The Peso Crash and Financial Market Performance in Mexico

José Antonio GonzálezChief of Staff

Deputy Minister of Finance in MexicoOctober 25, 2002

Outline

• Stylized facts about the financial market performance in México.

• Some basic lessons:– Monetary policy– Good prudential regulation of banks– Corporate governance – Fiscal discipline

Looking back

• The early 1990s financial liberalization had four components (Aspe 1993):– Transparent monetary policy– Liberalization of capital account and financial

innovation to mobilize savings– Solid prudential regulation– Strong public finances as foundation

Like many other LAC countries, Mexico embarked on an ambitious liberalization program

00.10.2

0.30.40.50.60.7

0.80.9

1

1970 1975 1980 1985 1990 1995

Mexico

Chile

Latin AmericaAvg

Liberalization Index. Morley et al

Financial Development or Credit Boom?

• Financial sector depth doubled and fixed capital formation increased from 15% to 20% of GDP .

• However, since1995 financial depth decreased from a high of 100% in 1994 to close to 70% of GDP in 1999.

Figure 3.1Financial Sector Assets

0%

20%

40%

60%

80%

100%

120%

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

(% o

f G

DP)

Development Banks Assets Commercial Banks Assets Stock Market CapitalizationPublic Bond Capitalization Private Bond Capitalization

The puzzle: Bank lending fell but investment did not and GDP growth averaged 5.4%

from 1996-2000Figure 3.3

Investment Flows by Source

-0.05

0

0.05

0.1

0.15

0.2

0.25

0.3

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999

(Flo

ws/

GD

P)

Foreign Savings

Private Bonds

Public Bonds

Commercial Banks

Development Banks

Gross Domestic Investment

Bank vs market based?: Wrong question

Bank Credit to Non-financial Private Sector/Value Traded in the Stock Market

0

5

10

15

20

25

30

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000

Relative Activity

Lower Middle Income(1986-1993)

High Income (1986-1993)

Stylized facts conclusions:financial depth is still shallow

Figure 3.2Financial Sector Assets

0

50

100

150

200

250

300

350

400

450

Switzerl

and

Mala

ysia

Japa

n

United

Stat

es

United

Kin

gdom

German

y

France

Spain

Canad

aChi

le

Korea

Mex

ico 19

94

Mex

ico 19

99

Brazil

Argen

tina

% o

f G

DP Private Bond Capitalization

Public Bond Capitalization

Stock Market Capitalization

Banks Assets

Looking ahead: Do more of the same…with some twists

– Monetary policy based needs to prevent moral hazard in exchange rate behavior (Gil 2000)

– Bank recovery: solid banking prudential regulation needs to include banking resolutions and limited deposit insurance.

– Sound market and corporate governance regulations to promote stock and bond markets.

– Strong public finances (including public banks) is key to allow institutional investors and forced savings turn into private investment.

Monetary policy: The probability of a vicious exchange rate-interest rate cycle has diminished.

90

110

130

150

170

190

210

230

250

90

100

110

120

130

40

50

60

70

80

90

100

90

100

110

120

130

140

FondeoFondeo

Tipo de Tipo de Cambio Cambio

FondeoFondeo

Tipo de Tipo de Cambio Cambio

Indices Abril =100

Abril- Octubre 1998

Abril- Octubre 2001

Mexican banks need to recover

Figure 3.5Bank Credit to Non-financial Private Sector

0

20

40

60

80

100

120

Japa

n

German

y

France

U.K.

U.S.A

.

Mala

ysia

Thaila

nd

Indo

nesia

Chile

Mex

ico 1

994

Filipi

nas

Brazil

Indi

a

Argen

tina

Mex

ico 1

999

Ecuad

or

Costa

Rica

Colom

bia

Venez

uela

Peru

% o

f G

DP

Policies to reactivate bank lending: (i) Improve repossession laws (2002) and

(ii) let go of the past (Gonzalez 2002)

IPAB Bonds as a share of Goodstanding Loans

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

BBVABANCOMER

BANAMEX SERFIN-SANTANDER

BITAL BANORTE SCOTIABANKINVERLAT

(% o

f go

od s

tand

ing

loan

s)

At the same time

• Keep banks healthy with sound prudential regulation that reduces moral hazard (Gil 2000):– Limit deposit insurance and have a credible

resolution framework.– Complement monetary policy with liquidity

requirements on dollar liabilities to level the playing field

The stock market is shallow and needs to develop

Figure 3.9Stock Market Capitalization

0

25

50

75

100

125

150

175

200

Mala

ysia

U.K.

Chile

U.S.A

.

Japa

n

Thaila

nd

Philip

ines

Mex

ico 1

994

France

Mex

ico 1

999

Spain

Indi

a

German

yBraz

il

Turke

y

Colom

bia

Venez

uela

Peru

Argen

tina

Ecuad

or

Costa

Rica

% o

f G

DP

Orígen de las Leyes (países)

Derechos de

Accionistas (0 a 6)

Derechos de Acreedores

(0 a 4)

Eficiencia del Sist. Judicial

(0 a 10)

Estándares Contables

(0 a 10)

Inglés (18) 4.00 3.11 8.15 7.01

Francés (21) 2.33 1.58 6.56 5.12

México 1.00 0.00 6.00 6.00

Alemán (6) 2.33 2.33 8.54 6.27

Escandinavo (4) 3.00 2.00 10.00 7.40

Mundo (49) 3.00 2.30 7.67 6.09

Fuente: La Porta, Lopez-de-Silanes, Shliefer, Vishny, "Law and Finance," (1998).

A clear indicator of regulatory lag is poor minority rights

As a result there has been a migration to the US stock market

05

10152025303540

English

Germ

an

Scandin

avia

n

French

Méx

ico

Capital Listed in US/Total capital

Firms with ADR in US/Firms listed locally

Indicators of migration by legal system

In April 2001 Mexico passed changes to the stock market laws which aimed to increase transparency.

• Minority rights Corporate governance of stock issuers and

intermediaries. Related transactions Restricted stock emissions. Control changes through public offerings Information standards Use of inside information.

Accounting practices homologated to U.S. standards

Imitate de SEC in the practice of certifying accounting statements.

Firms with ADRs in the U.S. will have to subject themselves to SEC requirements.

Install a national corporate governance board.

New reforms to corporate governance given corporate scandals in the U.S.

Pension reform and financial innovation have already and will continue to increase savings

Saldo de Activos Manejados por Aseguradoras y Siefores(Miles de Millones de Pesos)

0

200

400

600

800

1,000

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Aseguradoras Siefores Rentas Vitalicias

Financial Reform is not enough. It needs to be anchored with sound fiscal policies otherwise the public

sector consumes most of the financial resources

0

10

20

30

40

50

60

70

80

90

100

1992 1993 1994 1995 1996 1997 1998 1999 2000

Public Sector Private Sector

Use of financial resources in México

Crowding out has real effects

10

20

30

40

50

60

70

80

90

100

-5 0 5 10 15 20

50000

100000

150000

200000

250000

300000

-5 0 5 10 15 20

Déficit Financiero y Déficit Financiero y Tasa de InterésTasa de Interés

(1982-1999)(1982-1999)

Déficit Financiero e Déficit Financiero e Inversión PrivadaInversión Privada

(1982-1999)(1982-1999)

Déficit del Sector Público (% del PIB)(miles de millones de pesos de 1993)

Déficit del Sector Público (% del PIB)(miles de millones de pesos de 1993)

Ren

dim

ien

tos

Ce t

e s 2

8

Inve

rsió

n P

r iv a

da

(mil e

s d

e m

i llo

ne s

de

pes

os

de

1993

)

Fuente: SHCP y Banco de México

Conclusions

• Initial reforms were in the right direction but they need to be implemented carefully.

• Looking ahead requires the same basic principles:– Sound fiscal policies– Banking credit needs to recover.