Answer 1: The case of Mexico’s balance of payments
- The trend in Mexico’s key economic indicators –
The nations all over the world are engaged in doing transaction at international level, wherever all the documented statistical information in the record considered as the balance of payments. There are certain transactions that involve bank’s accounts, real-estate, security, bond, and investment. These transactions also include the import or export of services as well as products. Additionally, it is essential to have the balance of payment data in different manners, involving rendering data in relation to the demand along with supply of the currency of the nation. It also plays an important role as the signal of the potential of nation to become the partner in business with different nations. It can see that the nations can operate the balance of payment surplus or balance of payment deficits. In this way, the nations can run them by getting involvement in the different supported central bank reserve dealings. In this relation, there are certain key financial indicators like foreign reserve holdings, the balance of payment along with exchange rate (Romero, 2016). These key indicators are discussed below –
- U.S. Dollar V. Mexican Peso Exchange Rate (1st November 1994 – 31st January, 1995)
Source: Eun and Resnick (2015, p. 50)
- Mexican Foreign Reserve
Source 1: IMF Statistics
Source 2: Curtish, Gladish, Guntupalli and McElna (2005, p.4)
- Spot Exchange Rates 1994 (Jan-Dec): Mexican Pesos/US Dollars
Source 2: Curtish, Gladish, Guntupalli and McElna (2005, p.2)
- Lending rates of interest in Mexico
Source: Curtish, Gladish, Guntupalli and McElna (2005, p.4)
- The causes of Mexico’s Balance of Payment Difficulties prior to Peso Devolution –
It is essential to know about the reasons for which the balance of payments of Mexico complexities take place prior to the Peso devolution. It can see that there are two important causes that are accountable for the balance of payments of Mexico prior to Peso devolution. As per the first cause, under the direction of Ernesto Zedillo (President of Mexico), the government diminished or undervalued peso in against of dollars by fourteen per cent. In this way, this decision of the government of Mexico controlled the urgency of sales of Mexican stock or bonds, as well as pesos. In subsequent period, it became the reason of falling or Peso in against of the US dollars by as much as forty per cent by the earlier period of 1995. Therefore, it was noticed that the government or administrative body of Mexico was powered for better floating of the Peso. Therefore, it was the significant cause that lead to the balance payments (Koczan & Loyola, 2018).
Moreover, when it is analysed that what was the second cause of balance payments, then it is found that the second cause was deterioration in the faith of investors as the outcome of the current accounts’ deficits along with the overrated money. It is found that there was political uncertainty in Mexico. Various events took place that led to this political instability. These events were uprising Chiapas in the earlier period of January, 1994, as well as murder of Jos Francisco Ruz Massieu. Further, the kidnapping grinded down the faith along with belief of the investors, who later decreased the holding in Mexico. In this way, it can say that these above discussed causes were two reasons of the issues or problems in the balance of payments of Mexico earlier than Peso devaluation (Havisha, 2018).
(C) The policy’s action that may have mitigated or averted the issues of business of payments and later Peso-collapse –
There is important role of policy actions in averting as well as mitigating the problems related to the business of payments. With the help of proper policy actions, the government broke down the Peso. The government made transparency as well as clearness in relation to the actual state of the affairs in economy. In this way, it might have stopped the Peso disaster in Mexico. The Salinas management was disinclined for disclosing the accurate and related condition of the economy of Mexico. In addition, the Salinas management had no desire to disclose about the quicker reduction of enormous trading activity’s deficit as well as foreign exchanging reserve that finally resulted into the Peso crisis in Mexico. In this manner, it is clear that the limpidity in relation to the economy’s real estates might have averted the challenges related to the balance of payments.
In addition, the development of the multinational security net was another key policy action for securing the economic system of the world from this collapse of Peso crisis. It is also observed by Monras (2018) that the procedure of politics is improper individually. It is not possible to face or end the challenges of the business of payments by only using the political process. The establishment of the multi-national security net would be difficult to prevent the collapse of currency. It can see that the multi-national security net includes G-7 nations that sanctioned about fifty Billion dollars bailout funds to be managed by the IMF to the nation in the economic crises. These policy actions were the answers given by the Mexican government to the financial crisis.
Moreover, it is found that Mexican government was in the great depression. To end this depression, the government of Mexico adopted the approach of ISI (import substitution industrialization). As per the import substitution industrialization, the government of nation implemented the series of rules as well as policies for securing the local sectors from the competition at international level. The approach did not only install higher import tariff. However, it also implemented the non-tariff barrier on the import of international products. In addition, it rendered subsidy for helping the sectors of Mexico. Thus, in the ISI model, the producers of nation had no incentives for the exporting manufactures for the reason that they enjoyed the captive local marketplace with no competition or less completion. In this way, it was very good decision of government to implement the import substitution industrialization policy. Furthermore, the government of Mexico also followed policies for deregulating various sectors, started the massive programme for privatizing several government owned entities, as well as started to liberalize the trading activities through the board. For instance, the management of government individually reduced the upper limit of import tariffs from one hundred per cent to twenty per cent and lowered another tariff barrier along with non-tariff barrier (Villarreal & Bielma, 2017).
- Lessons from the Mexican experiences that can be helpful for different developing nations –
In spite of the point that Mexico had practiced constant trade deficit until December 1994, the currency of nation was not permitted for depreciating for party-political motives. Additionally, it was not required by the government of Mexico to make peso devaluation prior to the election of President conducted in 1994. In a case when the Mexican peso had been authorised to progressively criticise it in against of main currencies, then peso crisis would have averted. In this situation, three key lessons can be understood from this peso crisis. As per the first main lesson, it is found that Mexico was very much relied on the short-run international portfolio capital (that is simply reversible) for the financial development. Further, the nation maybe should have protected more nationally and be governed by more long-run international capital. In this relation, it is very helpful or significant lesson for various developing nations.
Secondly, an absence of consistent financial data was another subsidizing element to the peso disaster. It can see that the Salinas management was unenthusiastic for completely exploring the correct state of the economy of Mexico. While the investors had knowledge about a fact that the country was practicing severe deficit and speedy lessening of foreign exchange reserve, peso may have been steadily dissing, in place of unexpectedly misshapen as this ensured. The transparent disclosure of economic data can help prevent the peso-type crisis. According to the third lesson, this is very significant to secure the financial system from this type of crisis like peso disaster. In this way, the multi-national security net requires to be in place to have crisis like Peso in earlier time (Binelli, 2016).
Answer 2: Case of Shrewsbury Herbal Products Ltd.
Broadly described, the foreign exchange market (FX market) includes the adaptation of buying power from one currency in other currency, bank’s deposit of foreign currencies, an allowance of credits denominated in the foreign currencies, selling foreign currency option, selling future contract, as well as foreign trading finance. In the provided case, assume Shrewsbury Herbal Products Ltd. trades at markup of 20% (Bokhtiar, Delowar & Wahid, 2018). In this way, the cost to Shrewsbury of £ 320,000 order is £ 256,000. Thus, the appreciation of the pound can be as follows –
= € 465,184 / £ 256,000
= € 1.8171/ £ 1
= € 1.8171
From the above calculation, it can say that pound can be appreciated to € 1.8171 prior to elimination of all the profits. It appears rather improbable. However, 10% appreciation of the pound (€ 1.4537 x 1.10) to € 1.5991 /£ 1, will be the yield of the profit calculated as below –
= [€ 465,184/1.5991) – £ 256,000]
= £ 34,904
Further, Shrewsbury Herbal Products Ltd. May make hedging of the exposure by the trading of euro forward for the £ at –
3 months forward rate (€/£) = 3 months forward rate ($/£) ÷ 3 months forward rate ($/€)
3 months forward rate (€/£) = 1.8990 ÷ 1.3154
3 months forward rate (€/£) = 1.4437
In this way, Shrewsbury Herbal Products Ltd. may “lock in” the cost of £ 322,217 (€ 465,184 / 1.4437) for purpose of selling the at above calculated forward exchange rate 1.4437. The forward exchange rate indicates that the euro is trading at a premium to the British pound in the forward market (Rambo, 2019). In this way, it is clear to say that the forward hedging gives the permission to Shrewsbury Herbal Products Ltd. for locking-in the huge amount of £ 2,217, only then receivable Euros were changed in the pounds at current spot rate (Hendrawan, 2017). In addition, it is a point to be considered is that when euros were selling at the forward markdown, in that case the company will end up the lock-in the amount not more than cost to company of £ 320,000 (Vaishya & Sarkar, 2017).
Therefore, whether it will lead to the losses for the organization that will be depended on the level of discount, as well as the profit amount built in a cost of firm to £ 320,000. Merely if a forward exchange rate is even with spot rate will Shrewsbury Herbal Products Ltd. get accurately £ 320,000.
As per the above analysis, certain points are advisable to Mr. Peter. These are mentioned as follows –
- Evidently, Shrewsbury Herbal Products Ltd can make sure that it gets correctly £320,000 at the end of 3 months account receivable’s period if this can be invoices in Pounds (Hall, 2018).
- Even though, it is not satisfactory to a French supplier. In a case while the invoice has been made in euro, then Shrewsbury Herbal Products Ltd can develop or provide euro invoice’s amount by the utilisation of forward exchange rate in place of the current spot rate (Banaei & Oloomi-Buygi, 2019, April).
- The invoice amount will be the following –
Invoice amount = £ 320,000 x 1.4437
Invoice amount = € 461,984
Thus, the company may currently lock-in the receipt of £ 320,000 if this concurrently hedges the euros exposure through trading € 461,984 at forward rate of 1.4437. That is to say, £ 320,000 = € 461,984 / 1.4437.
References
Banaei, M., & Oloomi-Buygi, M. (2019, April). Forward Contract Negotiation Equilibrium in Uncongested Electricity Markets. In 2019 27th Iranian Conference on Electrical Engineering (ICEE) (pp. 497-502). IEEE.
Binelli, C. (2016). Wage inequality and informality: evidence from Mexico. IZA Journal of Labor & Development, 5(1), 5.
Bokhtiar, M., Delowar, M., & Wahid, A. N. (2018). Application of Forward Contract and Crop Insurance as Risk Management Tools of Agriculture: A Case Study in Bangladesh. Asian Economic and Financial Review, 8(12), 1394-1405.
Hall, M. G. (2018). Exchange rate crises in developing countries: the political role of the banking sector. USA: Routledge.
Havisha, T. (2018). Crisis, trends, and Economic slowdown: a global perspective. USA: Springer
Hendrawan, R. (2017). Forward, forward option, and no hedging which one is the best for managing currency risk. Jurnal Keuangan dan Perbankan, 21(3), 356-365.
Koczan, Z., & Loyola, F. (2018). How do migration and remittances affect inequality? A case study of Mexico. International Monetary Fund. New York: Springer
Monras, J. (2018). Immigration and wage dynamics: Evidence from the mexican peso crisis.
Rambo, R. G. (2019). Hedges of Recognized Foreign Currency–Denominated Assets and Liabilities. The CPA Journal, 89(8), 54-58.
Romero, L. Q. (2016). Crisis neoliberal y reforma laboral en México. Cuadernos del CENDES, 33(93), 113-123.
Vaishya, S. R., & Sarkar, V. (2017). Implementation of lossy FTRs for perfect risk hedging under the marginal loss pricing. IET Generation, Transmission & Distribution, 11(1), 166-173.
Villarreal, C. C., & Bielma, L. H. (2017). Integración económica, crisis económicas y ciclos económicos en México. Contaduría y administración, 62(1), 64-84.
