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    The Tequila Effect

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    Shrutakeerti Army blink
    The Tequila Effect refers to the impact of the 1994 Mexican peso crisis on South American economies. Mexico had implemented economic reforms from 1988-1993 that stabilized inflation and attracted foreign investment. However, the peso was devalued by 15% in December 1994, unleashing global financial turmoil. Over $4.6 billion fled Mexico in the two days after the devaluation announcement, depleting half of the foreign exchange reserves and causing a total peso devaluation of 35% by the end of December. This triggered an economic crisis in Mexico termed the Tequila Effect.

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    The Tequila Effect

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    Shrutakeerti Army blink
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    The Tequila Effect refers to the impact of the 1994 Mexican peso crisis on South American economies. Mexico had implemented economic reforms from 1988-1993 that stabilized inflation and attracted foreign investment. However, the peso was devalued by 15% in December 1994, unleashing global financial turmoil. Over $4.6 billion fled Mexico in the two days after the devaluation announcement, depleting half of the foreign exchange reserves and causing a total peso devaluation of 35% by the end of December. This triggered an economic crisis in Mexico termed the Tequila Effect.

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    The Tequila Effect refers to the impact of the 1994 Mexican peso crisis on South American economies. Mexico had implemented economic reforms from 1988-1993 that stabilized inflation and attracted foreign investment. However, the peso was devalued by 15% in December 1994, unleashing global financial turmoil. Over $4.6 billion fled Mexico in the two days after the devaluation announcement, depleting half of the foreign exchange reserves and causing a total peso devaluation of 35% by the end of December. This triggered an economic crisis in Mexico termed the Tequila Effect.

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    56 views2 pages

    The Tequila Effect

    Uploaded by

    Shrutakeerti Army blink
    The Tequila Effect refers to the impact of the 1994 Mexican peso crisis on South American economies. Mexico had implemented economic reforms from 1988-1993 that stabilized inflation and attracted foreign investment. However, the peso was devalued by 15% in December 1994, unleashing global financial turmoil. Over $4.6 billion fled Mexico in the two days after the devaluation announcement, depleting half of the foreign exchange reserves and causing a total peso devaluation of 35% by the end of December. This triggered an economic crisis in Mexico termed the Tequila Effect.

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    THE TEQUILA EFFECT

    The “Tequila effect” is the name given to the impact of the Mexican peso crisis on the South
    American economy during 1994.
    From 1988 to 1993, Mexico followed a strategy of economic adjustment and reform that
    strengthened fiscal consolidation and structural changes initiated after the 1982 debt crisis and
    the 1986 collapse of oil prices which had sent the economy reeling. The strategy, which had the
    active support of the IMF aimed at restoring macro- economic stability, reducing the role of the
    public sector in the economy and laying the foundations for private sector led growth. Inflation
    had reduced substantially, foreign investors were pumping money into the country, and the
    central bank had accumulated billions of dollars in reserves.
    Capping the favorable developments was the proposal to reduce trade barriers with Mexico’s
    largest trade partner, the United States, through the North American Free Trade Agreement
    (NAFTA). Less than twelve months after NAFTA took effect, Mexico faced economic disaster.
    On December 20, 1994, the Mexican central bank responded to the crisis by devaluing the peso
    between 13 and 15 percent, thereby unleashing financial turmoil on global a scale. To limit the
    excessive flight of capital, the bank also raised interest rates. Short-term interest rates rose to
    32 percent resulting in higher costs of borrowing.
    The timeline of the peso crisis is as follows:

     March-November 1994:
    Mexico had a crawling peg exchange rate system. Government intervention kept the
    exchange rate vis-à-vis the dollar within a narrow target band, but the upper limit of the
    band was raised slightly every day by a preannounced amount, allowing for a gradual
    nominal depreciation (a “crawling peg”) of the peso. This led to a rapid decline in foreign
    exchange reserves. In November USD 3bn is pulled out of the country, of which USD
    1.6bn on a single day (18 November).

     December 15th, 1994 


    The Wall Street Journal publishes an interview with the new Finance Minister Jaime
    Serra Puche, in which he denies that Mexico will devaluate the peso. The next day, USD
    855 m leaves Mexico.

     December 20th, 1994


    The new cabinet concludes that the situation is unsustainable. Therefore, the Central
    Bank of Mexico announces a lift of the upper band of the exchange rate by 15%, an
    effective devaluation of the peso.

     December 20-21th, 1994


    In the two days after the announcement, USD 4.6 bn leaves the country, half of the
    foreign exchange reserves.
     December 22th, 1994
    The intervention on the foreign exchange market is lifted, and the peso is allowed to float
    freely. The total devaluation of the peso amounts to 35% by the end of December.

    This caused an economic crisis termed as the Tequila Effect.

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