Borrowing Risk and the Tequila Effect

The collapse of the Mexican peso on December 20, 1994 triggered exchange market pressures and increased financial market volatility in a number of developing countries.1 In Latin America, two economies were hit particularly severely: Argentina and Brazil. In both countries, gyrations in market sentiment led in early 1995 to a sharp reduction in net capital inflows, a fall in official reserves, and intense pressure on asset prices. Between December 1994 and February 1995, the cumulative decline in stock market prices (measured in terms of US dollars) reached 24.8 percent in Argentina and 22.6 percent in Brazil.