The credibility earned by prudent policymaking over the past decade should help Mexico weather the current financial storm without devastating effects on real economic activity.Economic conditions - Mexico ; Financial crises ; Peso, Mexican ; Foreign exchange ; Financial markets

Edward Skelton

Erwan Quintin

English

Research Papers in Economics

SouthwestEconomy    FEDERAL RESERVE BANK OF DALLAS • NOVEMBER/DECEMBER 2008 10
How Much Will the  
Global Financial Storm 
Hurt Mexico?
By Erwan Quintin and Edward Skelton
Once inward-looking and crisis-prone, 
Mexico has transformed itself into a nation 
that thrives on foreign investment and trade 
and displays a steadfast commitment to 
monetary and fiscal discipline. 
Largely as a result of this transforma-
tion, Mexico has been crisis-free since 
1995. The country has now weathered two 
potentially turbulent presidential transitions 
without experiencing significant financial 
difficulties—a remarkable achievement, 
given its economic history.
Now, this newfound resiliency is being 
put to its biggest test yet as Mexico con-
fronts the consequences of a global shock 
of a magnitude not seen in decades. Finan-
cial turmoil around the world is reducing 
the availability of credit, hurting consumer 
confidence and spending, and depressing 
external demand, especially from the ailing 
U.S. manufacturing sector. Mexico’s pros-
pects for economic growth have been nota-
bly downgraded.
Two decades ago, these shocks almost 
surely would have pushed Mexico into fi-
nancial chaos. Fortunately, the country’s re-
cent transformation makes such a collapse a 
remote possibility. The credibility earned by 
prudent policymaking over the past decade 
should help Mexico weather the current 
financial storm without devastating effects 
on real economic activity.
Mexico’s Transformation
Between the mid-1970s and the mid-
1990s, sharp devaluations in the peso’s 
exchange rate against the dollar invariably 
occurred around presidential transitions. In 
several cases, these currency collapses were 
accompanied by debt defaults and bank-
ing crises, which took massive tolls on the 
economy. 
The 1982 crisis prompted Mexico to 
begin opening its economy to foreign trade 
and investment. These reforms, however, 
proved insufficient to insure against another 
crisis. Political uncertainty surrounding the 
1994 presidential contest and doubts about 
the nation’s commitment to macroeconomic 
discipline fed speculative attacks against the 
peso. In December 1994, authorities were 
forced to announce yet another drastic 
devaluation, throwing the recently priva-
tized banking sector into turmoil. In 1995, 
Mexico experienced its largest fall in GDP 
since the 1930s.1
The 1995 Tequila Crisis became a turn-
ing point in Mexico’s economic history. The 
nation no longer tries to defend a fixed 
dollar–peso exchange rate, a policy that 
frequently led to disaster during turbulent 
times. Since 1995, Mexico has managed to 
keep budget deficits within a reasonable 
range and has staunchly targeted inflation 
with remarkable results (Chart 1). 
Investors have grown increasingly 
confident in the country’s commitment to 
macroeconomic discipline, allowing Mexico 
to greatly improve its public debt manage-
The credibility earned by 
prudent policymaking over 
the past decade should help 
Mexico weather the current 
financial storm without 
devastating effects on real 
economic activity.
Chart 1
Mexico Conquers Inflation
Percent/year
0
10
20
30
40
50
60
’07 ’05 ’03 ’01 ’99 ’97 ’95
SOURCE: Banco de México.     FEDERAL RESERVE BANK OF DALLAS • NOVEMBER/DECEMBER 2008 SouthwestEconomy 11
ment. The government ran into trouble a 
decade ago in part because most of its debt 
was in foreign hands, dollar-denominated 
and short-term. 
The external share of total public debt 
has fallen from a high of 85 percent before 
the Tequila Crisis to 40 percent today. In 
1995, Mexico’s longest bond had a matu-
rity of one year. Today, the nation issues 
30-year, peso-denominated bonds. 
This deep change in the composi-
tion of debt became possible because of 
disciplined policymaking and has greatly 
bolstered Mexico’s ability to deal with 
short-term fluctuations in interest rates or 
exchange rates.2
Not Crisis-Proof
Through September 2008, the volatility 
in developed countries’ financial markets 
wasn’t seen as a threat to Mexico’s financial 
stability. The situation began to change in 
early October as international investors’ 
quest for liquidity and safety led them to 
reduce their exposure to emerging markets. 
The peso reached a six-year high 
against the dollar in early August but then 
began to falter. On Oct. 8, this weakening 
intensified as the peso dropped by 13.8 
percent on the day (Chart 2). 
The fall was exacerbated when sev-
eral large Mexican companies started sell-
ing pesos to cover speculative bets on the 
exchange rate (see box titled “Playing with 
Derivatives Burns Mexican Companies”). 
Mexico hadn’t experienced such a currency 
depreciation since the Tequila Crisis. 
The premium Mexico must pay on 
its debt relative to comparable U.S. instru-
ments also spiked in October and reached 
its highest level in over 10 years (Chart 3). 
There have also been some signs of 
stress within Mexico’s financial system. The 
cost of short-term funding has risen over 
the past three months. Some corporations 
are reporting difficulties rolling over their 
commercial paper. Moreover, corporate 
bond rates have been under pressure re-
cently as mutual fund managers scramble to 
sell some of their holdings to meet clients’ 
redemptions. 
Still, as a result of the steps taken since 
the Tequila Crisis, Mexico continues to be 
viewed as a relatively safe haven, and the 
spread on Mexican bonds remains lower 
than that of the rest of Latin America and of 
global emerging markets.
Fast Foreign Exchange Response 
In an effort to moderate volatility, the 
Banco de México has intervened in the 
foreign exchange market in two ways. First, 
the central bank has orchestrated four sepa-
rate extraordinary offerings of U.S. dollars 
(Chart 2). Second, the central bank has re-
instituted daily dollar sales.3 
Through these two facilities, more 
than US$13 billion of Mexico’s international 
reserves have been spent to ease peso vola-
tility. As of Dec. 5, US$84 billion in interna-
tional reserves remained for any necessary 
future interventions. Should that large cush-
ion not suffice, the Federal Reserve has es-
tablished a US$30 billion line of credit with 
Chart 3
Country Premium Rises
(Emerging Markets Bond Index yield spreads over U.S. interest rates)
Basis points
Emerging markets
Latin America
Mexico
0
200
400
600
800
1,000
1,200
1,400
1,600
1,800
’08 ’07 ’06 ’05 ’04 ’03 ’02 ’01 ’00 ’99 ’98
SOURCES: CTRB J.P. Morgan Chase Bond Indexes; Bloomberg.
Chart 2
Central Bank Supports Peso
Peso/U.S. dollar (daily close)
9.5
10
10.5
11
11.5
12
12.5
13
13.5
14
November October September August
Banco de México intervenes
SOURCE: Banco de México.
the Banco de México, authorized through 
April 30, 2009, to support dollar liquidity.
Foreign exchange market interventions 
are a temporary fix. The hope is that, in the 
long run, Mexico’s disciplined policymak-
ing, sound macroeconomic conditions and 
solid financial fundamentals will assuage 
investor concerns about the peso.
Government Helps Debt Markets Too
Mexican authorities have also taken a 
number of preemptive measures to support 
liquidity in debt markets. 
The Banco de México announced a 
new measure allowing commercial banks 
to use their required reserves as collateral 
for short-term funding through guaranteed 
loans. Banks can also access short-term 
funding through repurchase agreements 
with the central bank in exchange for a 
wide range of government and corporate 
debt instruments. 
As for nonbank financial institutions, 
the Secretaría de Economía has set up 
a guarantee fund of 2.5 billion pesos to 
improve their access to liquidity. It bears 
mentioning that, to date, no institution has 
taken advantage of these liquidity measures.
For its part, the Hacienda (Finance 
Ministry) announced a 50 billion peso 
loan guarantee program designed to help 
companies roll over short-term debt or 
commercial paper. The loan guarantees 
will be provided via development banks SouthwestEconomy    FEDERAL RESERVE BANK OF DALLAS • NOVEMBER/DECEMBER 2008 12
Nafin and Bancomext. Companies using 
the guarantees—which are for a maximum 
of 500 million pesos per issuance and for a 
maximum term of six months—are required 
to provide collateral. 
Although there have been anecdotal 
reports of liquidity shortfalls in Mexico’s 
mortgage market, data indicate that this 
market hasn’t yet been significantly affected 
by the credit crisis. Mortgages originated 
rose modestly year-over-year through Oc-
tober. 
Nevertheless, Mexico’s housing devel-
opment bank Sociedad Hipotecaria Federal 
will preemptively offer over 40 billion pe-
sos to shield the country’s 985 billion peso 
mortgage industry from the external crisis. 
This includes 20 billion pesos in credit 
lines, guarantees for mortgage finance 
companies, and more than 20 billion pesos 
for mortgage finance companies to fund 
individual mortgages and bridge loans to 
homebuilders. 
Finally, the Banco de México, the 
Comisión Nacional Bancaria y de Valores 
and the Hacienda introduced a series of 
measures aimed at alleviating pressures in 
the local bond market. 
The initiatives include a reduction of 
10-, 20-, and 30-year government bond is-
suances for the remainder of 2008 in favor 
of treasury bills; credit lines of up to US$5 
billion to the government from multilateral 
lenders through 2009; a reduction of the 
size of the weekly auction of debt securities 
issued by deposit insurance agency IPAB; 
and the establishment of a program that 
will enable the Banco de México to repur-
chase IPAB securities. 
These measures are all designed to im-
prove liquidity and short-term funding and 
alleviate pressure in the local fixed income 
market. Once liquidity conditions improve, 
government authorities will return to stan-
dard borrowing practices.
Mexico’s Outlook
Mexico is much better equipped to 
deal with adverse economic shocks today 
than at any point in its recent history. Nev-
ertheless, the global financial crisis will im-
pact the economy in several key respects. 
Domestic credit contraction and in-
creased uncertainty about future growth 
will dampen domestic spending for the 
short term. Mexican consumers are report-
ing that their situation has worsened com-
pared with 12 months ago and that they 
expect it to deteriorate further in the next 
few months. The fraction of households 
reporting plans to make a large purchase 
over the next 12 months has collapsed. In 
September, retail sales showed their weak-
est growth in over five years.
Another damper on consumer spend-
ing comes from a weak U.S. economy, 
which means less growth in remittances to 
Mexico over the next few quarters. 
The global slowdown is taking a toll 
on external demand as well. Mexico de-
pends on the U.S. manufacturing sector for 
about 80 percent of its exports, and the two 
nations’ industrial sectors are closely syn-
chronized (Chart 4). In light of this depen-
dence, the latest data hint that the worst is 
yet to come for Mexico’s industrial sector. 
A drastic contraction of U.S. manufac-
turing is under way. History suggests this 
will cause Mexico’s manufacturing output 
to weaken. Losses are particularly severe in 
the U.S. auto sector—a leading destination 
for Mexican exports—which hurts Mexico’s 
short-term prospects. 
These headwinds have caused analysts 
and government agencies to revise down 
projections for economic performance over 
the next two years. As of November, real 
growth was expected to be below 2 percent 
this year. For 2009, private analysts sur-
veyed monthly by the central bank of Mex-
ico expect growth to be below 0.5 percent, 
less than one quarter the rate they expected 
as recently as two months ago (Chart 5). 
Chart 4
Together, for Better or Worse
(Industrial production index, seasonally adjusted)
Index, 2002 = 100
Mexico
United States
70
75
80
85
90
95
100
105
110
115
120
’08 ’07 ’06 ’05 ’04 ’03 ’02 ’01 ’00 ’99 ’98 ’97 ’96 ’95
SOURCES: Instituto Nacional de Estadística, Geografía e Informática; Federal Reserve Board.
Mexico is much better 
equipped to deal with   
adverse economic shocks 
today than at any point 
 in its recent history.     FEDERAL RESERVE BANK OF DALLAS • NOVEMBER/DECEMBER 2008 SouthwestEconomy 13
Real growth fell to its weakest rate 
in five years during the third quarter. The 
industrial sector is already contracting. So 
far, the service sector is showing sufficient 
resiliency to keep the economy growing. 
Growth could weaken further once the 
Playing with Derivatives Burns Mexican Companies
The Comisión Nacional Bancaria y de Valores is investigating Mexican corporations’ use of financial 
derivatives after losses on these contracts caused the country’s third largest supermarket chain, Controla-
dora Comercial Mexicana, to declare bankruptcy. 
In its bankruptcy filing, Comercial Mexicana cited more than US$2 billion in liabilities, some tied to a 
$1.4 billion loss in peso derivatives. Other nonfinancial firms—hotel and resort company Grupo Posadas; 
steel, paper and consumer product conglomerate Alfa; tortilla maker Gruma; and glass producer Vitro— 
also disclosed large trading losses tied to financial derivatives. 
These firms all took unexpected and unusual currency risks having little direct relationship with their 
core businesses. Because they had bet that the peso would be stable or rise, they were caught exposed when 
the peso began to weaken. As these bets began to go bad, the companies had to buy dollars to cover their 
exposure, which aggravated peso weakness in an already illiquid global market. 
In addition, concerns about companies’ exposure to derivatives have compounded existing fears for 
Mexico’s corporate sector, whose core operations had already begun to be adversely impacted by the U.S. 
downturn and financial crisis. 
It should be pointed out that the list of Mexican corporations threatened by speculative positions 
on currency derivatives isn’t expected to grow further. Mexican companies with large dollar-denominated 
debt are generally exporters to the U.S., which provides them with a natural hedge against exchange-rate 
volatility. Exporters also tend to have long-term debt and, therefore, are less exposed to short-term currency 
fluctuations. 
Chart 5
Growth Expectations Have Plummeted in 2008
(Private growth forecasts by vintage)
Expected annual growth in real GDP (percent)
2008
2009
0
0.5
1
1.5
2
2.5
3
3.5
4
Month of survey, 2008
Nov. Oct. Sept. Aug. July June May  April March Feb. Jan.
SOURCE: Banco de México.
crisis’ toll on consumer spending becomes 
more pronounced.
The full impact of the global turmoil 
on Mexico will depend on how quickly the 
world financial system can return to normal 
and on the depth and length of the U.S. 
manufacturing contraction—factors that are 
eminently difficult to predict. However, for 
the time being, the biggest external shock 
in decades is causing analysts to forecast 
only a slowdown in growth rather than ut-
ter collapse, demonstrating how far Mexico 
has come over the past two decades. 
If anything, the adverse global en-
vironment is making the need for addi-
tional structural reforms even more urgent. 
Mexico has managed to greatly reduce its 
vulnerability to homegrown shocks. Better 
functioning domestic markets will provide 
the best possible form of insurance against 
external shocks. 
Quintin is a senior research economist and advi-
sor in the Research Department and Skelton is 
a business economist in the Financial Industry 
Studies Department at the Federal Reserve Bank 
of Dallas.
Notes
1 The economic slowdowns in Mexico arising from past 
financial crises, along with the impact on the labor market, 
are studied in “Labor Markets in Turbulent Times: Some 
Evidence from Mexico” by Sangeeta Pratap and Erwan 
Quintin, Federal Reserve Bank of Dallas Southwest Economy, 
no. 5, 2008.
2 For more details on Mexico’s recent economic history, see 
“Mexico’s Financial Vulnerability: Then and Now,” by José 
Joaquín López and Erwan Quintin, Federal Reserve Bank of 
Dallas Economic Letter, no. 6, 2006.
3 Policymakers had originally implemented daily dollar sales 
of US$40 million in 2003 to curtail the growth in foreign 
reserves. However, the peso’s strength and a decline in 
international reserves led to the suspension of dollar sales in 
July 2008. The current auction facility offers up to US$400 
million a day. For more information on the new auction 
facility, see Banco de México Circular 47/2008, published 
Oct. 8, 2008, http://www.banxico.org.mx/tipo/disposiciones/
bancos/47-2008.html.

How much will the global financial storm hurt Mexico?

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How much will the global financial storm hurt Mexico?

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