In Mexico the problem happened when investors became increasingly reluctant to roll over their short-term peso-denominated cetes and instead shifted their funds to short-term dollar-indexed tesobonos. This shift to dollar-indexed liabilities supplied a temporary respite for the government but the short-term nature of outstanding securities also meant that the transformation in the structure of debt towards tesobonos was extremely quick. The rapid withdrawal of foreign investment from the domestic market at the end of 1994 and the resulting sharp drop in the Mexican peso resulted in an explosive growth in the peso value of dollar-indexed government liabilities, thereby adding a fiscal dimension to the external crisis (Jeanneau and Tovar, n.d.). The local government bond market has expanded rapidly in Mexico since the mid-1990s. In part, this has reflected a conscious effort by the authorities to develop domestic sources of financing as a means of reducing the country's dependence on external capital flows. The abrupt withdrawal of external capital in late 1994, in what became widely known as the "tequila crisis," resulted in a deep economic and financial crisis in Mexico. This made policymakers acutely aware of the vulnerabilities associated with a heavy reliance on external financing (Jeanneau and Verdia, n.d.).

Domestic bond markets have stayed underdeveloped for much of Mexico's modern history. Consistent with the general results of emerging market economies, a poor inflation record and the consequently weak credibility of monetary policy made it practically impossible for the government or other Mexican borrowers to introduce standard long-term debt securities in the domestic market. Indeed, entrenched inflationary expectations meant that lenders were only willing to lend in domestic currency at very short maturities or with returns indexed to inflation, short-term interest rates or the U.S. dollar. They were, of course, also prepared to lend in foreign currencies, principally in U.S. dollars (Jeanneau and Verdia, n.d.).

One goal of the government's strategy to develop a domestic bond market has been to improve the demand...

Indeed, increased demand has been a major by-product of the more stable macroeconomic environment since the mid-1990s. The Bank of Mexico's monetary policy framework has led to a sustained reduction in inflation, with the rate of increase in the consumer price index declining from 52% in 1995 to slightly below 5% in 2004. At the same time, the government has been broadly successful in meeting its targeted reductions in the narrow fiscal deficit (Jeanneau and Verdia, n.d.).
Another key part in boosting demand for government debt has been a reform of institutional investment. In 1997, the government implemented a sweeping reform of its pension system for workers in the private sector. Schemes for public sector workers were not affected. The existing defined benefit system was replaced by a compulsory defined contribution plan that is fully funded by individual accounts managed by private administrators. The new privately managed pension system has experienced rapid growth since its inception, with assets under management rising from virtually nothing in 1997 to MXN 470 billion at the end of 2004, or 6.5% of GDP (Jeanneau and Verdia, n.d.).