A safer bet for investors became a heavier burden for Mexico
As political uncertainty unsettled investors in 1994, Mexico’s government faced a dangerous combination: people were pulling money out, while the government still needed to refinance its debts. It encouraged holders of short-term, peso-denominated government securities to switch into Tesobonos, which were repaid in pesos but adjusted in value to track the U.S. dollar.
That promise reduced one fear for investors: if the peso weakened, their repayment would not lose value in dollar terms. But it shifted the exchange-rate risk onto the Mexican government. The more the peso fell, the more pesos the government needed to repay those dollar-linked obligations.
Why confidence became a currency problem
The switch bought time, not dollars. Meanwhile, investors seeking to leave Mexico exchanged pesos for foreign currency, forcing the central bank to use its reserves to support the peso and meet demand. As reserves dwindled, investors had more reason to doubt that Mexico could maintain the exchange rate—and more reason to get out before others did.
When the peso was devalued late in 1994, the government’s dollar-linked debt grew costlier to repay just as confidence was collapsing. Mexico struggled to refinance the obligations coming due, and the crisis spread beyond its borders as investors reassessed the risks of other emerging markets.
The cost of insuring the exit
The Tesobonos had made Mexican debt look safer to individual investors, but they left the country more exposed to a sudden loss of confidence. International assistance helped Mexico meet its obligations and stabilize the crisis. The striking lesson was that a guarantee against currency losses can protect investors while making a government’s own debt crisis worse.
