In the period 1990-93 Mexico`s economy experienced expansion and structural change. This was associated with economic opening, market deregulation, and large inflows of foreign capital. Mexico had dealth with the external debt problem through a Brady debt restructurig. This restructuring lowered the fiancial requirements of the public sector, improved market expectations, and set the stage for a declin in domestic interest rates. In the early 1990s Mexico atracted fully one-fifth of all capital flows directed into developing countries. These inflows more than finance the current account deficit, and permitted Mexico to expand its official reserve holdings. The portfolio capital inflow bolstered the stock market, which appreciated in value. Mexico`s entry into NAFTA provided another reason to be optimistic concerning economic and business prospects. However, Mexico`s external payments position was falling deeper into deficit. By mid-1994 it was possible to observe that the current accout in Mexico`s balance of payments had shifted further into eficit, and that the high unsustainable level of capital inflow was diminishing. Political violence and assassinations in 1994 caused foreign investors to look more carefully at investment prospects, and steadily rising interest rates in the United States created incentives favoring dollar rather than peso financial instruments. As peso interest rather than peso financial instruments. As peso interest rates began to rise, the Mexican government and commercial banks turned to dollar-indexed oroutright dollar borrowing. By december 1994 this increased dollar liability position together with a runoff in foreign exchange reserves left Mexico in a difficult liquidity position. Th december 20, 1994 devaluation failed to renew confidence in the viability of Mexico`s payments position, and two days later the peso was floated. In the early weeks of 1995 a massive Mexican financial assistance package was provided by the United States, the International Monetary Fund, and others. An analysis of the components of Mexico`s GDP and balance of payments suggests that the financial disequilibrium was clearly evident by mid - 1994. Over the period 1993-94 domestic absorption had increased beyond the ability of the economy to sustain it. Parallel to this, the current account deficit had increased beyond the ability of foreign exchange resources to support this deficit. Failure by the government and central bank to take action n the third quarter of 1994 resulted in a runoff of foreign exchange reserves, concerning the viability of existing arrangements. Fiscal and monetary tightening early in 1995 produced an improved financial equilibriu, suggesting that similar action at mid- 1994 might have avoided the near debt crisis that manifested itself in December 1994 jand the following weeks

Volume 23

Numbers 5-8