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1. Why did Mexico devalue? What policies will the government now pursue to restore confidence? (Please explain as if you were Guillermo Ortiz about to face the investor group in New York.)
Mexico was forced to devalue peso due to its dwindling foreign exchange reserve. Due to the ongoing current deficit and capital flight that happened, it became impossible for Mexico to continue to keep the peso fixed in the foreign exchange market. Hence, the devaluation became inevitable.
Several factors led to investors withdrawing from Mexico which forced Mexico to devalue. Some of those were:
a. Even though in nominal terms, peso was allowed a gradual nominal depreciation, in real terms, it was appreciating. That in conjunction with the fact that Mexico had a large current account deficit; some investors felt that peso was overvalued.
b. There were several instances of violence that led to concerns about political stability of the country.
c. US interest rates rose several times throughout the year which made it more attractive for investors to park their capital there instead of Mexico.
d. Due to 1994 being the election year, several major initiatives were put on hold and the government did not respond to these internal and external shocks to the economy.
To restore confidence, the following actions and policies might be considered:
1. First and foremost, need to assure the investors that there will be no further devaluation and that Mexico will service the maturing liabilities.
2. Ortiz need to inform the investors about the $18B funding from IMF and $8.8B swap ...