Throughout the years 1994 and 1995, Mexico faced a crash in the value of their peso—depreciating almost 50% overnight. While catastrophic for the Mexican economy at the time, the tequila crisis troubled other Latin American countries with extended periods of economic instability—leaving a particularly exacerbated “hangover effect” on the Brazilian economy.
Unemployment.
Unemployment rates surged as a result of the Tequila crisis. Prior to the crisis in 1994, Brazil had just been revitalised by the success of the Plano Real, a plan set out to stabilise the economy after the “lost decade,” a period (1980–1990) of economic dismay in Brazil, fuelled by hyperinflation and failing commodity prices. The unemployment rate at that time sat at 4.6%. By 1995, unemployment rose to 5.9% and continued climbing to 6.2% in 1997. Latin American countries all thrive on their exports and thus sit in an economic web of sorts—whereby if one country experiences dampened economic activity, there is a ripple effect onto the others. In this case, the surging unemployment was driven by a lack of foreign investment and general austerity measures designed to stabilise Brazil's currency. It was also the economic uncertainty surrounding South America that led domestic businesses to furlough workers, notably the manufacturing sector, which was far more reliant on foreign capital.
Inflation.
Following the masses of hyperinflation in the lost decade, the Plano Real looked at introducing a new currency, one which the Brazilian people grew to have faith in, the (BRL), pegged to the US dollar. Seemingly in full recovery, the tequila crisis tested the strength of the new Brazilian monetary system. Following the devaluation of the peso, Brazil fell in the crosshairs of attacks on its own currency as foreign investors grew pessimistic about its ability to maintain a fixed exchange rate. Having just escaped hyperinflation in their rear mirrors, the Brazilian government augmented interest rates, avoiding probably what would have been a full- blown currency devaluation, but at an inevitably high cost to economic growth. As interest rates shot up 17% in 1994, borrowing became far more expensive than when they were at 7% in 1990. Naturally, this led to a decrease in consumption, which kept inflation rates tame. Inflation was reduced to 23% in 1994 and then dropped to a further 19% in 1995, as a result of aggressive monetary policies. Although interest rates were kept relatively low —in comparison to their pre-1994 levels—the flip side of the coin was that economic growth was conceded, with very little support from foreign investment and business confidence.
Trade balance
Even prior to the Tequila crisis in 1994, Brazil was plagued by a heavy trade deficit (-$10.1 billion); it was importing far more than it was exporting. The Plano Real stabilised the Brazilian real, making imports cheaper and thus more abundant, valued at $43.6 billion. Contrastingly, Brazil's exports were very seasonal, relying on commodities and failing to close down the deficit valued at $33.5 billion. The crisis saw nearly a 50% depreciation in the value of the Mexican peso and put immense pressure on the Brazilian real owing to capital flight and threatened investment confidence, both of which placed downward pressure on the Brazilian real. Now relatively weaker than other currencies, imports have become more expensive, which partially reduced the deficit. Moreover, exports became far cheaper, helping Brazilian goods become more internationally competitive. Brazil - being one of the biggest exporters in the world - benefited immensely from this, as it helped tighten their control on the deficit. Having said this, Brazil's trade balance still remained feeble as they were so dependent on their agricultural exports that the structural weaknesses in their industrial and agricultural sectors placed a limitation on how much they could actually export.
GDP growth
GDP growth slowed significantly in the 1990s. Okun's law tells us that with higher unemployment, GDP growth will slow. The tequila crisis was no exception to this. What’s more, the heightened interest rates meant a slowdown in consumption and growth in Brazil. Though GDP never experienced a severe recession, growth certainly slowed down. Prior to the crisis, in 1994, the Brazilian economy grew by 5.9% thanks to the Real plan. Post-crisis, however, the GDP growth rate slowed to 3.9%, and by 1996 had slowed even further to 2.1%. Here, the prolonged economic effect of reduced investment and spikes in borrowing costs are at play. While the Brazilian government avoided what could have been a catastrophic wipeout economic collapse, the harsh monetary policies that had been adopted—such as interest rates or tariffs on imports—meant that the GDP experienced slower growth.
The tequila crisis sent shockwaves through brazils economy. While the implementation of a new currency brought by the Plano Real helped Brazil bounce back from this turmoil, ultimately saving them from a full blown economic collapse, the crisis underscored the inter connectedness of the Latin American economies.
