The 1994 Mexican Peso Crisis

What Is The Tequila Effect?

The Tequilla Effect (otherwise called "Tequilla Shock" or the "Tequilla Crisis") is a shoptalk term for financial or economic fallout coming about because of the Mexican economy.

The Mexican peso (MXN) has been the official currency of Mexico since the country acquired its independence in 1821. The 1994 Mexican currency crisis was a sudden devaluation of the Mexican peso, which caused different currencies in Latin America (like in the Southern Cone and Brazil) to decline too. The effect of the crisis was casually known as the "Tequilla Effect" or the "Tequilla Shock."

The falling peso was at last set up by a $50-billion bailout package facilitated by then U.S. President Bill Clinton and administered by the International Monetary Fund (IMF).

Grasping the Tequila Crisis: The 1994 Mexican Peso Devaluation

On December 20, 1994, the Mexican central bank devalued the peso somewhere in the range of 13 and 15 percent. To limit the unnecessary flight of capital, the bank likewise raised interest rates. Short-term interest rates increased to 32 percent, and the subsequent higher expenses of getting were a threat to economic stability.

The Mexican government permitted the peso to drift freely again two days after the fact, yet rather than settle, the peso endured another sharp shot, devaluing almost into half of its value in the months that would follow.

Following the Mexican peso was devalued in the beginning of the Presidency of Ernesto Zedillo, South American countries likewise experienced quick currency depreciation and a loss of reserves. Foreign capital escaped Mexico as well as the crisis prompted financial contagion in emerging markets too.

It was undeniably true that the peso was overvalued, yet the degree of Mexico's economic weakness was not notable. Since governments and organizations in the area had high levels of U.S. dollar-named debt, the devaluation implied that repaying the debts would be progressively troublesome.

The Mexican Debt Bailout

In response to the crisis, the U.S. Congress passed the Mexican Debt Disclosure Act of 1995, which was instituted by President Clinton on April 10, 1995. The law gave billions in financial assistance to [swap facilities](/swap-execution-office sef) and securities guarantees utilizing American taxpayer dollars, and extra assistance given by the IMF.

The Mexican government — as a condition of the sizable bailout — was expected to carry out certain financial and monetary policies controls. They were likewise mindful so as to keep up with their current commitments to policies of the North American Free Trade Agreement (NAFTA). Mexico endured an extreme recession and episodes of hyperinflation soon after the crisis, as the country kept up with inordinate levels of poverty until the end of the nineties.

Highlights

• The Tequila Crisis started on Dec. 20, 1994 when the Mexican peso was devalued, causing a global currency crisis and coming about in a $50 billion IMF bailout to Mexico's economy.
• Both domestic and international economic factors, alongside political powers helped encourage the crisis.
• The central bank started changing over short-term debt, designated in pesos, into dollar-named bonds. The conversion brought about a decline in foreign reserves and an increase in debt.
• An unavoidable crisis came about when investors dreaded a default on debt by the government.