Between 1988 and 1994 the Mexican current account deficit grew steadily, reaching US$ 30 billion in 1994. A key question is the extent to which Mexico's current account deficit made it vulnerable to macroeconomic instability.
One way to judge the significant of the current account deficit is to look at its size relative to Mexico's GDP. The larger the share of the current account deficit in GDP, the larger the possible effect of shifts in external capital flows on the economy as a whole, and the greater the overall macroeconomic adjustment necessary to address pressure on the external acount. Between 1992 and 1994 the Mexican current account deficit averaged 7.4% of GDP. From a cross-country perspective, this level of current account is high but not unprecedented in more successful developing economies. It is worth noting, however, that an indicator scaling the current account deficit (differences in the value of goods priced in foreign exchange) by GDP (an income flow valued in pesos) is sensitive to the valuation of the peso. Without additional policy and behavioral responses, a devaluation of the peso would raise the current account deficit as a share of GDP. Thus, for example, a 40% devaluation of the peso implies a current account deficit ratio of 12.3% of GDP, and hence indicates a more significant macroeconomic adjustment.
A crucial issue is whether the current account deficit is sustainable. One aspect of this question is whether the current account deficit is consistent with a reasonable path for the total foreign liability to export ratio over time. Given that exports are growing, it is possible to continue to accumulate foreign liabiliies over time (i.e. run a current account deficit) without producing a continually rising liability to export ratio. If a sustainable current account defict is defined as one consistent with a constant foreign liability to export ratio over time, then the sustainable current account deficit (excluding factor services) is directly proportional to the difference between the growth of exports and the rate of return on foreign liabilities (see Dadush, Dhareshwar, and Johannes).
Between 1989 and 1993, export growth in Mexico averaged 8.7% per year while the current account deficit (excluding debt service) averaged 31.7% of exports. These figures imply a steady-state foreign liability to export ratio of 3.6 (ibid). This means that in such a steady state Mexico would have to devote 36% of its exports to cover factor services if the required return on its foreign liabilities was 10%. These figures are rather high and suggest that there was an imbalance on the current account, one consistent with an over-valued real exchange rate. Nonetheless, one needs to consider the question of how severe this imbalance was and how a correction might take place.
Another way to assess Mexico's vulnerability is to consider the size of its current stock of outstanding foreign debt. Averaged over 1991-1993, the present value of Mexico's future debt service obligations (a measure of the stock of debt) amounted to 184% of exports of goods and services and 36% of GDP. The World Debt Tables classify a country as severely indebted if its debt is greater than 220% of exports or 80% of GDP. A country is considered moderately indicated if the debt indicators are less than the above figures but higher than 132% of exports or 48% of GDP. Thus Mexico's debt stock relative to its level of exports places it in the moderately indebted category, while the debt stock to GDP indicator falls in the less-indebted category.
Moreover, other indicators of the relative size of Mexican debt show that the debt burden has been falling. The nominal value of foreign debt as a percentage of GDP has fallen from 58% in 1988 to 35% in 1993, and nominal foreign debt as a share of exports has fallen from 249% in 1988 to 185% in 1993. Thus Mexico does not appear to have been sliding back into the kind of debt problem that emerged in 1982 and crippled its economy in the mid-eighties.
In assessing Mexico's vulnerability to a foreign exchange crisis, one should keep in mind that the total debt stock does not include portfolio equity investments and direct foreign investment. These types of capital flows have grown increasingly important in the 1990's. In 1993 they amounted to 53% of aggregate net long-term resource flows to developing countries. Portfolio investment is particularly volatile, and the flight of portfolio investment from Mexico played a key role in the crisis of December, 1994.
Mexican Economic Crisis