MEXICO: HIGH COSTS OF MAINTAINING AUSTERITY

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• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP84S00552R000300170004-6
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 21
• Document Creation Date: December 22, 2016
• Document Release Date: January 10, 2011
• Sequence Number: 4
• Publication Date: August 1, 1983
• Content Type: REPORT

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Mexico:
High Costs of
Maintaining Austerity
Intelligence
ALA 83-10128
August 1983
302
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Directorate of Secret
Intelligence
Mexico:
High Costs of
Maintaining Austerity
This paper was prepared b Office of
African and Latin American Analysis. It was
coordinated with the Directorate of Operations.
Comments and queries are welcome and may be
directed to the Chief, Middle America-Caribbean
Division, ALA,
Secret
ALA 83-10128
August 1983
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UCN VI
Mexico:
High Costs of
Maintaining Austerity
Key Judgments De la Madrid's efforts to bring domestic spending in line with Mexico's re-
Irt/ormation available sources have yielded some financial results, but they have nearly derailed
as of 1 August 1983 the domestic economy. To meet IMF targets thus far, Mexico City has cut
was used in this report.
government spending by about 20 percent, in large part by slashing public-
sector imports. The large peso devaluation and disrupted trade financing
lines also helped keep imports in the first half of 1983 at rockbottom levels,
60 percent below the level a year earlier.
Harsh austerity has also sharply reduced economic activity:
? Real GDP fell at an annual rate of 6 percent during January-June.
? Bankruptcies and job losses have multiplied.
? Real wages and personal incomes have plummeted.
Meanwhile, consumer price inflation is running at an annual rate of about
100 percent and wholesale prices are up more than 130 percent over last
year.
Recent headway on Mexico's foreign accounts has encouraged the interna-
tional financial community somewhat. Nevertheless, bankers remain skep-
tical about the government's ability and willingness to provide foreign
exchange to pay private debt obligations. Defaults on private Mexican debt
will probably cost US bankers $3-4 billion over the next year or so.
Determination and skillful negotiating tactics have gained the President
the support of organized labor and earned him the grudging cooperation of
business and the middle class. The unions' primary goal has been to
maintain jobs for members, and-so far at least-most employment
cutbacks have occurred among less skilled, unorganized labor. Private
businesses have been pleased with wage restraints and the President's low-
key, down-to-business style. Nevertheless, they are concerned about the
absence of an explicit role for private enterprise and about de la Madrid's
economic policy initiatives.
It is likely to be much harder to maintain a consensus on the austerity pro-
gram for the rest of the year.
? Continuing to meet IMF targets means no rebound in private business
activity, further deep government spending cuts, and a substantial
reduction in the public-sector payroll.
iii Secret
ALA 83-10128
August 1983
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? Many Mexican economists and opposition politicians are already arguing
that the adjustments have gone far enough.
? Further trimming of spending for food and transportation subsidies and
the public work force will directly affect politically powerful interest
groups.
Even so, de la Madrid appears willing to test the limits of what is necessary
to stay in compliance with the IMF stabilization program. He is strength-
ening the austerity program he introduced last December with tough
initiatives on wages, food staple subsidies, and administrative policies.
On balance, we believe the chances probably are somewhat better than
even that concern over the high domestic costs will lead Mexico City to
seek adjustments in IMF restrictions as early as the next few months.
Requests for concessions on the public-sector deficit, expansion of the
money supply, and overseas borrowing are likely in an effort to hold the fall
in employment and consumption to politically acceptable limits. At a
minimum, Mexico City is likely to press hard for relaxation of IMF terms
for the remaining two years of its three-year program.
In any case, we believe the economy will continue to decline during the rest
of this .year.
? Even if Mexico eases up on austerity, we project that economic activity
will still fall about 5 percent.
? If de la Madrid holds firm, econometric analysis indicates an 8-percent
drop in GDP this year.
Moving into 1984, the economy will be better positioned to meet its
financial needs than at any time in the past 18 months, but the degree of
improvement-and subsequent prospects for GDP growth-hinge on the
rigor with which austerity is pursued in the interim. Because of the greatly
reduced imports in the first half of this year, enough foreign financing is al-
ready available for Mexico to boost imports and stimulate the economy,
but we believe the likely outcome would ultimately be more rapid inflation
and another financial crisis. Maintaining the austerity program for the rest
of the year, however, would put Mexico in a more favorable foreign
exchange position to achieve some economic growth in late 1984 without
rekindling triple-digit inflation.
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The prospects of prolonged austerity and a continued decline in consump-
tion almost surely will put pressures on domestic stability and will cloud
US-Mexican economic and political relations for at least the next two
years. Bilateral economic relations since de la Madrid took office last
winter have improved substantially. Nevertheless, heavy US financial
losses will continue, and grating bilateral episodes-such as an expropria-
tion of some properties owned by US firms or additional debt moratori-
ums-are still possible. Meanwhile, illegal migration to the United States
will remain at record levels.
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OM I CI
Meeting IMF Targets
Output 1
Winning Over Organized Labor 5
Limited Progress on Debt Rescheduling 5
Sticking to the IMF Program 8
Implications for the United States 8
Methodological Notes on Economic Forecasts for 1983 11
1. Mexico: Foreign Financing Gap
3. Forecasts of Key Economic Variables, 1983
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Table 1
Mexico: Foreign Financing Gap
1981
1982-
Jan-Jun a
1983
Jul-Dec b
Jul-Dec
Trade balance
-3,159
-1,471
-3,003
7,802
6,550
3,250
6,950
Exports, f.o.b.
3,540
17,015
20,927
22,224
10,550
11,250
10,950
Oil and gas
464
10,306
14,441
16,362
7,500
7,500
7,500
Manufactures
1,831
3,726
3,797
3,742
1,900
2,400
2,100
Agriculture
892
1,544
1,481
1,233
650
750
750
Minerals
353
1,439
1,208
887
500
.600
600
Imports, f.o.b.
6,699
18,486
23,930
14,422
4,000
8,000
4,000
Net services and transfers
-1,284
-5,290
-9,541
-10,486
-4,650
-5,650
-5,350
Interest
-1,437
-5,437
-8,383
-10,879
-4,750
-5,650
-5,650
Current account balance
-4,443
-6,761
-12,544
-2,684
1,900
-2,400
1,600
Debt amortization due
1,058
5,984
6,310
8,500
4,000
4,000
4,000
Financial gap
-5,501
-12,745
-18,854
-11,184
-2,100
-6,400
-2,400
Medium- and long-term capital
inflows
5,431
12,460
18,006
16,698 d
5,500 d
20,500 d
17,500 d
Net short-term capital (errors and
omissions)
215
1,173
External debt (at yearend)
17,600
50,700
Short term
5,200
11,100
Debt service ratio (percent)
Due
35.0
45.6
47.7
63.1
56.3
59.4
60.5
After debt relief
35.0
45.6
47.7
46.8
36.9
40.9
41.7
a Estimated.
b Assumes Mexican policymakers relax austerity, increasing imports
and public spending.
c Assumes Mexico City keeps imports and public-sector spending at
rockbottom rates through 1983.
d Includes $4 billion in 1982, $1 billion in the first half of 1983, and
$5 billion in the second half of 1983 in debt relief on medium- and
long-term debt principal due; and $1 billion in the first half of 1983
and $12 billion in the second half of 1983 in rescheduling of short-
term into long-term obligations.
e Includes rescheduled short-term debt and arrears, and in capital
flight.
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Secret
Mexico:
High Costs of
Maintaining Austerity
The future course of the Mexican economy is of key
concern to the United States. Most important, the
length and depth of the current economic crisis will
strongly influence the course of political stability for
our southern neighbor. The crisis also raises the risk
of large US bank losses, sharply reduced US exports,
and heavy losses by the US business community
operating in Mexico. In addition, it holds the prospect
of amplifying existing US-Mexican bilateral prob-
lems, such as the crossing of illegal migrants into the
United States.
This paper discusses the performance of the Mexican
economy in the first six months of 1983 and examines
likely macroeconomic outcomes for the remainder of
the year. It considers de la Madrid's far-reaching
economic policy changes, including sharp hikes in the
relative prices of energy, many consumer goods, and
foreign exchange, and a simultaneous reduction in
real wages and business profits. It looks into the
dilemma the President now faces in deciding whether
to ask Mexicans to continue bearing the harsh bur-
dens of austerity and hold fast to the IMF program, or
to ease up on austerity. The study also analyzes the
effects of a politically palatable adjustment in eco-
nomic policy on the pace of recovery.
Mexico City has managed to cut the budget deficit to
some 10 percent of GDP despite a falloff in tax
revenues. The 1983 budget mandated a 20-percent
real cut in spending not related to debt service and a
20-percent increase in revenues. Actual spending to-
tals, which are down as a result of trimmed capital
goods imports, appear to be at or below target, and
the government has just announced further sharp
reductions in food subsidies. Government revenues,
however, have sagged with lower world oil prices and
declining receipts from retail and income taxes.
Implementation of the IMF austerity program has
slashed foreign purchases generally and enabled Mex-
ico to meet its external financial targets and build
foreign exchange reserves somewhat. We estimate
that Mexican imports during January-June were 60
percent below the level during the same period in
1982. This boosted Mexico's trade surplus to $6.6
billion during the first half of the year, allowed $4.8
billion in interest payments on the foreign debt, and
pushed the current account into surplus. Capital flight
continued-but at levels that were more than offset
by the new foreign loans allowed under the stabiliza-
tion program.
Domestic Economic Tailspin
Output. Financial restraints have provoked growing
domestic economic problems, however. We calcu-
late-based on import, consumption, and investment
trends, early industrial statistics, and econometric
studies-that economic activity fell at an annual rate
Meeting IMF Targets
De la Madrid has been moderately successful in
managing his austerity program by devaluing the
peso, restraining wages, cutting government spending,
and freeing most price controls. In May, the IMF
characterized austerity implementation as forceful,
and-based on preliminary data judged Mexico in
compliance with first-quarter program objectives.
More recently, the US Embassy indicated that Mexi-
can officials expect to attain second-quarter targets as
well-but by a much less comfortable margin.
of about 6 percent during January-June.
Import shortages have hit industrial production hard-
est. Continuing price controls on basic commodities
and shortages of imported raw materials, intermedi-
ate goods, machinery, and spare parts have eliminated
profits for many firms and led to numerous bankrupt-
cies and plant shutdowns. A May poll by a private-
sector business association showed that 76 percent of
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Mexico City will find it increasingly difficult to
meet IMF domestic targets in the second half of this
year, in large part because the public sector will have
to bear a greater share of the burden. Trimming
public- sector spendingfurther will require additional
reductions in food and transportation subsidies and
smaller payrolls. Moving in this direction presents
policymakers with a difficult choice. Without the
cuts, especially in the face of depressed government
tax revenues, we-and Mexican policymakers-
believe that Mexico City cannot achieve its budget
deficit target. On the other hand, inflation is eating
away at the purchasing power of budget allocations,
and reducing the real level of public services. The
next round of budget cuts will hit especially hard at
the urban poor and public employees-groups that
the administration fears may spark sudden violence.
In the next few months, we expect the more powerful
ministries to use budget overruns in an effort to
maintain their programs. We also see public employ-
ment unions and their organized labor allies applying
private business anticipate losses this year, and that
15 percent were already in liquidation. During the
first half of 1983, idle capacity in industry grew
rapidly. An industrial survey released in June by the
Bank of Mexico indicated that the 163 largest indus-
trial firms were operating at two-thirds capacity,
down from 90-percent capacity in 1982. Based on
first-quarter data released by the Mexican treasury,
we estimate that industrial production dropped at an
annual rate of 12 percent during the first half of 1983.
Other sectors are also declining. We estimate that
public and private construction activities are off near-
ly 75 percent. Traditional commercial activities have
been cut sharply by the falloff in industrial output and
imports and by the higher value-added tax. As a
result, barter and underground trade are expanding.
The outlook for agriculture is also poor because of
falling real farm price guarantees and growing short-
ages of fertilizers, machinery, and other imported
inputs. Even the minerals sector has been hit by sharp
budget cutbacks and low world oil prices.
strong pressures to persuade Mexico City to retreat
from firing the thousands of employees that it would
take to stay within budget limits. Success in either'
area will cause the budget deficit to rise above the
target.
Mexico City will be hard pressed in its efforts to hold
down rapid expansion of domestic credit in the face of
higher-than-projected inflation and any expansion of
the budget deficit. The IMF program restricts nomi-
nal increases in credit from the Bank of Mexico to
both the public and private sectors to 34 percent for
all this year. To achieve this in the face of triple-digit
inflation would require a real cut in the money supply
of 35 to 40 percent. Such a credit crunch would boost
bankruptcies by further depleting private sector
working capital and, in our estimation, also lower
government consumption and employment below po-
litically acceptable levels.
Investment in all sectors has plunged, contributing
both to this year's decline and the setting of the stage
for slow recovery later. Depreciation exceeds new
capital formation in many firms in industry, construc-
tion, agriculture, and commerce
Capital goods imports, which
previously accounted for more than two-thirds of
investment in machinery and equipment, were 90
percent below last year's level in the first few months
of 1983, according to official statistics.
Employment. In these circumstances, job losses-
particularly among unskilled labor-have become se-
vere. Some private-sector economists in Mexico esti-
mate that 1-2 million jobs have been lost since mid-
.1982 and that unemployment is now in the 20- to
30-percent range. While government authorities claim
the figures are much lower, they admitted in May
that the unemployment rate had doubled during the
last year. The Bank of Mexico survey reports that
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Shaded portion of bar indicates range
Real GDP Growth
Percent
Merchandise Imports
Billion US $
Gross National Savings and Gross Capital
Formation as a Share of GDP
Capital -
formation
Oil Production'
Million b/d
n
Consumer Price Inflation
Percent
125
100
75
5-0-
T5_
6--
F7 n
Public-Sector Deficit as a Share of GDP
Percent
Money Supply Growth
Percent
125
100
75
50
25
0
Debt Service Obligationsd
Billion US $
rvmoruzauon
4
Interest 2
la
b
"Assumes Mexican policymakers relax austerity by increasing imports and dlnterest on all debt, amortization due on medium- and long-term only; in
public spending. 1982 debt moratorium and private sector arrears lowered actual debt
bAssumes Mexico City keeps imports and public spending depressed. Payments $5 billion, in 1983 we expect debt rescheduling to reduce actual
'Excluding natural gas liquids. payments on interest and medium- and long-term debt by about $7 billion.
e Projected.
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Table 2
Mexico: Impact of Economic
Deterioration, 1983
Relaxed
Austerity a
sticking to the
IMF Program b
1,500,000
2,000,000
115
90
-25
-50
Decline in supplies of locally -7
available goods and services
(GDP plus exports minus im-
ports) (percent)
-13
Change in investment (percent) -15
-35
Change in per capita consump- -7
tion (percent)
-10
Current account balance -0.5 3.5
(billion US $)
Free market exchange rates, 150 to 200 200 to 300
yearend (pesos per US $)
a Assumes Mexican policymakers relax austerity by increasing
imports and public spending.
b Assumes Mexico City keeps imports and public spending
depressed.
total employment in the largest industrial firms had
fallen 28 percent since June 1982, and that 94 percent
of the firms indicated that they would further reduce,
or hold constant, their work force
Job losses have thus far been concentrated in the
private sector. Based on preliminary official data and
US Embassy reporting, we believe government jobs
stayed constant or increased slightly because of the
$2.7 billion public works program announced by
Mexico City last January.
The bulk of the 800,000 or so young Mexicans
entering the labor force for the first time are having to
resort to make-work or artisan jobs. This swells the
ranks of the underemployed-those with part-time,
low-paying, marginal jobs. We estimate that those
underemployed have grown from 40 percent of the
work force last year to about 50 percent this year.F-
Inflation. Inflation remains in the triple-digit range,
despite the recession and much higher unemployment.
In the January-June period, consumer prices rose 41
percent-an annualized rate of 100 percent-fueled
by the soaring peso cost of imports, mounting con-
sumer goods shortages, and the still high budget
deficit. During the same period, wholesale prices rose
substantially faster-52 percent, an annualized rate
of more than 130 percent-as a result of raw material
shortages, lower input subsidies, and fewer price
controls.
Public Relations Efforts
Our analysis of recent public opinion polling indicates
that the President's low-key, down-to-business style,
his vigorous attack on inefficient policies, and his
measures to curb official abuses of power have con-
vinced many Mexicans that belt tightening is essen-
tial. To maintain the cooperation of organized labor,
business, and the middle class, the government is
attempting to improve its reputation for honesty,
efficiency, and fairness, and ensure that austerity is
shared equally. A vigorous anticorruption campaign
has targeted even key ruling party loyalists, in part to
show that the government too must sacrifice. More-
over, we think the budget-monitoring authority given
to the cabinet-level Comptroller General has helped
keep spending within targets and has moderately
reduced official rakeoffs.
De la Madrid's National Development Plan, pub-
lished 30 May, is a major effort to retain public
support for belt tightening. The plan suggests that 18
more months of tough austerity are needed but that
equity will be considered and living standards of the
poor improved, in part by eliminating privileges of the
rich. For example, the plan suggests rural investment
will be redirected to less efficient, nonirrigated areas.
It also promises improved access of the "great major-
ity" to food, housing, education, transportation, and
recreation.
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Private-Sector Hesitation
Private business has been pleased with de la Madrid's
lack of rhetoric, his nonconfrontational style, the
anticorruption campaign, and wage restraints. Never-
theless, businessmen are concerned about the absence
of an explicit role for private enterprise in the develop-
ment plan. Even though the plan does not specifically
call for more nationalizations, many of them believe
government ownership of Mexico's productive capaci-
ty will increase. Mexican and US economists doubt
the government's ability to increase greatly nonoil
exports in the short or medium term-as the plan
calls for-without substantial support from private
business.
Winning Over Organized Labor
We continue to believe that retaining support of
organized labor remains key to keeping austerity
going. Gaining and maintaining unions' support thus
far has been-in our opinion-de la Madrid's most
notable achievement. Official labor unions have re-
mained quiet, despite the administration's unwilling-
ness to make concessions on wages. In January,
minimum wages were raised just 25 percent and in
June only 15.6 percent. These increases lag far behind
the rise in the cost of living
The President also has taken a hardline stance with
small Communist-dominated unions. According to
press and US Embassy reports, a monthlong strike by
nonacademic employees of the National University,
organized into Mexico's largest Communist-led labor
union, ended in early July without a pay increase for
the strikers. The administration was inflexible during
bargaining sessions and was prepared to terminate the
workers' contracts. Members of another leftist union
were undercut by the announced liquidation of the
government-owned company they were striking. We
believe de la Madrid's maneuvers increase confidence
in his ability to handle challenges to the system
without resorting to repression.
The Cumulation of Pressures
Even allowing for the President's success on austerity
so far, we anticipate an easing of the program over the
next few months as de la Madrid responds to vocal
interest groups and advisers who suggest that the
damage to the economy has gone far enough. Govern-
ment spending is likely to rise, causing Mexico to fall
short of IMF targets. In particular, outlays for subsi-
dies will remain high because of the administration's
refusal to raise bus or subway fares and an unwilling-
ness to simultaneously adjust more controlled prices.
In the face of severe unemployment, strong pressure
will be put on the President to avoid cutting the public
payroll. In addition, now that the new administration
is getting its programs in shape after eight months in
office, incentives will grow for the more powerful
ministries to use the traditional practice of budget
overruns to increase spending. Cabinet officials also
are likely to fight to preserve existing programs even
as inflation eats away at the real level of services.
Meanwhile, any outburst of violence would cause
funds to be shifted to the police and military budget.
This would tend to reduce allocations for other pro-
grams and encourage demands to boost overall
expenditures.
Limited Progress on Debt Rescheduling
The IMF stabilization package-purchased at the
short-term cost of economic austerity and possible
social unrest-was intended to open a window to
reschedule Mexico's mammoth foreign debt. None-
theless, debt rescheduling efforts continue to move
slowly. while pre-
liminary agreement between representatives of for-
eign bankers and 30 public sector agencies has been
reached, final terms have yet to be worked out. .
Moreover, previously unreported public sector debt
obligations are still coming to light. While we believe
most of the public-sector debt of some $67 billion will
eventually be rescheduled, few bankers are pleased
with the terms offered on $19.5 billion in arrearages
and debt payments on public debt due through 1984.
Even less has been accomplished in efforts to restruc-
ture private debt. The Mexican Treasury officially
reported that as of mid-July only $854 million of the
$10 billion to be renegotiated had been rescheduled,
despite Mexico City's offer to guarantee availability
of foreign exchange to pay private-sector debt for
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Government Help With Private-Sector
Debt Rescheduling
To aid the private sector in reducing debt arrearages,
Mexico City established a trust fund within the Bank
of Mexico and promised the private sector future
access to foreign exchange at subsidized exchange
rates. Under the conditions of the program, if a
foreign creditor accepts medium- to long-term debt
rescheduling, the trust fund called FICORCA (For-
eign Exchange Risk Coverage Trust Fund) establish-
es dollar escrow accounts payable to the foreign
creditor in exchange for peso deposits by the Mexican
debtor. The escrowed accounts earn interest and the
Bank of Mexico guarantees that these accounts will
be paid out to service specified debt obligations as
they come due. While FICORCA will administer the
accounts and accept exchange risk for the funds in
escrow, it will not guarantee or accent commercial
risk on the debts.
The Bank of Mexico offers different mechanisms to
restructure private-sector debt. For supplier credits in
arrears, FICORCA sets up escrow accounts convert-
ing pesos at the controlled exchange rate, currently
about 20 percent below the free market exchange.
FICORCA will pay off the accounts that were set up
by 15 July and total some $370 million by next
spring. Other supplier-credit arrearages-totaling as
much as another $4 billion-will be paid off later,
depending in part on the availability of foreign ex-
change. On the other hand, the Bank of Mexico has
announced that the small amount of supplier credits
coming due during the remainder of this year will be
Using FICORCA Mexico City worked out debt re-
scheduling in late June for nearly $2 billion in
private-sector credits guaranteed by foreign govern-
ments. The resulting agreement reschedules over six
years (including a three-year grace period) medium-
and long-term principal and interest unpaid as of
30 June and principal payments due during July
through December 1983. Arrears on short-term debt
will be paid over the next three years, and short-term
debt due after 30 June will be paid on schedule.
Principal payments due in 1984 will be rescheduled
on similar terms at the end of 1983, according to
Mexican officials. Under the June agreement, the
debts will be repaid if the private firms deposit pesos
with FICORCA at the controlled exchange rate.
For some $10 billion of other private-sector debts
past due or maturing by the end of 1984, FICORCA
will provide future dollars at an exchange rate from
20 to 30 percent below the controlled exchange rate
depending on the length of rescheduling. This allows
foreign exchange purchases from 40 to 45 percent
below the free market rate. A multiple option pro-
gram allows companies with current peso liquidity to
make full payment for dollar contracts upfront. It
also permits other companies that can demonstrate
long-term solvency a peso-loan mechanism to pay for
contracts over the long term at commercial rates of
interest.
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serviced as originally scheduled.
loans rescheduled over six to eight years. arrearages, bankers remain skeptical about the gov- 25X1
foreign creditors are resisting ernment's ability to provide foreign exchange to pay 25X1
stringent Mexican
overnment requirements, while private debt obligations.
25X1
many Mexican and foreign businessmen doubt the
administration's ability to deliver promised foreign
exchange, citing its earlier failures to live up to
commitments. The recent headway on Mexico's for-
eign accounts has encouraged the international finan-
cial community somewhat, but, because of the contin-
ued capital flight and problems in reducing debt
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At the same time, Mexican authorities are moving up
some repayments to foreign suppliers because of the
lighter-than-expected participation by Mexican firms
in the government's scheme to reduce private-sector
supplier-credit arrearages.
that escrow accounts for only $370
million of $4 billion in registered supplier-credits had
been set up by the 15 July deadline set by the Bank of
Mexico. To pay off escrowed balances, Mexico City
will remit some $185 million on the fifth business day
in September to foreign suppliers and the remainder
on the fifth working day in March 1984. US Embassy
officers report that participation in this debt resched-
uling scheme was low because of:
? Insolvency or illiquidity of many Mexican firms.
? Reluctance of foreign creditors to go along with the
plan.
? Some direct debt reductions by Mexican firms with
access to foreign exchange.
Financial authorities also announced that a new pro-
gram will be developed soon to help those Mexican
firms that did not participate in the first program.F-
While Mexico has largely stayed current on public-
sector interest obligations, the substantial interest
arrearages owed by the private sector continue to
grow. Over the last six months, government efforts to
help the private sector reduce arrearages on interest
obligations have been only partially successful be-
cause of the illiquidity of many Mexican firms and
government foreign exchange shortages. As a result,
we estimate that the past due interest on private-
sector debt during this time rose by $200 million to
some $1.2 billion.
We project that the economic decline will persist
throughout this year, whether de la Madrid responds
to cumulating pressures and eases up on austerity or
not.
? If Mexico City fails to make sufficient additional
cuts in public spending to meet the targets-and we
put the odds at a little better than even that it will-
GDP would decline 5 percent and consumption
would dip 7 percent.
? On the other hand, if de la Madrid moves to
maintain austerity, we see GDP falling 8 percent
this year and personal consumption plummeting 10
percent.
Current estimates of changes in key economic vari-
ables by US econometric services and by the Mexican
Government are nearly, but not quite, as pessimistic
as our own. The US econometric services have sub-
stantially increased their forecasts of economic de-
cline within the past two months because Mexico has
held imports far below expectations. While the IMF
has also significantly altered its foreign trade esti-
mates, it is still holding to its initial economic growth
and inflation projections.
The Relaxation Case
By relaxing austerity to boost imports and spending,
we believe that Mexico City can. stem-but not halt-
the steep slide in the economy by the end of the year.
Divisions among government officials over whether
this should be done are growing. The sharp drop in
imports this year could be slowed by using foreign
exchange reserves gained in the first half of the year
and a renewing of a few trade credit lines. This would
relieve certain critical shortages and enable some
plants to raise production slightly. Even so, import
volume is likely to be at best 25 percent below last
year's result and nearly 60 percent lower than the
1981 level. We would expect most businessmen to
maintain a "wait-and-see" attitude before making
substantial new commitments to purchase raw materi-
als, intermediate goods, and spare parts abroad be-
cause they are still suspicious of de la Madrid's
commitment to private enterprise.
As we note above, we believe it more likely that the
government itself would provide the principal stimula-
tion to the economy. Increasing public spending
enough to boost the budget deficit as a share of GDP
3 or 4 percentage points from the current 10-percent
rate would slow the decline in economic activity by
about one-third for the year. Higher public spending
would spur both investment and consumption. We
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LDA I
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Table 3
Forecasts of Key Economic Variables, 1983
Changes
in GDP
(percent)
Inflation
(percent)
Current
Account
Balance
(billion
US $)
Imports
(billion
US $)
Exports
(billion
US $)
Wharton Econometric Fore-
casting b
-5.1
101
Mexican Government e
-2 to -4
77
International Monetary
Fund d
NEGL
55
Central Intelligence Agency
-5 a
-8f
115e
90f
-0.5e
3.5 f
12.Oe
8.0 f
21.8e
21.5 f
a Latin America Review, Second Quarter 1983, Data Resources,
Inc., June 1983.
b Latin America Outlook, Summer 1983, Wharton Econometric
Forecasting Associates, July 1983.
e From National Development Plan, May 1983.
d IMF Staff Report, 9 May 1983.
e Assumes Mexican policymakers relax austerity by increasing
imports and public spending.
f Assumes Mexican City keeps imports and public spending
depressed.
believe, however, that any substantial rebound in
government spending would aggravate inflation and
boost the increase in consumer prices to an annualized
rate of 130 percent in July-December. This would
lengthen the period required to wring out the econo-
my, and postpone the beginning of economic recovery
beyond 1984.
Sticking to the IMF Program
If de la Madrid stands firm on austerity, import
volumes would stay at rockbottom, and the economic
slide would accelerate. In this case, we project real
imports in 1983 would 11 50 percent below last year,
and almost 75 percent below the 1981 level. While
industries would continue drawing down nearly de-
pleted inventories, capacity utilization would drop to
less than half. As a result, locally available supplies of
goods and services would decline further.
With continued budget cuts and the contraction of
demand, we expect inflationary pressure would ease
somewhat, and the increase in the cost of living would
rise at an annualized rate of 80 percent for July-
December. This, along with a more favorable. foreign
exchange position, would make it possible for solid
economic recovery to begin by late 1984
Prospects for prolonged austerity, a continued falloff
in consumption, and mounting political pressures will
cloud US-Mexican economic and political relations
for at least the next two years. Despite substantial
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improvements in bilateral economic relations since de
la Madrid took office last winter, grating bilateral
episodes-such as an expropriation of properties
owned by US firms or additional debt moratoria-are
still possible, particularly if the United States is
blamed for increasingly poor economic performance.
We believe Mexico City's principal bilateral concern
will still be to preserve Washington's backing in the
international financial negotiations. De la Madrid has
indicated his gratitude for the US initiative in arrang-
ing new financial credits and the progress on debt
relief. Mexico City expects US officials to back its
efforts to maintain austerity with additional credits
from the Commodity Credit Corporation and Wash-
ington's help in restoring trade credits. In addition,
Mexico will call for the United States to intercede
with the IMF and international banks if it seeks to
adjust the stabilization program and to obtain new
loans over the next few years.
US-Mexican economic relations will suffer in several
areas. We expect private-sector Mexican bankruptcies
to cause US banks to write off $3-4 billion in bad debt
over the next year or so. US exports to Mexico-our
third-largest trade partner-will fall by $4-5 billion
this year, after dropping $6 billion in 1982. US-owned
businesses in Mexico that produce for the domestic
market-the majority of the $7 billion US invest-
ment-will continue to face poor demand, and many
will pull out because of mounting losses. Meanwhile,
illegal migration to the United States will remain at
record levels.'
On the positive side, US-owned assembly operations
along the border that process goods for reexport to the
United States will increase profits because of lower
real wages and the weak peso. During the next several
years, the Mexican Government will be taking steps
to keep US businesses operating so that the compa-
nies' home offices will still subsidize Mexican losses.
Mexico City has already announced that to spur
increased production for exports it will adjust rules
and interpret its foreign investment laws liberally. F_
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Appendix
Methodological Notes on
Economic Forecasts for 1983
Our economic projections for 1983 are derived from
analysis of official Mexican Government projections,
IMF data, and recent forecasts published by major
US econometric forecasting companies. Econometric
models have become conventional tools for analyzing
market economies like Mexico's. In a system of
equations, these models combine a theoretical repre-
sentation of the economy, a statistical analysis of the
key relationships, and assumptions about government
policies and external events. The solution of the
system of equations produces conditional estimates of
the future; comparisons of separate runnings under
different assumptions can be used to determine the
sensitivity of the economy to alternative future condi-
tions.
The deterioration in Mexico's economic performance
this year reflects the continued sharp reduction in
imports that began last year. While the import plunge
was primarily caused by a drying up of international
bank credits and the sharp devaluation of the peso,
the 15-percent decline in the OPEC oil sales price last
winter also constrained Mexico's import capacity.
Imports dropped $4.5 billion in the first half of 1983,
on top of a $9.5 billion cut during 1982.
Our economic projections for 1983 are based on two
import and government spending scenarios for the
remainder of this year. We believe that the chances
are slightly better than even that Mexico will relax
austerity and boost imports and spending to keep the
fall in employment and consumption to more political-
ly acceptable levels. It is also quite possible-based on
policymaking decisions to date-that de la Madrid
will maintain tough austerity and stick to the IMF
program.
Relaxed Austerity Case
In the more likely case, we see Mexico easing up on
austerity, regaining some trade credit lines, and sub-
stantially boosting imports during the second half of
this year. This would relieve some shortages of pro-
ducers goods and permit some plants to boost capacity
utilization. Nevertheless, imports for all 1983 would,
at best, remain 25 percent below last year and 60
percent below the 1981 level. Because of continued
private-sector skepticism, we expect that the govern-
ment would have to take the lead in halting the
decline in the economy by expanding imports and
public-sector spending. A recent survey of business
indicated that private firms are planning to cut real
investment spending 35 percent this year.
In these circumstances, recent projections by the
Mexican Government and the IMF show higher
imports holding the decline in GDP to 0 to -4
percent while inflation slows to the 55- to 77-percent
range. Our projections and current projections by US
econometric services show a more serious economic 25X1
deterioration. We essentially agree with Data Re-
sources, Inc., (DRI) and Wharton Forecasting Asso-
ciates (WEFA), that GDP will fall about 5 percent. To
achieve this, Mexican public spending would have to
increase. In this case, we see the public-sector deficit
as a share of GDP increasing from about 10 percent
in the first half of 1983 to about 15 percent in the last
half of the year. Even though there would be a small
increase in availability of producer and consumer
goods, higher spending would fuel inflation; consumer 25X1
price gains would be more than 100 percent this year.
This drop in GDP would entail the loss of 1.5 million
jobs this year. Because of the lack of social services
for the unemployed, many of those who lost modern-
sector jobs-including virtually all those who are their
family's principal breadwinners-would scramble for
jobs in lower productive artisan fields or personal
services. Most of the 800,000 or so young Mexicans
entering the job market for the first time this year 25X1
would be unsuccessful in finding modern-sector jobs.
As a result, both unemployment and underemploy-
ment would increase substantially.
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If de la Madrid holds fast to the austerity program
during the rest of the year, we project that the
economic slide will accelerate. We and most observers
believe this case is somewhat less likely and the US
econometric services, the Mexican Government, and
the IMF have not yet addressed it. In this case,
industrial firms would continue to draw down nearly
depleted inventories, capacity utilization would fall to
less than half, and industrial production in the second
half of the year would decline at an annual rate of
some 20 percent. Gross domestic product would fall at
an annual rate of about 10 percent. Despite reduced
local availability of goods and services, we project that
holding the line on government spending would reduce
inflationary pressures slightly, and hold average con-
sumer price inflation under 100 percent for the year.
Our results reflect the overwhelming importance of
imports to the economy. Official Mexican statistics
show that two-thirds of all investment in machinery
and equipment in recent years was accounted for by
imported capital goods. Imported industrial inputs,
many of which are not locally available, make up
almost one-fifth of all raw materials and intermediate
goods used in Mexican industry. In this situation,
disrupted investment would reduce private spending
below the level needed to replace wornout capital
goods. Because of the deteriorating capital stock and
reduced imported inputs, 2 million jobs would be lost
this year.
The longer term advantage to the Mexican economy
inherent in this case is that the necessary wringing out
and restructuring of the economy would be accom-
plished quickly. By eliminating the factors that con-
tributed to the overheating of the economy-such as
soaring government expenditures in the face of a weak
infrastructure and limited productive capacity-a
sound basis for a return to the moderate economic
growth patterns of the 1960s would be established.
The faster adjustments are made, the smaller the risk
that the sacrifices required of most Mexicans would
promote unmanageable unrest.
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