June 25, 1987

June 25, 1987 | Backgrounder on Trade, Economic Freedom

Deja Vu of Policy Failure: The New $14 Billion Mexican Debt Bailout

(Archived document, may contain errors)

588 I June 25, 1987 I I' I DEJA VU OF POLICY FAILURE THE NEW $14 BILLION MEXICAN DEBT BAIEOUT INTRODUCTION On the list of soaring Third World indebtedness, Mexico's $100 billion debt to foreign governments and banks ranks second only to Brazil's. Of this, Mexico owes 80 billion to banks in the industrialized countries, and one -third of that, to banks in the United States. This debt to American banks has meant that the overriding concern of U.S. officials dealing with Mexico's chronic debt difficulties is the stability of U.S. financial institutions.

Since Mexico sparked the int ernational debt crisis in 1982, the U.S. Treasury along with Federal Reserve Board Chairman Paul Volcker, has encouraged increased borrowing by Mexico through an International Monetary Fund (1MF)-led approach of recurring debt rescheduling and new money p a ckages. The latest package, the 1986-1987 bailout, includes an IMF loan granted last fall and a bank package agreed to by Mexico's foreign commercial creditors this March. These periodic infusions have kept Mexico from defaulting on interest payments due U .S. banks the new money they have lent Mexico has returned immediately as debt service economic reform necessary if Mexico ever is to repay all, or even much, of its Failing to Spur Growth. Yet the strategy has failed to trigger the sustained This paper, p repared in cooperation with the Arthur Spitzer Institute for Hemispheric I Development, is the fifth in a series of Heritage studies on Mexico. It was preceded by Backgrounder No. 583, "For Mexico's Ailing Economy, Time Runs Short June 4, 1987 Backgrounde r No. i581 1987 and Backgrounder No. 573 Keys to Understanding Mexico: Challenges to the Ruling PRI April 7, 1987). Future papers will examine other aspects of Mexican policy and development Mexico's Many Faces May 19, 1987 Backgrounder No. 4 75, "Mexico: T he Key Players" (April 4, outstanding debt. The rescue package currently underway is unlikely to bring anything new. Bankers are increasingly recoping this as manifest in the decision by Citicorp and other banks to take losses this year in order to put as ide billions of extra dollars into loan loss reserves.

The 1986-1987 bailout of Mexico is a $14 billion package, which includes $7.7 billion from commercial banks in the U.S. and other Western nations, about $2.2 billion in new World Bank commitments, an I MF "standby" credit facility of $1.7 billion, and extensions in trade credit facilities from creditor governments.

Put together by the IMF, this effort, as its two predecessors, ties the financial rescue of Mexico to desperately needed fiscal reforms. In return for the new cash Mexico is promising, among other things, to liberalize trade, restructure state-owned enterprises, and bring domestic prices closer to market levels. Though the content of the rescue package is laudable, it evokes a numbing feeling of deja vu. Mexico has given similar assurances in the past but seldom fulfilled them reason to expect this effort to be any more successful In the 1976 and 1982 IMF rescues from illiquidity, Mexico's ruling Institutional Revolutionary .Party PRI responde d by imposing narrow fiscal restraints borne largely by the poor. And each time, Mexico reverted to its former fiscal habits and reflated the economy about 18 to 24 months after the crisis There is no Testing the Baker Plan. In late 1985, the U.S. Treasury changed its strategy shifting away from the required "austerity" of past IMF programs that aimed at forcing nations to cut back their budget deficits drastically. Treasury Secretary James A. Baker emphasized that debtor countries should be helped to "grow their way out of debt As such, the new conditions tied to rescues concentrate on structural adjustments to trigger growth, such as trade and investment liberalization tax reform, and privatization of state-owned enterprises. The $14 billion Mexican packag e is the first test of the "Baker Plan While some of the required economic reforms ne otiated with Mexico this time are new, there are few signs that its handling o P loan conditionality will be any different than in the past.

The U.S. has significant econ omic and security interests in Mexico. It is America's third largest trading partner, behind only Canada and Japan In 1986 U.S. exports to Mexico were over $12 billion, while imports from that country were 17.5 billion. Aside from this, a destabilized Mex i co would not only invite Soviet sponsored adventurism but provoke an explosion in the already high flow of illegal immigrants across the 1,950-mile border shared with the U.S of Mexico. It is not a good investment to shore up the same policies of the PRI t hat have created and perpetuated Mexico's problems. In fact, the Mexican economic crisis is, in large part, a political one Web of Regulation. Mexicans endured a revolution from 1910 to 1920 in the name of representative democracy. What they ended up with has been 60 years of quasi-dynastic, one-party rule in which every six years the president chooses his successor, who is then duly "nominated and "elected Under PRI-style "Mexican socialism successive Mexican presidents steadily have consolidated their au t hority It thus is a good investment for Washington to prevent the economic collapse 2into an almost absolutist presidency, while bringing virtually every basic industry and national resource under state control. Today only about 30 percent of the economy remains entirely in the private sector, which in any event is entangled in a tight web of state regulation.

Organized labor has become almost synonymous with the PRI and fiercely opposes attempts to privatize state-owned enterprises. Corruption and nepotis m meanwhile, pervade the government, the party, and big labor. Large-scale vote fraud has marked all important elections for the past three years. Such political realities are directly connected to Mexico's irresponsible economic policies.

Ironically, but predictably, eriodic external financial rescues have proved the in Mexico These rescues do Memco no good and should be discontinued. The government has a variety of means for raising revenues to service its debt. It should divest itself of most of its in e fficient state owned enterprises, stop impeding the flow of equity capital, and promote the growth of the private sector and domestic capital markets through deregulation 'and 'a commitment to the sanctity of property rights enemy of sustained economic re o rm r THE MEXICAN BATLOUT OF 1986-1987 The current rescue package contains about a dozen new loans to Mexico 1) IMF stand-by facility of $1.7 billion. And $720 million committed to Among the most important commercial banks' oil and growth-rate funds see be l ow 2) World Bank $400 to $500 million loans for trade liberalization 3) World Bank $950 million loans for the investment programs of 4) World Bank $300 million industrial sector loan government-owned enterprises 5) World Bank $700 to $800 million loans fo r agriculture credit 6) Commercial Banks $7.7 billion loan package containing $6 billion in new loans at a slim interest rate of 13/16 over LIBORl (partially covered by World Bank cofinancing and guarantees a $1.2 billion loan, activated if oil prices drop below $9/barrel in 1987; a $500 million loan, activated if Mexico's owth rate falls loans rescheduled in 1984 and the extension of their maturities to 20 years from 14 and relief on the payment of the 1983 and 1984 rescue loans In exchahge for this infusi o n of capital, the lenders are imposing conditions on Mexico. Among the most important are below 3.5 percent in 1987; a second interest rate reduction on the !r 43.7 billion in 1. The banks' cost of borrowing funds 31) The IMF loan insists on current expen d iture cuts, increased public investment, tax reforms, price adjustments to bring prices closer to market levels and a 3 percent decrease in the fiscal deficit to 10 percent of GDP by the end of this year 2) The World Bank trade loans insists on phasing in of GATT compliance* and a move from import quotas to a system based strictly on tariffs with gradual reduction of the latter 3) World Bank loans to state-owned enterprises are linked to phasing out subsidies and are targeted for the steel sector, the fert ilizer monopoly, and enterprises with mixed public/private participation.

PROBLEMS WITH THE RESCUE A central element of the 14 billion package is IMF acceptance of the continuation of a large budget deficit by Mexico 10 percent of gross domestic product GDP) for 19

87. B the end of this year, Mexico will owe at leasVan encourages Mexico to grow its way out of debt, any economic growth it enjoys in 1987 will come about mainly as a result of a large public sector deficit additional 12 billion, plus x e corre sponding interest. While the Baker strategy More important, fiscal austerity has never been completely tested in Mexico.

The 1976 and 1982 IMF bailout programs required Mexico to halve the budget deficit during 1977 and 1983, respectively (see Table I Yet the IMF allowed the Mexican government to implement this as it saw fit and even counseled tax hikes in 19

83. The result was that Mexicans suffered inordinately because the deficit was cut without cutting the bureaucracy and state-owned enterprises. While genuine fiscal austerity is still desperately needed, the IMF's high deficit target only makes it easier f or Mexico once again to put off drastically trimming the bloated state sector At Cross Purposes. In fact, IMF and World Bank conditionality even ,calls for increased investment for government-owned enterprises (GOEs The World Bank is lending $950 million t o GOEs for their investment programs, based upon promises that government subsidies to them will be phased out. This would clearly seem to be at cross purposes with an effort to make these enterprises more efficient or with the World Bank's purported advo cacy of privatization of GOEs.

Additional loan facilities tied to the growth rate and price of oil were a key negotiating position of the Mexican government. A $1.2 billion fund will be activated if oil prices drop below $9 a barrel before the end of 19

8 7. A $500 million facility will be triggered if Mexico's growth rate falls below 3.5 percent this year Unprecedented Disincentives. Such provisions are unprecedented and provide further disincentives for genuine reform. They imply that a government need n o t set aside reserves for adversity and that a country's fortunes are determined almost exclusively by external factors. In addition, the manipulation of government policies 2. Mexico joined in 1986 and has until 1994 to reach full compliance 4or the judic i ous use of statistics can roduce a growth rate below 3.5 percent,-thus allowing Mexico to collect the extra P 500 million loan3 Ironically, an IMF economist recently described the new facilities as a si nificant tactical improvementon debt management sinc e they allowed B or the inevitable failure of an assumption or two in the IMF's country-specific economic models In other words it is now even more difficult for Mexico to "default There are yet no signs that the conditionality in this Mexico package will f are any better than in the past. Recent signals from Mexico City reveal that little has changed. In response to the urging by World Bank officials to privatize, the government has been merging smaller or ailing state-owned enterprises into larger ones. Re a l divestments have been few and include a hotel chain and a small airline. The government-owned Fundidora steel plant in Monterrey has been closed Off Limits. Mexicana, one of the nation's two government-owned airlines, has been up for sale to investors f o r eighteen months. Its failure to move is no doubt caused by the terms imposed by the powerful labor unions, which would preventithe new owners from dismissing any workers. The more profitable airline, Aero Mexico is not for sale. Other government-owned c oncerns likely to remain off-limits include the federal electricity monopoly, and the state sugar, steel, railway and fertilizer corporations.

The recent sale of stock in the three largest commercial banks nationalized in 1982 was characteristic of Mexican political patronage. In 1983, President' Miguel de la Madrid promised to return 34 percent stakes in the banks to private hands by spring 19

84. Finally, this March, 34 percent in each of the three was offered in greatly underpriced new capital issues. T he share certificates were distributed almost entirely to employees and clients of the banks who are friends of the government A HISTORY OF FINANCIAL MISMANAGEMENT Economic irresponsibility 'is nothin4 new in Mexico. The country defaulted on its late 19th century government borrowngs in 19

14. In the 1920s and 1930s a succession of debt agreements was reached with British bondholders and American and French creditor banks, each of which was followed by breakdown and renewed default 114 was the debt roblem resolved. Debts totaling $510 million in 1942 were paid off for less than P 45 million, roughly nine cents on the dollar, despite Mexico's Only after Mexico had begun to receive U.S. assistance during World War 3. Peter Bauer Ethics and Etiquette of Third World Debt vol: 1 1987 p. 83 4. This included U.S. agreements of 1941-1942 to: purchase silver from the Bank of Mexico up to 6 million ounces/month, purchase pesos up to $40 mdlion to stabilize the curreny, and extend Export Import Bank credits to provide material for the construction of cargo vessels and rolling stock for increasine the capacity of Me~ican railroads and to frnance industrial development, including the construction of a steel and tin plate rolling mill and a gas refinery 5 ability to meet d one this.5 I its existing obligations easily--the flow of U.S. aid alone could have Few instances typify Mexico's self-inflicted economic damage more than does the PRI's mismanagement of the Mexican oil industry. In 1938, President Lazar0 Cardenas nationa l ized the foreign oil companies operating in Mexico. At first, the new state-owned oil company, Petroleos Mexicanos (Pemex was able to resist the demands of the Oil Workers' Union. By the 195Os, however, all efforts to contain the union and run Pemex by so u nd business principles were abandoned. The government's direct control over Pemex grew. Said President Ruiz Cortines in 1954 The role of Pemex was not one of profit but of social service 1946 to 1974, denying the company the revenues needed for expansion, exploration or even, at times, the maintenance of day-to-day operations. Friends and relatives of politicians were given Pemex jobs, and lucrative gasoline station concessions were Most Inefficient Oil Firm. Domestic oil prices were raised only twice from awarded as political favors As a result, Pemex became known as the world's most inefficient oil company.

Only in 1972 did Mexico finally pump more oil than it had in 19

21. By the early 1970s, in fact, domestic demand was so high that Mexico was importin g 100,000 barrels of oil a day from Venezuela, where output per worker was four times higher.6 THE MOVE AWAY FROM A MIXED ECONOMY Since World War II, the Mexican government has used high tariffs, import licensing, overvalued exchange rates, domestic subsi d ies, and state-owned enterprises to achieve growth in selected manufacturing industries. These policies of import protection and selected subsidies of capital and energy predictably impaired Mexico's mternational competitiveness product (GDP) in 1950 to 5 percent in 1970 Under President Luis Echeverria Alvarez (1970-1976 the government's role in the economy intensified dramatically. The public sector deficit, which had averaged 3.5 percent of GDP from 1965 to 1970, reached 8.5 percent of GDP in 19

75. It i s now well over 10 percent. The number of state-owned companies doubled between 1970 and 1976, a rate of expansion much greater than that of the economy in eneral. Echeverria financed state expansion through oil revenues and heavy foreign Lrrowing.

The fo reign public debt, which had amounted to $6.8 billion at the end of 1972, reached almost $21 billion four years later. Echeverria's developing liquidity crisis came to a head in August 1976, just months before his term was to end. He devalued the peso by almost 60 percent, the first devaluation since 1954 Exports fell from 10 percent of gross domestic 5. See Clifford M. Lewis When Countries Go Broke: Debt Through the Ages,"

Winter 1986/87 6. See Alan Riding chapter 8 The Oil IS Ours."

A P New York Alfred A. Knopf, lW 6Capital Flight. The growing deficit spurred an inflation that encouraged Mexicans to send their money abroad. From 1970 to 1982, the average level of deposits by Mexican residents in U.S. banks rose from $276 million to $6.2 billion.

The tot al capital flight from Mexico from 1974 to 1982 is estimated to be $31 billion. This is close to the $37 billion increase in foreign public debt under Echeverria's successor, President Jose Lopez Portillo 1976-1982 After taking office in December 1976, Lo p ez Portillo signed a letter of intent with the IMF to obtain emergency "stand-by" credits to bolster the eso. In 1977 of GDP to 5.1 percent; this was close to the IMF target of 4.5 percent pursuant to the IMF program, he reduced the public sector deficit E om 9.9 percent Betting on the Price of Oil. In 1977, oil discoveries off the southeast and Gulf coasts boosted Mexico's proven reserves from 6.4 to 16 billion barrels. This oil bonanza, along with rising crude oil prices and the fiscal deficit reduction a chieved after 1977, boosted Mexico's credit rating. Foreign lenders competed fiercely to grant new loans to the Mexican government and to public enterprises This was not project lending, but general balance-of-payments support from foreign commercial bank e rs. For repayment, they were betting sole1 on the price of oil future which was widely predicted to increase sharply in real terms r or the foreseeable Lopez Portillo paid off the 1977 IMF loan in 1978, a year early. That done he then abandoned budgetary r estraint and returned to the public sector-led growth approach of his predecessors, claiming that the new oil wealth would finance Mexico's development in a noninflationary way. He launched Mexico on a consumption spree, which not only absorbed all of its oil revenues, but also vast sums in foreign loans. Renewed growth in public expenditure fueled unchecked consumer demand? Imports by 1980 were up to $20 billion. Oil exports in 1980 however, at not quite $10 billion, failed to cover even half of Mexico's im orts become severely overvalued--by 50 percent in 19

81. About $8 billion in capital fled Mexico in that year alone Since the exchange rate earlier essentially had been fixed, the peso again x ad In an attempt to arrest the growing fiscal deficit, the Mexican Congress approved a fiscal 1981 budget mandating no deficit increase in nominal terms.

Lopez Portillo ignored this As Echeverria before him, he approved grand projects as off-budget items, which ended up being paid for by foreign borrowmg. In 1981 alone, Mexico's external debt increased 38 percent. In t he Lopez'Portillo years, the total external debt rose from 27.3 billion to $84.1 billion. Over 80 percent was owed to private creditors; approximately 75 percent was at floating rates of interest 7. Fiscal Deficit 1976 9.9 1980 7.9 as of GNP) 1977 5.1 lps l liLz 1978 6.7 B82Ize 19-79 7.4 1983 8.7 7CORRUPTION UNDER ECHEVERRIA AND PORTILLO The high .level of corruption of the 1970s, excessive even by Mexican standards, played a significant role in precipitating the debt crisis. During Echeverria's tenure, gove r nment spendmg on massive industrial projects and rural public works was audited very casually. Top government officials, responsible for assigning contracts for public works or procurement of locally made goods, made fortunes through kickbacks and grantin 8 contracts to companies they owned. When the Las Truchas Steel complex was built 100 miles north of Acapulco in the early 197Os, for example, a consultant from British Steel estimated that $150 million of the 1 billion cost was lost through corruption As h ad several of his predecessors, Lopez Portillo promised to combat 1 corruption. But the wealth of the oil boom soon became irresistible for him and most top officials. Nepotism also flourished at an unprecedented pace. Lopez Portillo gave ministerial and o ther top posts to his son, two sisters, a cousin, his mistress, and his wife. When he left office in 1982, the Mexican press claimed he had amassed a fortune of 3 billion.8 r I MANAGING MEXICAN DEBT SINCE 1982 After world oil prices declined in the early 1 98Os, another Mexican liquidity crisis erupted. In August 1982, Lopez Portillo declared a three-month moratorium on principal payments to foreip creditor banks. He then imposed blanket foreign exchange controls and nationallzed private banks to stem the f low of capital abroad.

That Au st also, the IMF granted Mexico a "stand-by" credit facility of $3.7 billion, while fll oreign commercial banks granted $5 billion return for the loan, the IMF insisted that Mexico cut its from 16.5. percent of GDP in 1981 to 8.5 percent of GDP President Miguel de la Madrid (1982-present the deficit was down to 8.7 percent but GDP had declined by 5 percent. While part of the contraction represented the long-delayed retrenchment of consumption, a large part can be attributed t o the government's refusal to reduce its own dole As Mexican professor Luis Pazos has shown, all austerity demands were made of industry, commerce, and private consumers, not the g~vernment Growing Bureaucracy. While Mexico's population increased 25 percen t from 1975 to 1983, the bureaucracy grew by 85 percent. Even during the ostensible austerity of 1983, the bureaucracy went up another 281,000 jobs. Salaries of ministers, underministers, directors, and high-level bureaucrats increased two to three times f a ster than the rate of inflation, while junior bureaucrats and labor suffered declining real salaries 8. See Ridmg, a, pp. 113-133 9. See The False Austerity Policies of the Mexkan Government Journal of E Vol. 1 no. l, 1986 8- I To pay for this expanding g o vernment, taxes were raised. Upper bracket Mexicans found themselves paying steeper income taxes, and everyone was hit by the hike to 15 percent in the value-added tax. Prices charged by public enterprises for such products as gasoline, electricity, and t elephone service were all raised substantially.

Mexico's foreign commercial creditors, concerned that debt repayment remain on schedule, took account only of the country's impressive 1983 trade surplus of 13.7 billion. Both a restructuring accord and a sec ond emergency loan, this one for 3.8 billion, were negotiated in 19

84. Yet even as these accords were being reached, Mexico was already violatine the earlier IMF a eement; de la Madrid was as an opportunity for fiscal relaxahon.

By 1985, the deficit had mounted to 10 percent of GDP. The money supply was up 63 percent in 1984 after an increase of 41 percent in 19

83. Lendmg to the central government from the nationalized banks reached record levels in 1984 and early 19

85. From April 1984 to April 1985, the value of treasury bonds 'in circulation doubled. In response, the IMF withdrew its loan agreement in 1985 and canceled the last disbursements. Yet, by the summer of 1986, Mexico was back negotiating another fmancial rescue with the IMF and commercial banks pumping up the money supply. Aea~n, the availability o Y foreign loans was exploited THE WORLD BANK AND THE INTER-AMERICAN DEVELOPMENT BANK Some $13 billion has been loaned to Mexico over the years by the World Bank and the Inter-American Developmen t Bank (IDB This money was to finance specific projects, in contrast to the general balance-of- ayment loans made by foreign made to the Mexican government, thus fueling expansion of.the public sector. In 1985, for.instance, the World Bank loaned $300 mill i on to Mexico's nationalizedrailroad system. The railway's financial troubles should have prompted the World Bank to insist that it not remain in the public sector. Instead, the Bank's financing assured that it would Commercial banks and the IMF. About 90 percent o P these project loans were The Inter-American Development Bank had approved loans totaling 4.5 billion for Mexico through 19

86. The two largest sector recipients were agriculture/fisheries and industry/mining, both of which are owned largely by the government. In 1985, the Bank approved a $300,000 agriculture credit loan from the Fund for Special Operations, its soft-loan window that makes loans at 1 to 2 percent annual interest. Targeted to low-income farmers, these loans will go mainly to the t he farmers who cultivate Mexico's state-run farms CHANGING COURSE With the PRI choice of presidential candidate approaching this September and the formal election following in July 1988, temptations for the Mexican government to inflate the economy are rn c reasin It happened in Brazil prior to last fall's presidential elections and the July 1985 mid-term congressional and gubernatorial elections. The money supply in Mexico is already up. When the $7.7 billion in parliamentary. elections. It happene fi in Me xico preceding the 1976 and 1982 9I commercial bank loans of the new rescue package are delivered, Mexico actually will enjoy a temporary cash surplus. This almost surely will be used to inflate.

The IMF's job of providing short-term relief to cash-strappe d countries has become discredited. While many countries, such as Mexico, increasingly depend upon such emergency funds the accompanying IMF policy guidance rarely leads to genuine reform. The end result is that the IMF is becoming entrenched in countries where it has made big loans. This is transforming the IMF into an international FDIC for commercial banks. With the new Mexican bailout, the World Bank is joining the IMF in this role. This was necessary to get the commercial banks to increase their expos u re by 13 percent in a country whose debt had declined in the secondary market over the past year from 68 percent of face value to 58 percent Dismayed Creditors. From the beginning, the commercial bank package has been very unorthodox. Other debtors such a s Brazil, Argentina, Venezuela, and the Philippines have been eyein enviously the slim interest spread of 13/16 over The banks are not likely ever to agree to such terms again. The dismayed creditors of Mexico: contend that the interest spread does not pro perly reflect Mexican risk at long maturities.

Des ite this, the large banks decided it was better to "go the distance" with the $7.7 E illion loan to Mexico than to face the alternative of taking large losses in earnings through writing-down the value of their Mexican portfolios regional banks have signed on the $7.7 billion package largely because of tremendous pressure from the U.S. Treasury, the Federal Reserve Board, and other Western central banks LIBOR (the banks' cost of t orrowing funds) offered M exlco.

The smaller The recent decision by Citicorp, Bank of America, Chase Manhattan, and other banks to increase substantially their loan loss reserves signals an end to the ost-1982 strategy of lending new money to Latin debtors so it can come right back Lorn them as interest payments on their debt. The banks' actions are an admission that the bad Latin debts are not worth one hundred cents to the dollar and probably never will be repaid fully 85 Cents on the Dollar. Late last year, Republic National Ban k of New York took a still more drastic step and became the first of Mexico's major U.S. creditors to revalue, or 'Mte-down," a significant portion of its Mexican public sector debt.

First, it sold off some of its Mexican debt to third party investors at a $2 million loss. Next, in preparation for further sales, it moved some loans into its investment account, where they must be carried at market rather than face value. Republic's effective write-down amounted to $39 million. The combined $41 million loss a nd Mexico. The bank in effect said that the nation's loans are worth only 85"cents on the dollar write-down constituted roughly 15 percent of Republic's $257 million in loans to U.S. banks are increasingly able to make such moves because they have been st e adily strengthening their capital bases since 1982 through enhanced internal capital generation and substantial cutbacks in loan expansion. A recent study by a leadmg mvestment firm, Salomon Brothers, contends that the banks' improving equity ratios 10 - w ill allow them to absorb modest write-offs on bad loans and still maintain capital bases that are satisfactory when viewed in an historical framework.lO What is often forgotten in the debt debate is that the rates for U.S. banks loans to Mexico and Latin A merica reflected the high credit risk. The have default. Even after the 1982 crisis, bankers were charging front-end fees of 3 to 4 percent of the new loans. The bottom line is that the banks were funding Mexican current account deficits by betting on oil revenues, and it proved to be a bad bet therefore already taken out much of the profit against the possibility o l future CONCLUSION Debtor governments, such as Mexico's, will modify their policies only if continued pursuit of these olicies leads to econo m ic breakdown threatenmg the continue their suicidal policies. As such, the bailout is the enemy of sustained reform in Mexico. A government that has subjected its populace to cuts in consumer subsidies, drastically increased taxes, and a real wage cut of. SO'percent between 1983 and 1985 without a mass revolt surely can survive the divestiture of the bulk of its inefficient state-run enterprises and substantial cuts in its bloated bureaucracy.

These include ruling pmes and elites. I P Mexico and similar countries are rescued, they will There are many ways in which Mexico can find resources for paying its debt 1) the sale of some state-owned enterprises in their entirety or in part 2) the lifting of the 49 percent o wnership limit and other restrictions Ion the flow of foreign direct investment 3) the reduction of extravagant public spending; and 4) the pursuit of market-oriented policies to encourage growth, such as As a start, the government should rivatize Pemex t h rough a genuine public banking system in like manner. Most important, in order to rein in its claim on domesbc credit expansion and its appetite for foreign loans, it should make drastic cuts in the federal bureaucracy southern neighbor to behave as an ec o nomically responsible member of the dismantling many of the controls on the heavily regulated private sector sale of shares. Second, it should divest tg e remaining two-thirds of the nationalized Mexico has the resources to honor its debts. The U.S. shoul d expect its of states. As President Reagan said in 1983 If policies are all the aid in the world wll be no more than money down the drain."

Melanie Tammen Research Assistant 10. Salomon Brothers, "Bank Weekly January 20, 1987 11 - TABLE I A CHRONOLOGY OF REFORM AND RETREAT 1976 1977 1978 1979 1981 1982 1983 1984 1985 IMF stand-by facility of $963 million. Mexico agrees to reduce public sector deficit from 9% of GDP in 1976 to 4.5% in 1977, and to liberalize trade and enter GATT.

Deficit down to 5.1% of GDP. Inflation has come down, domestic savings up, current account deficit down, and capital flight down significantly. Vast new oil reserves discovered.

Mexico pays off the IMF early. (Crude oil prices more than double between 1975-1980 Portillo revives public sector-led growth. Plans to liberalize trade and to join GATT abandoned.

The 1977-1978 adjustment in the current account deficit is lost. While the value of oil exports has quadrupled merchandise imports still running ahead of oil revenues.

Mexico's total external debt rises by 38% this year IMF stand-by facili of $3.6 billion arranged. Mexico in 1983, reduce foreign borrowing to $5 billion in 1983 raise taxes, cut subsidies, and limit wage increases.

Emergency $5 billion loan subscribed pro rata by foreign creditor banks on basis of e osure as of August 19

82. Banks offered spread of 2.5 7 o over LIBOR or 2.125% over Prime; maturity requested only 6 years; 3-year grace period; substantial codtment/facility fees attached.

Fiscal deficit down to 8.7 % of GDP, near the target is to cut budget de x 'cit from 16.5% of GDP in 1981 to 8.5 Fiscal deficit down to 7.4% of GDP. Restructuring accord reached with Mexico's largest foreign creditors, covers roughly half the $97 billion of debt outstanding. Credit ors get choice of LIBOR 1.875% or Prime +1.75 a still attractive 1% restructuring fee; maturities stretched out over 14 years 2nd emergency loan ($3.8 billion) from commercial creditors.

Option of LIBOR 1.5% or Prime 1.125 maturity .is 10 years 5 1/2 year grace. Money supply-on the upturn: up 64% in 1984 from 41% in 1983 a Fiscal deficit back up to 10% of GDP, instead of target of 4%. IMF withdraws facility, cancels last disbursement 12 } {\f1

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