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he economy was essentially inward oriented and it largely practiced import substitution industrialization (ISI) strategy indicating high trade barriers and selective preferential credit schemes (World Bank, 1998). This protected system helped in attracting private investments but by 1970 this strategy could not sustain due to growing economic distortions.

Mexico's GDP growth is 6 per cent in average till late 1970's because of sound resource allocation and living standard coupled with protective regulations. However, by 1980's there is a drastic reduction in GDP growth to nominal 1.81 per cent and a negative downturn in GDP per capita growth. This slump was signaled prior to the crisis when macroeconomic indicators started to show wary results listed in the points below (World Bank, 1998):

As ISI strategy was discarded, the private sector was authorized to lead in investing but it was not fully equipped to execute its intermediating role. This caused misallocation of savings in projects and investment in low return assets in the cost of investing in innovative ventures which ultimately lowered the economic growth.

Such misallocation of resources was amplified with inflow of foreign capital and also extensive asset holdings in foreign currency mainly dollars, augmented financial system's vulnerability.

These distortions led to increase in domestic inflation and the real interest rates also turned negative. Consequently, there was increased capital flight which reduced the portions of funds that were loanable to domestic investors.

The above points signify the onset of macroeconomic instability in Mexico during 1970-1980 when it lowered its guards towards the forthcoming crisis. Had the domestic financial intermediaries and system as a whole been appropriately regulated against misallocation and avoided greater inclination towards foreign impulses then Mexico could have had a stronger standing at least in financial context.

Restrictive FDI policies in early 80's

The government adopted and operated under restrictive law to promote Mexican investment and regulate FDI in 1973. This law created uncertainty between foreign investors since there was widespread discretionary power with the policymakers. The side-effect of such weak foreign investment system was that capital inflows made its way mainly through sovereign bank lending to which Mexico had grown to be largely dependent (World Bank, 1998). This increased the vulnerability since those capital inflows could be by large reversed and there were limited alternatives to those sorts of capital resources.

Weak Fiscal Discipline

One form of persistent government intervention in financial sector was the adoption of repressive policies. This allowed government to have an easy access on private savings to finance its expenditures and deficits which encouraged a rise in government spending and expansion of public enterprises. In 1978 as shown in the Figure 1, there is a step rise from around 19 per cent to above 25 per cent by 1982 whereas the private investment remained low. Hence, such public-sector driven growth deteriorated fiscal discipline gradually and generated greater dependence on foreign borrowing.

Also, government absorbed an increasing share of banking system deposits by imposing high reserve requirements. The effective reserve ratio rose