber of Deputies of the
Mexican Congress under the new Zedillo government (and the
person responsible for the evaluation of the August 21st
presidential election) - shocked the political system more
than at any time in the past 60 years.
The killings of both Mr.Colosio and Mr.RuizMassieu, and
the ensuing processes to find and name their successors,
testified to the deep and disturbing decay that has penetrated
Mexico's present political system, revealing the divisions
within the PRI and the need for modernizing the decision-
making apparatus of the government itself. [Authors note: this
was, coincidentally, the topic of Mr. Colosio's speech on
5 February,the anniversary of the PRI'sfounding, in which he
issued the first call for separating the PRIfrom the government,
a theme which has recurred under Zedillo and which remains
a highly controversial subject.] The assassinations also indi-
cated that the political reform initiated under Salinas had failed
to uproot the interests of the PRI'sold guard, some of whose
members were eventually alleged to have links with, or be
implicated in, the assassination of the two politicians.
As it turned out, the Zapatista rebellion and the political
turmoil raised by the assassinations clouded the atmosphere
for Mexican society and the nation as a whole for the balance
ANDMOLINA:
SPRINGER THEMEXICAN
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CRISIS 63
of the year and continues to haunt the new Zedillo administra-

tion down to this day. Although the EZLN-led military uprising
lasted only 12 days, the Zapatistas also managed, through the
elusive Subcomandante Marcos, to manipulate politics and
society for the remainder of 1994 and into 1995.
From the initial uprising in Chiapas on 1 January 1994,
through the 15% widening of the exchange band on December
20th at the end of the year (not to mention adoption of a
floating exchange rate only two days later), Mexico experi-
enced one of the most difficult years in recent history. When
the devaluation took place at the end of 1994, Mexico was
facing a crisis on three fronts: politically, economically, and in
society. Before President Ernesto Zedillo had even completed
his first month in office, his government had come under strong
criticism for being weak and, in the view of many, possibly
unequal to the task of dealing with a country in crisis.
III. CHRONOLOGY OF THE ECONOMIC

CRISIS OF DECEMBER 1994
N 20 December 1994, the Mexican Secretary of Finance,
Jaime Serra Puche, called an emergency meeting of
representatives of business, labor, and other interest groups in
which he proposed to increase the band within which the peso
would be allowed to float by N$0.53, or 15%. Why the meeting?
First, the EZLN had left the positions which they had held in
Chiapas for several months (and which gave them control of
38 municipalities in the state). In the aftermath of this move,
foreign portfolio investors suddenly withdrew more than
$3 billion from Mexico's capital market in a single day
(19 December 1994). It was this development that provoked
the emergency meeting. Initially, the Mexican government
took the position that it was this shift in the Chiapas political
situation that was responsible for setting off the stampede
among foreign investors to withdraw their money from Mexico,
claiming that it raised alarms of imminent instability. In any
event, fear overtook the market to such an extent that Mexico's
international reserves plunged sharply downward: falling from

$17 billion (at the end of November) to less than $6 billion in
just two days. As it turned out, the Mexican government was
no longer in a position to resist another speculative attack on
the peso. On 22 December 1994, without the acquiescence of
either business or labor, the government adopted a system of
floating exchange rates, and the peso fell to nearly N$6:US1.
Such speculative attacks were a natural outcome of the
opening of the Mexican economy and financialsystem through-
out the Salinas administration. Attacks against the peso date
back at least a year, to the first half of November 1993, when
the peso edged to the ceiling of the band as investors reacted
to their concern that the NAFTA,then under hot debate by the
US Congress, might not be approved. [In point of fact, the US
House of Representatives approved the free trade agreement
by a margin of 234-200 on 17 November 1993, with the US
Senate approving the measure three days later; the Mexican
Senate gave its approval on 22 November 1993. The Canadian
Parliament had already subscribed to the agreement earlier in
the year, in June 1993.]
Then, in late Marchof 1994, there was a second attack on
the peso when Mexico's stance on monetary policy weakened
relative to that of the United States:US interest rates had begun
a sharp upward climb which served as a strong attraction to
foreign capital. At nearly the same time, Luis Donaldo Colosio,
the PRI candidate for president and a front-runner in the
election campaign, was assassinated (23 March 1994), an event
that sent shock waves through the international markets and
spurred the United States and Canada to establish an
$8.8 billion emergency swap line of credit to enable the Banco
de Mexico to defend the peso. The Mexican government
announced that it did use the US funds.
The third attack on the peso came in the early Fall, when
Francisco Ruiz Massieu, secretary-general of the PRI and
possible appointee to a cabinet position with the incoming
Zedillo government, was assassinated on 28 September 1994.
At the time, the international financial market was disap-
SPRINGER
AND MOINA: THEMEXICANFINANCIAL
CRISIS 65
pointed by the decision of the Mexican government not to alter

the exchange rate band in any way in the context of a renewal
of the Pacto (the wage-and-price agreement between labor,
business, and government designed to control inflation and in
place, in modified form, ever since 1987), particularly as
confidence in the efficacy of the Pacto was beginning to wane.
By the beginning of November 1994, it had become apparent
that the government was no longer willing to raise interest rates
in order to defend the peso. Some attributethis attitude on the
part of outgoing Salinas administration to the fact that the
change in administration was drawing closer and, as a result,
the nation's decisionmakers were more involved in domestic
politics. The country's international reserves, which had stood
at nearly $30 billion in March 1994, had dropped to almost $17
billion by early November.
Thus, by the time that tensions between the EZLNand the
Mexican government intensified in December, the peso was
already under great pressure. By 19 December 1994, Mexico's
international reserves dropped below $11 billion, only to
plunge sharply to $6 billion on 22 December - at which time
the government abruptly adopted a floating exchange rate
system. In doing so, however, it failed to provide the financial
markets with a credible plan for tightening monetary policy
and reducing demand in Mexico, an omission which only
served to undermine investor confidence even more.
From the onset of the crisis at the end of 1994 until late
in January 1995, the financial markets were insistent in their
concern that Mexico did not have sufficient international
reserves to meet the weekly amortization payments on its
Tesobonos(government bonds pegged to the US dollar), which
would amount to about $10 billion for the first quarter of
1995. Despite the fact that a new Pacto was announced on
3 January 1995 which embraced a series of emergency eco-
nomic measures, it was greeted with skeptism and disbelief on
all sides, both internationally on the part of the investor
community and domestically by Mexican business and labor.
While the new Pacto took a sound, realistic approach to the
situation, its reception was undermined by several factors-

the length of the negotiations, the uncertainty regarding their
outcome, the delay in announcing the agreement and new
policy - which, taken together, raised expectations that,
ultimately, were not met. This served to deepen what had now
become a serious, ongoing crisis of confidence and credibility.
The announcement of an assistance package from the
United States, on 12 January 1995, initially helped to stabilize
the peso. However, when the Clinton emergency assistance
package, totalling nearly $40 billion, was introduced to the US
Congress for approval, it was subjected to strenuous debate.
The disturbing tenor of the debate and the obvious unwilling-
ness of the Congress to support the package - as evidenced
by the unacceptable levels of conditionality larded onto the
legislation - further eroded investor confidence and led the
peso to decline even more steeply. During this time, some
estimates have held that Mexico's international reserves may
even have fallen into a negative position.
Finally, on 31 January 1995, President Clinton made the
courageous, and unprecedented, executive decision to use
funds from the US Exchange StabilizationFund (ESF),together
with funds made available by the InternationalMonetary Fund
(IMF),the Bank for InternationalSettlements (BIS), commercial
bank loans, and LatinAmerican and Canadian credit facilities
to create a package - totalling nearly $53 billion - to help
Mexico stabilize the peso. Nevertheless, the nearly 3-week
delay in negotiating the terms of the package between Mexico
and the United States, as well as the attacks on Mexico voiced
in the US Congress, nourished the fears of, and allowed
uncertainty to intrude upon, the international capital markets.
The terms of the package were controversial. The United
States designed the support package as a straightbusiness deal:
(1) it required Mexico to pay interest and fees on medium-term
swaps; (2) it made disbursement of funds contingent on
"certification"of Mexico's adherence to strict IMF monetary
targets; and (3) it took the revenues from Mexican oil exports
as collateral, to be deposited in the Federal Reserve'Bank of
AND MOLINA:THEMEXICANFINANCALCRISIS
SPRINGER 67
New York. Nevertheless, the terms of the final agreement were

larger, more flexible, and with a longer maturity than the
original package proposed by Clinton earlier in the year, and
they allowed Mexico some breathing space in which
(a) to build up its international reserves, (b) to implement a
structural adjustment program, and (c) to construct a support
program for the domestic banking system.
With the package in place, the Zedillo administration
announced (9 March 1995) an economic austerity plan de-
signed to stabilize its financial market both at home and abroad
and to restore confidence in the credibility of Mexican eco-
nomic policy. This time there was no Pacto because business,
labor and the government could not agree on such issues as tax
hikes and wage increases. As a direct consequence of the
yawning distance between the private and the public sectors,
the government announced its own economic package to
stabilize the economy and increase revenues. Some of the
elements in the program, which draws on suggestions from
both business and labor, are (1) an increase in the value-added
tax (VAT or - as it is known in Spanish - the IVA) from 10%
to 15%, which has drawn a very loud, unfavorable outcry from
the public; (2) an increase in the price of gasoline and other
goods and services provided by the government; and
(3) monthly increases in tolls and fees for highways and other
roads. The program, though unpopular, is designed to reduce
demand and bring stability to the economy, a remedy often
prescribed by the IMF and well known in the country. After
nearly 90 days of drift and uncertainty, the markets appeared
to respond cautiously, but favorably, to the new plan.
IV. IMPACT OF THE CRISIS
A. Domestic Impact on Mexico

THE most immediate impact of the devaluation can be seen
in the raw figures of the new 1995 economic forecasts for
Mexico: inflation close to 50% (compared to 7.5% in 1994); a
contraction of the economy of 3-5%; interest rates spiralling

upward (to over 100%),which has led to a sharp decline in the
availabilityof credit;and an exchange rate of more than N$6.00
pesos/US dollar (compared to N$ 3.46 at the end of November
1994). Although the minimum wage was increased almost 20%
from its December level, it is anticipated that, in 1995,
consumers will experience a net loss in purchasing power of
anywhere from 20% to 30%.
However the raw data tells only the most obvious part of
the story; a look at the longer term impact of the crisis would
have to include:
Loss of confidence and credibility. Perhapsthe most
important consequences of the devaluation and ensuing
economic crisis are (1) the blow it has dealt to the Mexican
government's hard-won international credibility, and
(2) the extent to which it has damaged the confidence of the
Mexicans themselves, both consumers and investors, in their
own government. Business suddenly had no parameters or
benchmarks by which to make decisions or plan for the future.
It was clear that the trustbetween the public and private sectors,
so carefully developed and nurtured during the last four years
of the Salinas administration, had disappeared, and it was
necessary to fall back on older formulas more distant in time.
Poor external communications. The crisis was aggra-
vated and exacerbated by a pattern of inconsistent, inadequate
communication both at home and abroad. The inconsistency
of the messages, in particular, served only to damage the
credibility of the Zedillo administration as it struggled to
control the situation. No matterhow sensible the plan (whether
that of 3 January or of 9 March), the vacillation, hesitancy and
delays that surrounded their inception only fuelled the atmo-
sphere of uncertainty that imbued the domestic and interna-
tional markets. It appeared, at times, that the Mexican govern-
ment was its own worst enemy. For instance, the Zedillo
administration lost much time and sacrificed considerable
credibility by looking for a scapegoat to blame for the situation.
Initially, the Zapatistas were blamed as the guilty party, an
SPRINGER
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allegation that continued long afterthe militarythreatwas over;

subsequently the blame was shifted to former President
Salinas, and, finally, to the current account deficit. This focus
on finding someone to blame appeared more as a smokescreen
to avoid taking action than as an effort to deal with the
situation. Another example of crossed signals took place early
in the year when certain details of the January plan were made
available to the internationalpress but withheld from Mexico's
own domestic media. This oversight, ratherthan the substance
of the plan, quickly made headlines in Mexico. Indeed, the
media "spin" on the story was the crash-and-burn of the
Mexican "miracle,"the instability of the government's eco-
nomic policy, and the regime's lack of resolve. Many financial
analysts, who felt betrayed by the Mexican authorities, showed
a striking willingness to get even with Mexico through the
international press. Because, at least in the early stages of the
crisis, little effort was made to develop and control the message
of the Mexican government, the media were free to exploit the
situation to the utmost; as a result, their near-hysterical
headlines only heightened the fears that gripped the market.
Loss of Mexico's reputation. As a result of Mexico's
mismanagement of the December devaluation, more than four
years of painstaking effort to establish itself as a reliable
member of the internationalfinancial community was seriously
undermined, impairing its hard-won reputation for sound
management of economic and monetary policy. After having
been widely praised for his role in bringing the NAFTA
negotiations to a successful conclusion, Finance Secretary
Jaime Serra Puche found himself under attack - to the point
of demanding his resignation - by his former admirers for
failing to warn of the impending crisis in advance (though, had
he done so, global investers would probably have withdrawn
their money from Mexico even faster!).When he did resign (on
28 December 1994), his successor - Guillermo Ortiz - was
faced with the immediate task of trying to repair the nation's
relations with investors and creditors alike by restoring a
semblance of credibility to its policies on the one hand and
communicating more openly on the other. Nonetheless, the
fallout from this latest crisis was brutal: Mexico almost fell off
the radar screen of international portfolio investors, and the
risk factors of investing in Mexico only multiplied in the eyes
of the analysts.
End of the Pacto: Another important casualty has been
the collaboration between business, the public sector, and
labor unions, a relationship now being redefined. For over
eight years, these three sectors worked together under the
umbrella of the Pacto (a kind of negotiated consensus or
concertaci6n), an anti-inflation accord in which they came to
a joint agreement on such matters as the amount and timing of
certain wage and price increases, on a mutually satisfactory
exchange rate policy, and the size of the fiscal deficit, among
others. To a considerable extent, the Pacto offered a bench-
mark by which the investment community could assess the
economic risk in any given year, thus helping to add an
element of predictability to business planning. Under the de la
Madrid administration (1982-88), the Pacto was used to stabi-
lize the economy. During the Salinas administration (1988-94),
the Pacto proved a reliable mechanism at a time when the
economy was growing and inflation was declining year by
year. Under the current Zedillo administration (1994 +),
however, the Pacto became an instrument for distributing
economic losses. The devaluation of the peso made the last
Salinas-era Pacto (signed in September 1994) obsolete and
created a bitter atmosphere when Zedillo undertook to nego-
tiate a new one in the first days of January 1995, early in his
administration. By then, the prospects for 1995 - including
low economic growth, higher inflation, and an unstable
currency - made it impossible to negotiate a new one. When
the three parties to the Pacto came together in early March
(1995) to try to reach another accord, they were unable to
agree. In fact, certain elements of the business community
publicly threatened to default on their debts if the government
raised the tax on assets. In the end, the government announced
its own plan (9 March 1995) without the acquiescence or
support of either business or labor, though the new package
did not raise the tax on assets.
SPRINGER THEMEXICAN
ANDMOLINA: FINANCIAL
CRISIS 71
Priority ofthe rule of law over the exercise of power.

Even though the crisis over devaluation got the Zedillo
administration off to a shaky start, it also opened a certain
amount of political space in which Zedillo and his supporters
could exhibit their real strength: e.g., the desire to build more
participatory, democratic institutions based on modem juridi-
cal regimes and transparent processes. Among other novel
steps, Zedillo has taken great pains to distance his government
from the former practices of the ruling PRI and has sought to
include Mexico's legislative branch in the process of drawing
up, and debating, important new laws, rather than, as so often
in the past, merely endorsing administration-conceived mea-
sures. For example, when the law setting forth the require-
ments for mediation of the Chiapas situation was presented to
the Mexican Congress, it bore the signatures of the congres-
sional leaders of all the major political parties, plus that of the
president - almost unprecedented in Mexican politics. From
the outset, Zedillo has been subjected to challenge from both
the political Right as well as the Left and, indeed, from his own
party. The EZLN provoked his government into mounting a
military response; his predecessor, who appeared unwilling to
shoulder any responsibility for policies that had led to the
economic crisis, has been openly critical; and he has taken
enormous political heat for allowing judicial investigations into
the assassinations of Colosio, Ruiz Masseiu, as well as the
earlier killing of Cardinal Posadas, to proceed unimpeded by
political considerations. As has been widely reported, the latter
have led to the arrest of Raul Salinas, elder brother of the former
president, a development that - again - represents an
unprecedented break from PRI practices of the past. At least at
the outset of his administration, Zedillo appears to be trying to
lay the foundation for a more modern political and legal system
in Mexico, and doing so under very difficult circumstances.
More international interdependence. Mexico's present
economic circumstances have also entailed certain interna-
tional consequences. The most significant is its increased
dependence upon the United States. Undoubtedly, the emer-
gency financial relief package will provide the United States
72 JOURNAL OF INTERAMERICANSTUDIES AND WORLD AFFAIRS
with additional leverage on a variety of bilateral issues, like the

drug traffic. Also for the first time, Mexico's rescue package
brought some non-financial items - like migration - to the
table, which may set a precedent for future negotiations not
only with Mexico, but with other countries as well. For
instance, one controversial aspect of the package is the need
for US "certification"of Mexico's implementation of the eco-
nomic plan in order for it to gain access to the second tranche
of capital inJune 1995. This is certainto create political hurdles
in both countries until such time as the tranche is released. In
this way, just as the negotiation of NAFTA allowed for the
incorporation of a non-commercial agenda into the final
agreement, the 1995 financial package for Mexico has opened
the door to bringing the two countries closer together while,
at the same time, making management of their bilateralagenda
that much more difficult.
Reliability of Mexico as a trading partner. Finally,
Mexico's reliability as an international trading partner is now
under scrutiny, particularly since several trade agreements,
including those with Colombia, Venezuela, Costa Rica, and
Bolivia, entered into force in 1995. Negotiations are still
pending with the rest of the Central American countries
(excepting only Belize and Panama), and there is a clear need
to redefine Mexico's relationship with South America, particu-
larly now that MERCOSURhas begun operations. In the United
States, those who opposed the NAFTA have responded to
Mexico's devaluation and economic problems with a resound-
ing "I told you so," which gives this sector of US opinion an
opportunity to take up the cudgels once again against Mexico,
the NAFTA, and international trade in general. With Chile
starting to negotiate its entry into NAFTAas well, these attacks
will only intensify.
B. Impactfor the UnitedStates

With the NAFTA,the United States and Mexico entered
into a whole new era in their historically difficult bilateral
SPRINGER THEMEXICAN
ANDMOLINA: FINANCIAL
CRISIS 73
relationship. NAFTAis not, of course, a panacea for resolving

the ills of the relationship. However, it does provide clear rules
of the game, an institutional framework for constructive
engagement and dialogue, and a structurefor settling disputes.
The NAFTAalso represents a significant commitment by the
two countries to collaborate in bringing qualitative improve-
ment to every area of the relationship.
The Mexican economic crisis marks the first real test of
that long-term commitment. President Clinton showed great
courage and resolve in taking executive action to come to the
assistance of Mexico in the face of the resistance manifested by
the US Congress. By the same token, President Zedillo also
exhibited great maturity and political guts in asking for that
assistance. The US Congress, on the other hand, only showed
that, once again, it is ill-equipped to act quickly, decisively, or
with one voice on an important foreign policy issue, even
when US economic interests are clearly at stake.
Other implications for the US worth mentioning would
include:
Overall decline in US exports to Mexico. Afterthe US
registered a predictably strong growth in exports to Mexico
under the first year of the NAFTA, the devaluation and
economic crisis caused most of those export sectors to suffer
a sharp decline. February-to-Februarytrade figures showed a
US surplus of $400 million in February1994, and a $1.25 billion
surplus for Mexico in February 1995 - a $1.6 billion turn-
around in Mexico's favor. Also in late February 1995, a US
Embassy report, reviewing 27 sectors of what had been
considered "bestbets" for US exports to Mexico, predicted that
most of these sectors would register either substantial reduc-
tions, if not outright elimination, due to the higher cost of
imports (and, hence, higher costs to the consumer) and the
general downturn in economic activity and purchasing power.
[On the other hand, the import of services from the United
States continues to grow strongly.] While this alteration may
provide some breathing space to those Mexican industries still
in the process of adjusting to and consolidating the market
opening initiated by the Salinasadministration,exporters in the

United States will experience disappointment, if not frustra-
tion, until the Mexican market stabilizes and begins an upturn
once more.
US leverage over Mexico. The conditions imposed by
the US financial stabilization package, combined with the strict
structural adjustment program of the IMF, will undoubtedly
operate to increase the influence of the United States in matters
concerning Mexican economic policy and could even be
applied to increase the US leverage in areas beyond the
economic sphere, making itself felt in such areas as immigra-
tion policy and control of the drug traffic.This leverage might
even be extended to pressure changes in other areas, like the
state monopoly of the petroleum industry. Such a possibility,
though most likely only temporary, would certainly add to, and
exacerbate, traditional tensions in the bilateral relationship -
particularly as these could be issues raised against President
Clinton in the upcoming 1996 political year in the US. None of
this will play well in Mexico.
Intensification of Mexico-bashing. Naysayersin the
US - including putative presidential candidates like Ross Perot
and Pat Buchanan - haven't missed a beat in their excoriation
of the US policy toward Mexico. Legislation was even intro-
duced to tighten and extend the initial conditionality of the
support package by traditionalMexico bashers and administra-
tion opponents like Senator Alfonse D'Amato and his coterie,
and Senator Jesse Helms, the new Chairman of the Senate
Foreign Relations Committee, who hasn't missed any opportu-
nity to criticize the Clinton administration.Even Clinton's own
Democratic partyrefused to cooperate in the support package.
This was an intensified "business as usual" by NAFTAoppo-
nents, but the sound level has definitely been turned up and
is likely to affect the ongoing debate regarding extending the
NAFTAto other countries in the Hemisphere, as called for at
the Summit of the Americas in December 1994. After so much
success in the first year of the NAFTA (and Mexico's past
success in changing its international image), those who take a
SPRINGER
ANDMOLINA:
THEMEXICAN
FINANCAL
CRISIS 75
short-term view of the relationship are certain to make all

things Mexican a domestic political issue in the United States
if they can.
C. Effecton ThirdParties
The "Tequila Effect" (effect of Mexican crisis on other
Latin American countries). Emerging markets, particularly
those in Latin America, have also been affected by the Mexican
crisis. The flow of portfolio capital into Latin American stock
markets, and into financial instruments held outside the region,
all but stopped. This should not be a surprise since the Mexican
market had become the bellwether of emerging markets, and
studies have demonstrated the marked correlation between the
fortunes of the Mexican stock market and those in Argentina
and Chile. Finance ministers around the world now go out of
their way to point out how their economic and monetary
regimes differed from that of Mexico prior to the crisis. The
recent meeting of APEC spent considerable time discussing the
Mexico situation with a view to avoiding a similar problem in
the Asian markets. There has been, in short, a "giant sucking
sound" of portfolio investment capital moving out of the
region, a process that is likely to reverse itself only when the
greed factor replaces the fear that has gripped the market.
Lack of confidence in Mexico as a trading partner.
Those who were interested in Mexico as a partner for trade, like
the countries in Central and South America, have come to view
their emerging trade relationships with Mexico with something
like dismay. Many may already be recalculating the hoped-for
benefits of their existing agreements and be looking in other
directions. This will make it more difficult for Mexico to
reestablish these relationships once the economy stabilizes.
Dampening of the Summit of the Americas process.
The Mexico financial crisis hit just a few short days after all of
the countries in the Americas adopted the Summit of the
Americas plan of action which called for creation of a "Free
Trade Area of the Americas" within 15 years. Since then,
enthusiasm within the United States has begun to wane, and it

remains to be seen how willing LatinAmerican policymakers
will be to commit to long term liberalization and negotiation
with partners who may be viewed as capricious on the one
hand (the US) or as unreliable (Mexico) on the other. The
Mexican situation has been a clear setback for this pragmatic,
forward-looking process.
V. IMPLICATIONS
W HILEsome have drawn parallelsbetween the foreign

debt crisis of the early 1980s (the so-called "lostdecade"
in Latin America), there are distinct differences in both the
substance and the perception of this crisis. Using Mexico as an
example (although they could, by extension, apply to most
Latin American markets), we would make the following
observations:
* In 1995, the eyes of the world press and financial markets
are focused on Mexico (as well as all emerging markets)
and the perceptions by the media are responsible for the
rapid movement of investment capital.
* The opening of the market, the successes Mexico has
enjoyed as the most bullish emerging capital market in the
world, the substantial flow of private capital investment to
Mexico, and the NAFTA,among other events, have drawn
the world's attention to events in Mexico in recent years.
Every blip in risk factors and every mini-crisis and
sideshow are covered in the press, and every inconsistent
official statement by Mexican officials is reported and
analyzed.
* In the early 1980s, there was no foreign portfolio invest-
ment in the Mexican market, and the economy was not
subject to the market forces to which it has become
exposed by the opening in the 1990s. The rapid liquida-
tion of portfolio investment - the risk capital that has
been financing the currentaccount while investors reaped
SPRINGER
ANDMOLINA:
THEMEXICAN CRISIS
FINANCIAL 77
enormous benefits - is a clear indication of the new

market forces pressuring the Mexican economy.
And, finally, only a handful of international commercial
banks were Mexico's creditors in 1982; getting them into
a room to negotiate new terms was difficult, but not
impossible. Today, over 12 million individuals hold Mexi-
can debt and equity instruments. Communicating with
them, and rebuilding their confidence, offers a far greater,
more public challenge than that faced by negotiators in
the 1980s.
What does all of this mean for the players in this drama?
and where will it all play out? Some thoughts.
The bottom line for the Mexican economy is less
growth in 1995. Imports will cost more although exports will
be more competitive and attractive.However, export markets
are not developed overnight, and the added competitiveness
of Mexican exported goods will take some time to be realized.
Some private debt will have to be restructuredover the medium
term, particularly that debt which is held abroad. Consumer
spending will contract, wages will rise only marginally, and
interest rates will spiral. It will make more sense to invest in
Mexico than to export to Mexico in the short-to-mid term.
Nevertheless, it is worth remembering that Mexico has a far
greater capacity to recover in the medium term than most, if not
all, other emerging markets. President Zedillo has pledged that
this will be a crisis of short duration to the Mexican people. It
will be no easy task to deliver on this promise.
The fundamentals for trading and investing long-
term in the market remain sound: the Zedillo administra-
tion has responded with an orthodox policy which, once in
place, provides the business sector with rules of the game to
begin planning for coming months. Furthermore,NAFTArules
for trade and investment are also in place, serving to discipline
the market and provide clear rules and transparency of the
legal process. NAFTAwill provide some relief in other respects
as well, since it guarantees market access to Mexico's most
important partner. Although the flow of goods into Mexico has
fallen substantially, this market access will help Mexico eco-

nomically through this temporary hardship. There are signs of
support by the international allies of the business community,
a support that should be nurtured and maintained in order to
help Mexico weather this storm. For example, the early
willingness of the international banking community to open a
line of credit was well-received and given positive coverage by
the press. In addition, investors are still looking at Mexico as
a destination for direct investment, and opportunities for equity
investment opportunities abound.
On the other hand, there may be some retaliation from
those countries with whom Mexico has no trade agreement
due to the increase in Mexican tariffs. The opening of the
Mexican economy has had dire consequences for some of the
country's industrial sectors, which is certain to add to the
growing unemployment there. In addition, the Zedillo admin-
istration is mandated to carry out a strict IMF structural
adjustment program, which means that it will have to restrict
the growth of credit, another factor that will contribute to
economic downtur. Once the crisis is under control, the
administration is more likely to turn its attention to an
aggressive economic growth policy in order to furnish the
funds needed to increase social spending.
An increase in the pace of privatization will also help
to fund this policy, at least in part, as the administrationbegins
to sell off its secondary petrochemicals industry (now a part of
the state-owned Pemex), ports, airports, roads, bridges, rail-
roads and, possibly, the federal electricity monopoly (CFE).
Much of this was already part of the Zedillo economic package
and would represent a boost for government revenues, long-
term gains in terms of efficiency, and would help to reduce the
size of the government and its influence over the economy.
Success ofthe Marcheconomic package and a return
to growth are key elements in establishing the Zedillo
government's leadership. The Mexican president faces an
uphill battle as he endeavors to restore the confidence of
Mexican citizens in (1) their political institutions, (2) the
country's economic viability, and (3) hope for the future.
SPRINGER
ANDMOUNA:
THEMEXCAN
FINANCIAL
CRISIS 79
It should not be forgotten that Mexico is currently

undergoing a political transformation that is far more
painful than -but equally as significant as - its economic
modernization of the recent past. President Zedillo has far
less of a mandate than his predecessors, is pledged to separate
his party(the PRI)fromhis government, and has begun a process
of judicialand legislative reformthat, if successful, is intended to
make Mexico a countryruled by law ratherthanby executive fiat.
While laudable and worthy of recognition by the international
community, this is a difficultlong-term goal even in good times
and adds yet another element of risk to the market.
The quiet, but growing, backlash against US compa-
nies that has occurred over the last 10 months, from both
consumers and domestic competitors in Mexico, can be
expected to intensify due to the economic crisis. This
backlash is due to a mix of a number of elements that includes,
among others: (a) a residue of the ill-feeling that rose to the fore
during the NAFTAdebate; (b) resentment engendered by anti-
immigrantsentiment and legislation in the US (viz."Proposition
187"in California);(c) umbrage at the arrogance of some newly
international US companies, which has lent substance to the
specter of the "uglyAmerican"of the 1990s; (d) the perception,
if not fear, that the gringos will own Mexico; (e) lingering
effects from the need to compete in the international market-
place (a competition that began in the mid-1980s, with the
initial opening of the domestic market to imported goods, and
which culminated in the permanent opening guaranteed by
NAFTA);(f) a nationalistic feeling that the economic opening
has gone too fartoo fast; and (g) a more pervasive concern that
the country is in danger of losing control of its economic future.
The nervousness of the market will require inves-
tors to consider the timing and scope of their strategic
entry into Mexico with great care, not only because they face
a new economic situation and new rules of the game, but also
because a variety of new political actors and faces, both in and
out of government, add to their perception of risk.
Although the medium term focus of Mexican officials will

be on implementation of domestic policy, the economic
crisis will continue to influence US political and public
support for the NAFTAin particular and Mexico in
general Under the changed and changing circumstances,
Mexico will need to rethink its overall communications strat-
egy, paying particularattention to the extent to which the crisis
impacts the export of US goods to Mexico (combined with a
corresponding rise of Mexican exports to the United States) and
the resultant outcry on the part of certain sectors of the US
business and political communities (fuelled by feelings of
betrayal) who find themselves hurt at this state of affairs.
Furthermore,Mexican programs in support of domestic indus-
try will have to be carefully crafted to avoid violating the
NAFTA,and the government may have to face the prospect that
some of these programs will be challenged by its partners.
Moreover,NAFTAopponents may seize the opportu-
nity to use the crisis to cripple its long-term economic
benefits, raising various side issues as part of their negative
campaign. Mexico will be hard-pressed to manage these
NAFTA-relatedissues and non-issues pro-actively while, at the
same time, focussing its attention on domestic economic issues.
Mexico continues to see its hard-won reputation
denigrated in the domestic and international arena. The
experience of the last few years - particularly during the
negotiations and debate over the NAFTA- has created the
expectations, on the part of the media and the public at large,
that the Mexican government and private sectors will hence-
forth communicate openly, professionally, and forthrightly.
Because this expectation was not met during the initial stages
of the crisis, the media was afforded an opportunity to criticize,
if not castigate, the government on both its substantive and
stylistic handling of the situation. In order to repair its credibil-
ity both at home and abroad, the Mexican government will
have to open up its communications system and be prepared
to deal with difficult subjects in a more direct and clearcut way.
ANDMOLINA:
SPRINGER THEMEXICAN CRISIS
FINANCIAL 81
Finally, Mexico is viewed as the bellwether for Latin

America in terms of economic health and level of risk.
Whether rightly or not, this perception has already contributed
to the lack of investor confidence in the capital markets of the
region and, thus, to the long-term viability of, and commitment
to, the economic modernization policies so recently estab-
lished there.
VI. CONCLUSIONS:
THE OUTLOOK FOR MEXICO
THE economicopening,the introductionof the NAFTA,and
the currenteconomic crisis have combined to open up
additional political space in Mexico that is quickly being
occupied by new elements: emerging interest groups, the
privatesector, and opposition parties.The realityof this new
politicalspace is reflectedinthe opennessof protestagainstthe
establishmentand a weakening of political institutions.This
situation provides additionalchallenges, both political and
social, for the governmentover and above the need to restore
economic growth. Economic recovery and restoration of
confidence will depend as much on improvingthe country's
political and social conditions as it will on meeting the
requirements established under the multilateral financial
assistance package. Much remains to be done, including
ending the insurrection in Chiapas, to restore the confidence
and trustof Mexicansin Mexico,perhapsthe greatest- and
the most important- challengeto the Zedilloadministration.

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The Mexican Financial Crisis

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The Mexican Financial Crisis: Genesis, Impact, and Implications

Author(s): Gary L. Springer and Jorge L. Molina

Gary L. Springer is Vice-President of Fleishman-Hillard, an interna-

sparked severe economic repercussions, including a crisis of

II. HOW DID IT ALLSTART?

(2) become an active participant in the Uruguay Round of the

ness executives), investor mood was generally upbeat, particu-

men: Alfredo Harp, Chairmanof Banamex; and Angel Lozada,

the candidate of another party remained a threat for much of

of the year and continues to haunt the new Zedillo administra-

III. CHRONOLOGY OF THE ECONOMIC

international reserves plunged sharply downward: falling from

pointed by the decision of the Mexican government not to alter

situation, its reception was undermined by several factors-

New York. Nevertheless, the terms of the final agreement were

IV. IMPACT OF THE CRISIS

A. Domestic Impact on Mexico

contraction of the economy of 3-5%; interest rates spiralling

allegation that continued long afterthe militarythreatwas over;

Priority ofthe rule of law over the exercise of power.

with additional leverage on a variety of bilateral issues, like the

B. Impactfor the UnitedStates

relationship. NAFTAis not, of course, a panacea for resolving

opening initiated by the Salinasadministration,exporters in the

short-term view of the relationship are certain to make all

enthusiasm within the United States has begun to wane, and it

W HILEsome have drawn parallelsbetween the foreign

enormous benefits - is a clear indication of the new

fallen substantially, this market access will help Mexico eco-

It should not be forgotten that Mexico is currently

Although the medium term focus of Mexican officials will

Finally, Mexico is viewed as the bellwether for Latin

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