What Lessons Does the Mexican Crisis Hold for Recovery in Asia?

• Author: Guillermo Ortiz Martinez
• Position: Former Executive Director of the IMF, is Governor of the Bank of Mexico

The Mexican and the Asian crises have striking similarities. A comparison of the two provides lessons about how emerging economies can safeguard themselves against sudden capital outflows.

MICHEL CAMDESSUS, the Managing Director of the IMF, described the Mexican crisis in 1994-95 as "the first financial crisis of the twenty-first century" to draw attention to the volume and velocity of the capital flows involved. The similarities between the Mexican crisis and the recent financial crises in some Asian countries are striking. What stand out are the problems of economic policy management faced by emerging nations in a world of highly mobile capital. A comparison of the two crises can help us to understand better their causes and yield some useful lessons about the vulnerability of emerging economies to sudden capital outflows.

The foreign exchange and financial problems encountered by Mexico in 1994-95 and by the Asian economies in 1997-98 caught many by surprise, given that these economies were considered to be fundamentally sound and even held up as models for others to emulate. The huge fiscal deficits or high inflation seen in other countries that have experienced financial crises were not apparent in either Mexico or the Asian countries. Both the Mexican and the Asian crises were preceded by very buoyant financial markets for the assets of the countries in question and, therefore, by major inflows of capital. In both cases, investors abruptly changed their attitudes, leading to bouts of panic and massive outflows of capital. Similarly, the sudden interruption of capital flows unleashed a profound crisis in domestic financial systems, threatening the stability of the productive sectors.

Prelude to the crises

The process of structural change and macroeconomic stabilization initiated in Mexico 12 years ago, and the exceptional economic development of most of the Asian countries from the late 1980s through early 1997, contributed to the very rapid growth of net capital inflows into those countries (see chart). In addition, investors seeking better returns at a time when industrial country markets seemed to offer less profitable opportunities, owing to slow economic growth and lower interest rates, transferred vast amounts of capital to the emerging markets, possibly underestimating the risk in those markets. Mexico and the Asian countries are high on the list of countries that benefited from this behavior.

[ SEE THE GRAPHIC AT THE ATTACHED RTF ]

In both cases, the capital flows contributed to a very pronounced expansion of aggregate demand, a considerable increase in stock and real estate prices, accelerated growth of bank assets and liabilities, and a sizable external current account deficit (Table 1).

[ SEE THE GRAPHIC AT THE ATTACHED RTF ]

Mexico received considerable capital inflows in the years leading up to the crisis of 1994-95. To a large extent, this capital was attracted by the favorable outlook for the economy after years of macroeconomic stabilization and intensive structural reform. Starting in the mid-1980s, the country had embarked on a program of fiscal consolidation, deregulation, and privatization. It had also undertaken major financial reforms, renegotiated its...