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Al-Ahram Weekly 18 - 24 November 1999 Issue No. 456 
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Published in Cairo by AL-AHRAM established in 1875 |
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Al-Ahram Weekly 18 - 24 November 1999 Issue No. 456
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| Published in Cairo by AL-AHRAM established in 1875 |
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Egypt Region International Economy Opinion Culture Special Profile Travel Living Sports People Time Out Chronicles Cartoons Letters No no to Mexico
By Khaled Sherif *Economists and financial analysts eye recent interventions in the currency market by the Central Bank to stabilise the dollar with increasing uneasiness. And the suggestion has been raised more than once that Egypt may well be treading the path disastrously followed by several Asian economies or even, it has been whispered, by Mexico. Such suggestions, though, remain wide of the mark, ignoring important differences between the Egyptian and Mexican economies. A brief examination of the Mexican experience, however, should suffice to show that the situations faced by the two economies are in no way corollary. After the onset of the debt crisis in 1982, Mexico suffered a sharp recession, followed by several years of slow and sputtering growth. By the end of the decade, though, things were beginning to improve. President Carlos Salinas de Gortari, a reformer with a degree from the Kennedy School of Government, was elected in 1988 and, after years of inaction, the implementation of the Brady Plan helped resolve the debt crisis. These developments increased the confidence of foreign investors and marked the return of foreign capital to Mexico. Flows of capital continued to grow in the early 1990s, boosted by legislation that allowed foreigners to buy government bonds and (non-voting) shares in Mexican companies and increased confidence in the proposed North American Free Trade Area (NAFTA). Whereas only about $100 million of private capital flowed into Mexico in 1988, over $21 billion arrived in 1993, the year before the onset of the crisis. These large inflows caused the current account deficit and gross international reserves to grow considerably. Fiscal policy during this period was relatively tight, with the government running modest surpluses. This was quite different from the period before the debt crisis when inflows of capital were used to finance large government deficits. Because the money was going to the private rather than the public sector there was less concern about the sustainability of the flows of capital. It was thought that since the inflows were based upon the rational investment decisions of private parties, they must reflect Mexico's potential for growth. Despite the large inflows of capital, some potential problems remained. First, growth remained modest, averaging only 3.7 per cent per year between 1990 and 1993. Although this was faster than growth had been in the 1980s, it was slower than might have been expected given the large inflows of capital. A second, and perhaps related concern, was that some of the capital inflows were financing increased consumption rather than increased investment. Sachs, Tornell and Velasco (1996) claim that the conversion of investment resources into peso consumer loans, which was performed through the banking sector, resulted in instability within the sector. Further, to the extent that these expenditures did not increase investment, they would not increase exports, making debt service difficult in the future. After several years of rapid inflows and modest growth investor confidence collapsed in 1994. Two events that contributed to the turn around were the peasant uprising in Chiuapas in January and the assassination of the PRI's presidential candidate in March. Since 1991, the exchange rate had followed a crawling peg (i.e., the peso was allowed to vary within a band that had a ceiling that slowly increased over time). The shocks resulted in a sharp depreciation, causing the peso to hit the ceiling. This forced the central bank to intervene in the currency market to stop the exchange rate from falling. International reserves fell from $25.1 billion at the beginning of January to $17.7 billion by the end of April. To stop this intervention from resulting in a decrease in the monetary base and an increase in interest rates, which would be controversial in an election year, the Central Bank sterilised its intervention by expanding domestic credit. The decrease in investor confidence also increased the government's cost of borrowing. In response, the government adopted an explicit policy of switching from long-term to short-term debt and issuing bonds valued in US dollars (Tesobonos) rather than pesos. These policies turned out to be riskier than the government imagined. Another crisis in November, caused by the Attorney General's resignation, increased the outflow of capital and caused a further drop in reserves, from $17.7 billion at the end of October to $12.9 billion at the end of November. With reserves dwindling investors began to suspect that the government would devalue the peso. The threat of devaluation undermined confidence further increasing outflows of capital and provoking attacks on the peso. Finally, on 20 December, 1994, with inadequate reserves for a further defence, the central bank widened the exchange rate band to 15 per cent. At this point a modest devaluation was insufficient. It merely provoked further attacks. Two days later the government was forced to float the peso. By this time, a significant amount of the short-term dollar-denominated debt that the government had been issuing since the beginning of the year needed to be rolled over. However, a 27 December auction of Tesobonos failed, raising concerns about the government's solvency. Fearing collapse, the US government and the IMF quickly arranged a $52 billion package to support the Mexican government and prevent further economic deterioration. Although Mexico was briefly plunged into a severe recession, and the crisis threatened to spread to Argentina, meltdown was avoided. The Mexican economy shrank by six per cent in 1995, but growth and foreign capital returned the following year. Egypt and Mexico's circumstances are quite different. Mexico's crisis seems to have been caused mainly by large inflows of short-term capital that were partially used to fund private consumption. Consequently, the large inflows of capital were not sustainable in the medium term. However, there are some similarities across the cases of Egypt and Mexico. While both Mexico and Egypt have pegged exchange rates, Egypt does not have a current account deficit of over five per cent of GDP which was a key factor in making Mexico vulnerable. Mexico too had a budget deficit at the onset of the crisis of over three per cent of GDP, again making it extremely vulnerable. Egypt does not. Mexico's short term debt was greater than 50 per cent of reserves before the crisis and Egypt is in a much more prosperous position. Finally, Mexico's short term debt at the start of their crisis was greater than 50 per cent of reserves. Again, Egypt is nowhere close to this benchmark. However, Egypt does have one thing in common with Mexico and that is that private sector credit is now growing at over 10 per cent per annum. This, by itself, does not mean that a crisis is looming, but this is in fact how Mexico became vulnerable early on. While Egypt needs to protect the banking system by putting into place safeguards that will ensure the stability of the banking system, this does not mean that a shock is around the corner. Having heard much talk about the similarities between the interventions of the Egyptian Central Bank and what happened in Mexico from many, let me respond with one simple statement to all that see a correlation: there isn't one.
* The writer is the knowledge manager of the Eastern Europe and Central Asia department of the World Bank.
