Armed rebellion in the poor Mexican state of Chiapas and the assassination of a presidential candidate shook investors’ faith in Mexico’s financial system in 1993 and 1994. Capital flowing into Mexico was mostly in the form of stocks and bonds (portfolio investment) rather than factories and equipment (foreign direct investment). Portfolio investment fled Mexico for the United States as the Mexican peso grew weak and U.S. interest rates rose. A lending spree by Mexican banks, coupled with weak banking regulations, also played a role in delaying the government’s response to the crisis. In late 1994 the Mexican peso was devalued, forcing a loss of purchasing power on the Mexican people.
In response to the crisis, the IMF and private commercial banks in the United States stepped in with about $50 billion in loans to shore up the Mexican economy. Thus Mexico’s peso crisis contributed to an additional boost in the level of IMF loans. Mexico repaid the loans ahead of schedule and once again has a sizable reserve of foreign exchange.
Southeast Asia’s Currency Crisis
The roar of the “four tiger” economies and those of other high-growth Asian nations suddenly fell silent in the summer of 1997. For 25 years the economies of five Southeast Asian countries—Indonesia, Malaysia, the Philippines, Singapore, and Thailand—had wowed the world with growth rates twice those of most other countries. Even though many analysts projected continued growth for the region, and even though billions of dollars in investment flooded in from the West, savvy speculators were pessimistic.
On July 11, 1997, the speculators struck, selling off Thailand’s baht on world currency markets. The selling forced an 18 percent drop in the value of the baht before speculators moved on to the Philippines and Malaysia. By November the baht had plunged another 22 percent and every other economy in the region was in a slump. The shock waves of Asia’s crisis could be felt throughout the global economy.
Suddenly, countries thought to be strong emerging market economies—“tigers” to be emulated by other developing countries—were in need of billions of dollars to keep their economies from crumbling. When the dust settled, Indonesia, South Korea, and Thailand all needed IMF and World Bank funding. As incentives for these countries to begin the long process of economic restructuring, IMF loan packages came with a number of strings attached. For example, the Indonesian loan package involved three long-term goals to help put the Indonesian economy on a stronger footing: (1) to restore the confidence of international financial markets, (2) to restructure the domestic financial sector, and (3) to support domestic deregulation and trade reforms.
What caused the crisis in the first place? Well, it depends on who you ask. Some believe it was caused by an Asian style of capitalism. They say that blame lies with poor regulation, the practice of extending loans to friends and relatives who are poor credit risks, and a lack of transparency regarding the financial health of banks and companies. Others point to poor management of these nations’ short-term debt obligations. Still others argue that persistent current account deficits in these countries are what caused the large dumping of these nations’ currencies. What really caused the crisis is probably a combination of all these forces.7
Russia’s Ruble Crisis
Russia had a whole host of problems throughout the 1990s—some were constant, others were intermittent. For starters, Russia was not immune to the events unfolding across Southeast Asia in the late 1990s. As investors became wary of potential problems in other emerging markets worldwide, stock market values in Russia plummeted. Another problem contributing to Russia’s problems was depressed oil prices. Because Russia depends on oil production for a large portion of its GDP, the low price of oil on world markets cut into the government’s reserves of hard currency. Also cutting into the government’s coffers was an unworkable tax collection system and a large underground economy—meaning that most taxes went uncollected.
There also was the problem of inflation. We learned earlier in this chapter how an expanded amount of money chasing the same amount of goods forces prices higher. This is exactly what happened when Russia released prices in 1992. As prices skyrocketed, people dug beneath their mattresses where they had stashed their rubles during times when there were no goods to purchase. We also saw earlier how inflation eats away at the value of a nation’s currency. Russia saw inflation take its exchange rate from less than 200 rubles to the dollar in early 1992 to more than 5,000 to the dollar in 1995.
Then in early 1996 as currency traders dumped the ruble, the Russian government found itself attempting to defend the ruble on currency markets. As its foreign exchange reserves dwindled in a hopeless effort, the government asked for, and received, a $10 billion aid package from the IMF. In return, Russia promised to reduce its debt (which was averaging about 7 percent of GDP), collect taxes owed it, cease printing inflation-stoking sums of currency, and peg its currency to the dollar.
Things seemed to improve for a while, but then in mid-1998 the government found itself once again trying to defend the ruble against speculative pressure on currency markets. In a single day the government spent $1 billion trying to prop up the ruble’s value, forcing its hard currency reserves to shrivel to $14 billion. As it grew obvious that the government would soon be bankrupt, the IMF stepped in and promised Russia another $11 billion. But when it was alleged that some of the IMF loan had been funneled into offshore bank accounts, the IMF held up distribution of the money. On August 17, 1998, badly strapped for cash, the government announced that it would allow the ruble to devalue by 34 percent by the end of the year. It also declared a 90-day foreign-debt moratorium and announced a de facto default on the government’s domestic bond obligations. On August 26, the Russian Central Bank announced that it would no longer be able to support the ruble on currency markets. In less than one month, its value fell 300 percent. Inflation shot up to 15 percent a month in August from 0.2 percent in July and reached 30 percent in the first week of September. By the time it was all over in late 1998, the IMF had lent Russia more than $22 billion.