Financial Crises in Emerging Markets: The Lessons from 1995

THE MEXICAN PESO crisis of December 1994, and its reverberations in the financial markets of developing countries around the world, has intensified the debate over the nature of balance of payments crises in developing countries. Many simple explanations have been given for the crisis and its aftermath, but none of them does very well at accounting for the main patterns of behavior in emerging markets during late 1994 and 1995. For example, many observers claim that it was Mexico's yawning current account deficit in 1994 that led to the drying up of capital inflows, and thereby to the collapse of the peso. Nonetheless, countries such as Malaysia and Thailand ran comparably large current account deficits in 1990-94 (as a percentage of GDP) without suffering reversals of capital inflows. Other observers claim that investor panic spread contagiously from Mexico throughout emerging markets. This story fits well with the strong adverse market reactions experienced by Argentina and Brazil in early 1995, but not with the experiences of