RaboResearch - Economic Research

The Tequila crisis in 1994

Economic Report


In the second half of the 20th century, Mexico was confronted with multiple economic crises. In this Special we focus on the crisis of 1994, where a strong devaluation of the peso led to both a currency and banking crisis. A sovereign crisis was just prevented. Next to explaining how the crisis evolved, we describe the economic background and triggers of the crisis.

Evolution of a crisis

March - November, 1994
The crawling peg of the Mexican peso (figure 1) is under fire. Not only does the US Federal Reserve raise its policy rate by 250bps during this time span, Mexico also suffers from political homocides in the lead-up to the presidential elections later that year. Foreign exchange reserves therefore decline rapidly (figure 3). In April, to stop the outflow of foreign currency, the Mexican government issues short term dollar denominated debt, called tesobonos. As investors buying the tesobonos are protected for a potential devaluation of the peso, the outflow of foreign currency stops, while the foreign exchange rate stabilizes. However, in November USD 3bn is pulled out of the country, of which USD 1.6bn on a single day (18 November).

December 1st, 1994
The new Mexican government, headed by President Zedillo, takes office.

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.

Figure 1: Exchange rate

Figure 1: Exchange rate

Source: Banco de Mexico

January 26th, 1995 
The IMF announces a rescue package of USD 7.8 bn.

January 31th, 1995
The US announces a USD 50 bn rescue package for Mexico, consisting of USD 20 bn from the US, USD 18 bn from the IMF (including the USD 7.8 billion already announced on January 26th), USD 10 bn from the Bank for International Settlements, and USD 3 bn from private commercial banks (Musacchio, 2012). Due to the credit line, Mexico is able to roll over its short term dollar denominated debt, although at considerable higher yields. Without the help Mexico probably would have defaulted on its tesobonos.

Early March, 1995 
Mexican government announces a stringent austerity package, leading to renewed confidence by investors. (Whitt, 1996)

Impact on the economy

Just after the devaluation of the peso, Mexico’s economy started to rebalance (table 1). The process started by a considerable contraction of both private and government consumption, which helped Mexico to lower its import bill. This while Mexico’s export sector was given a boost, thanks to the devaluation of the peso.

The process of rebalancing proceeded quite fast. In the first half of the year, Mexico’s economy contracted by 10%. In the three years thereafter, the economy recovered rather well, with an average growth rate of almost 6%. Moreover, the current account deficit declined from -5.8% in 1994 to -0.5% in 1995. Along with the fall in GDP, unemployment  rose from 3.7% in 1994 to 6.2% in 1995. But, as with the overall economy, the situation on the labor market improved fast, showing a decline to 5.5% in 1996.

The story for inflation was different. Due to the devaluation of the peso, goods and services from abroad became more expensive, pushing up inflation. In addition, given Mexico’s history of high inflation, the expected inflation shot up as well, worsening the inflation outlook. It would take Mexico years before inflation was at an acceptable level again.

Table 1: Overview of economic indicators

Table 1: Overview of economic indicators

Source: IMF

After 1982: liberalizing the economy

In the years after the sovereign debt and balance of payment crisis of 1982 (See Special Report 2013/14: The Mexican 1982 debt crisis), the Mexican government shifted to a more market orientated economic model. The policy shift led to the privatization of government-owned enterprises, the deregulation of industries, and the reduction of trade barriers. In addition, restrictions on foreign investment in many sectors were lifted. 

1989: Final deal and more liberalization

In 1989, the government agreed on the “Brady plan”, legitimizing the concept of debt relief, a remainder of the 1982 crisis. Only then, did banks and companies regain the option to borrow in financial markets abroad. 

Furthermore, in anticipation of joining the North American Free Trade Agreement (NAFTA) in 1994, Mexico started to further open up its economy. Mexico had to do so, as the free transfer of funds was a core principal of US treaties, including NAFTA. Next to a further trade liberalization for both goods and services, Mexico eliminated most capital and exchange controls. This paved the way for foreign investment in; securities, loans, direct investment, bonds (sovereign and private) and derivatives (Nordgaard, 2013). 

There is one exception: a currency pact

Part of the reform agenda was the introduction of a crawling peg to the US dollar in November 1991. Since then, the peso was allowed to float within a constant lower band and a slowly increasing upper band, therefore, a gradual depreciation was allowed. The pact served at least three purposes. First, it gave foreign investors additional assurance, as the risks of currency fluctuations were limited. Second, it allowed Mexican companies to borrow money in international markets to finance their expansion. Third, a managed exchange rate would help Mexico to fight domestic inflation (Musacchio, 2012).

Reforms in the financial sector…

After the nationalization of almost all private banks in 1982, Mexico privatized them again in 1991-92. However, at that time the banking sector could be characterized as highly concentrated, with loans being primarily provided on the basis on political priorities rather than on credit worthiness.  

The privatization process itself caused skepticism. First, the government was mainly focused on maximizing the sales price, with the restriction that foreign banks could not participate in the bidding process. To drive up the sales price the buyers were given considerable privileges: the four banks controlled 70% of all bank assets and the sector was almost closed to foreign competition. 

Second, the bidders’ experience in the banking sector was not taken into account. Third, the Mexican government delayed the implementation of international banking standards. And according to the old standard, after the maturity of a non-performing loan (NPL) expired, only the interest rate payments were reported as non performing, while the principal was reported as performing. This led to a strong overestimation of the value of the banks. 

Another important feature of the banking sector was that the regulator was inexperienced in monitoring the banks. And depositors had no incentive to monitor the banks, as the Mexican government guaranteed both deposits and liabilities (Musacchio, 2012). 

… leading a credit boom

After the privatization of the banks, Mexico experienced an enormous credit boom, as all banks competed strongly to gain more market share to earn back their investments (table 2). This credit expansion later turned out fatal, as the performance of the existing portfolio was worse than expected. In addition, new loans were of poor quality due to this rapid expansion. Finally, banks borrowed in dollars to finance their expansion (Musacchio, 2012). 

Table 2: Performance of the banking sector

Table 2: Performance of the banking sector

Source: Haber (2005)

Triggers for the crisis of 1994

It is impossible to just point at one trend or event to explain the Mexican crisis. Below we will discuss the triggers, which in our view, played an important role:

1) The liberalization of the financial account allowed money to flow freely in and out of Mexico.

2) The low policy rate set by FED at the beginning of the ’90, led to a search by investors for higher yields. Mexico, which was fighting inflation, had a relatively high policy rate, making it attractive for foreign investment. This resulted in a strong increase of portfolio investment. In 1994, the FED raised its policy rate, causing a lower spread, as Mexico’s central bank did not follow. The result was a strong decline in portfolio investment. 

3) Until 1994, Mexico was running a current account deficit, which was compensated by the financial account. However, a sudden stop of the inflow of portfolio investment in March/ April, led to a considerable depletion of the foreign exchange reserves.

4) To stop the outflow of foreign currency in March 1994, Mexico’s government started to issue short term dollar denominated debt, called tesobonos. By November 1994, 70% of foreign holdings was dollar denominated. The deterioration of the ratio of foreign exchange reserves to foreign denominated debt (with a short maturity) started to concern investors.

5) In the year prior to the crisis, Mexico’s was confronted by social unrest. Two political leaders were assassinated, while the province of Chiapas was confronted with violence. In addition, there were doubts about the fairness of the presidential elections of 1994.

Figure 2: Financial account Mexico
Figure 2: Financial account MexicoSource: Banco de Mexico
Figure 3: Foreign reserves
Figure 3: Foreign reservesSource: Banco de Mexico, Macrobond

Impact on the banking sector

As explained above, Mexico’s banking system was already in a bad shape prior to the crisis, and the events in December were according to Haber (2005), just a tipping point. 

The devaluation of the peso and the strong rise of inflation, resulted in an interest rate hike. A majority of the banks’ debtors were unable to pay the higher interest rates, which led to a strong rise of the NPL ratio. Banks were therefore unable to honor their foreign currency liabilities. To prevent a systemic banking crisis, the government implemented a bailout program:

1) Providing dollar liquidity to the banks.

2) Allowing banks to transfer part of their ‘bad’ portfolio to the government, including NPL’s.

3) Recapitalizing all banks, that did not have a minimal capital ratio of 8%.

4) The debt burden of borrowers was relieved. Loans could be converted to a CPI-index unit, whereby debtors paid a real interest of 4% plus a premium, which reflected the credit risk.

Due to the measures, a collapse of the banking sector was prevented and no obligatory write-offs took place. It would however, take years for the banking sector to recover (table 2). As a consequence of illness of the banking sector, new credit was almost not available, exarcebating the economic crisis (Krueger and Tornell, 1999). 

Lessons from the crisis

How the crisis shaped Mexico is hard to tell, but there have been some structural breaks after the 1994 crisis.

- In July 1997, the PRI, the political party that had been in control of Mexican politics for almost 70 years, lost the mayoral election of Mexico City. In addition, the PRD took over control of Congress.

- In 2000, the PRI lost the presidential elections.

- The credit to GDP ratio is still low compared to international levels. This could have been caused by the bad shape of the banking sector after the crisis. Another explanation could be that Mexicans are still reserved to take loans.

- The Mexican peso remains freely floating, although during the Global Economic Crisis, measures were taken to prevent a large slide

- The central bank has built up an adequate stock of foreign exchange reserves, currently representing 4.8 months of imports.


The Mexican Tequila Crisis was triggered by a combination of poorly carried out reforms, a currency peg, current account deficits, policy rate hikes in the US and social unrest, and finally led to both a currency and banking crisis. A sovereign crisis was just averted, due to financial assistance of among others the US and the IMF. The banking sector, which was already in a bad shape, would have collapsed without the help of the government.  


- Krueger, A. and Tornell, A. (1999) “The role of bank restructuring in recovering from crises: Mexico 1995-98” working paper 7042

- Haber, S. (2005) “Mexico’s experiments with bank privatization and liberalization, 1991-2003,” Journal of Banking and Finance 29: 2325–2353.

-Musacchio, A. (2012) “Mexico’s Financial Crisis of 1994-1995.” Harvard Business School Working Paper, No. 12-101, May 2012

- Nordgaard, T. (2013) “Hot Money and the Tequila Crisis, Comparing Capital Acount Regulatory Regimes: Mexico & Chili”

- Whitt, J.A. (1996) “The Mexican Peso Crisis” Federal Reserve Bank of Atlanta

Maarten van der Molen
Rabobank KEO
+31 30 21 62666

naar boven