When the “Tequila Crisis” dealt Mexico the mother of all hangovers twenty years ago it is fair to say that the country was ill-prepared, says Edwin Gutierrez, Head of Emerging Market Sovereign Debt at Aberdeen Asset Management.
“But a country has rarely shaken off a hangover so well and so quickly. Mexico is partway through a cyclical slow-down at the moment, but gross domestic product (GDP) per capita has nearly tripled since the trough of 1995, inflation is manageable and debt-to-GDP is less than 37% (Japan’s is more than 225%). It is amazing what twenty years, a volley of painful lessons and sensible policymakers can do for a hangover”, explains Gutierrez.
One of Mexico’s biggest lessons from the Tequila Crisis was to issue debt in its own currency. A key moment in the crisis was the decision by Mexico to issue short-term debt in dollars. That debt came due very quickly and cost the country dearly as the value of the peso plummeted. It now issues largely in its own currency, which avoids that currency risk. The term of Mexico’s debt is much longer now too, giving it more time to repay it.
When the crisis hit, Mexico had woefully inadequate amounts of foreign exchange reserves which were promptly swallowed up as the peso’s tailspin kicked in, points out Gutierrez. When the coffers ran dry, the U.S. was forced to step in with a bail out. But the country has built up these reserves since, growing from a low of just under US$6 billion in 1994 to around US$180 billion (they have nearly doubled since the financial crisis alone). These reserves are a country’s way of saving for a rainy day, providing insulation when economies turn.
In 1991, the Bank of Mexico effectively fixed the exchange rate by allowing the peso to move within a short range against the dollar. By the end of 1994, a series of events pushed the dollar peg to a breaking point. The U.S. Federal Reserve (Fed) raised rates in February of that year, then a number of domestic events steadily led investors to lose faith in Mexico’s ability to finance its current account deficit, triggering a full-on rout of the peso ensued. Mexico has maintained a floating rate mechanism ever since, which has acted as a shock absorber as confidence has periodically ebbed and flowed.
“The lessons of the Tequila Crisis have been shared throughout emerging markets. Most fixed exchange rates have been replaced by floating systems. Local currency debt is the fastest growing part of the emerging market debt asset class”, says Gutierrez.
The average duration of the local currency debt index is around seven years (Mexico was issuing debt with a term of 28 days in the build-up to the crisis). In other words, issuers are trying to avoid the exact peril which befell Mexico.
Recent reforms under President Peña Nieto may help prevent future crises from emerging. In his first 20 months in office, Peña Nieto passed eleven structural reforms. Reforms to the energy sector, financial services, education, telecommunications, labor and competition policy aim to increase productivity and growth. Mexico’s reforming zeal makes it a bright spot among emerging markets, which in general tend to wait until crises happen before reforming. Spooked investors tend to pull money which forces policymakers onto the back foot and into knee jerk reactions.
According to Aberdeen, Mexico’s reforms should have a meaningful impact on consumer price inflation and get the country some way towards its ambitious 3% inflation target. In Aberdeen’s view, they do not, however, resolve the toxic combination of corruption and the inability of government to enforce the rule of law. There is no better example than the recent, dire abduction and execution of 43 students on the orders of a mayor in Guerrero state. “We do not believe time is on Peña Nieto’s side to fight this particular war, but the sheer zeal and foresight of his reform agenda so far bodes well. It is worth acknowledging, too, how enlightened they are. His energy reforms, for example, should not be fully realized for at least a decade, long after he has left office. We believe introducing competition into Mexico’s oligopolies will actually harm the country’s stock exchange in the short term as these companies see competition squeeze margins”, says Gutierrez.
“Much needs to be done to make sure the reforms lead to the change everyone wants, but it takes enlightened political leadership to have gotten this far. Mexican politicians have also shown a laudible ability to work together that those north of the border would do well to emulate. Mexico’s problems are far from solved but, in our view, the outlook is good. We also believe the reforms will bear fruit. Wage costs are relatively competitive so jobs should be created as China’s wages continue rising and manufacturers stand to benefit from the U.S. recovery. The trick for Mexico is to abstain from the bottle and focus on the task at hand,” concludes the report.
For Funds Society, Madrid
For Alicia Miguel Serrano