MEXICO: FINANCIAL PROBLEMS AND POLICY ADJUSTMENTS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP83B00225R000100150001-4
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 19
• Document Creation Date: December 21, 2016
• Document Release Date: September 24, 2008
• Sequence Number: 1
• Publication Date: June 1, 1982
• Content Type: REPORT

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Mlrect?Vate of ll,?flIllill ll 7Il~1~
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Mexico: Financial Problems
and Policy Adjustments
State Dept. review completed
Confidential
ALA 82-10057
June 1982
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tournte off Con lidentual
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LDo l ~nvec
n I '?lky Add UEZ~ me n1 25X1
An fntelligence Mennornndnun
Information available as of 3 June 1982
has been used in the preparation of this report.
This paper was prepared b Office of 25X1
African and Latin American Analysis. Comments and
queries are welcome and may be addressed to the
Chief, Middle America-Caribbean Division, ALA, on 25X1
This paper has been coordinated with the Directorate
of Operations and the National Intelligence 25X1
Council.
Confidential
ALA 82-10057
June 1982
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Conff dentnall
Mexllcn: IFllnannciall Prthleuuns
and Policy Adjustments F__-] 25X1
Summary Mexico's oil boom is over, and in its wake are galloping inflation and a
huge and burdensome foreign debt. The growing economic and financial
troubles could cause increasing social and political difficulties if they are
not soon alleviated. To begin to solve the economic problems, harsh
austerity measures must be implemented soon.
President Jose Lopez Portillo, however, has sought to reduce the political
backlash in an election year by keeping government spending, public-sector
growth, and consumption high. Meanwhile, Mexico has run low on foreign
exchange and has almost $10 billion in debt service obligations due during
the rest of 1982. Thus far, most of the impact of the straitened financial
conditions has been felt by the private sector, where heavy business losses
and bankruptcies are emerging.
In the weeks prior to July's ritual election of ruling party candidate Miguel
de la Madrid, Mexico City will go to great lengths to avoid cutting either
social services and subsidies or private consumption. We expect to see some
reduction of spending on highly visible public works, but this will not be al-
lowed to go far enough to affect employment substantially.
After the election, policymakers in the lameduck administration will be
more willing to introduce stricter austerity measures. The primary result of
such a course of action would be a sharp slowdown in economic growth. We
estimate that the GNP growth rate for 1982 as a whole would run about
3 percent; a sharp reduction from more than 8 percent annually over the
previous four years. Even so, inflationary pressures-still fueled by pre-
vious expansions of the money supply and the impact of devaluation on
import prices-would remain high.
Policymakers can not rely on increased oil exports to satisfy financial needs
fully. Even if Mexico maintains competitive pricing, it lacks the productive
capacity to boost exports much further. The extra revenue that could be
obtained by exporting at capacity would cover only one-fourth of its debt
service needs.
If austerity policies are not enforced, economic growth may continue
strong, but inflation could explode into triple digits. Beyond the end of the
year, even this expansionary path would likely be cut off by foreign creditor
resistance, and even sterner austerity measures would then be called for.
iii Conftnsentiall
ALA 82-10057
June 1982
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Over the longer term, we believe the Mexican Government must find the
will to continue a slower pace of economic growth and rein in subsidies, lest
the remaining oil dividend be squandered. The consequences of this more
sober course for the United States would include lower US exports to
We believe the alternative of continued reckless expansion would
bode large losses for heavily exposed US banks.
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and Pinky Adjustments
Il eainng the Oil Since the mid-1970s Mexico has fully spent its oil dividend and looked to
IlD Adend foreign bankers for still more funds. Between 1977 and 1981, real
economic growth averaged 8.5 percent yearly, with import volume pacing
upward at 40 percent. Foreign bankers, attracted by the rapid development
of large oil reserves, were willing lenders. In 1977-81, external debt tripled
to $67.5 billion (40 percent owed to US banks) and pushed Mexico into the
same league as Brazil, the largest L DC debtor. Soaring government
spending soon collided with severe bottlenecks in productive capacity and
skilled manpower; inflation passed the 25-percent mark in 1980 (see
figure 1).
The social benefits of this rapid economic growth and massive public
spending were substantial. Enough jobs were created to maintain open
unemployment at relatively low levels, even as new entrants flooded the
labor force. In addition, the government was able to continue large-scale
subsidies for consumers.
The Tu iiiing Point To finance 8-percent economic growth last year, Mexico relied on higher
oil revenues and a doubling of foreign and domestic borrowing. Exports
were up 40 percent, to $14 billion, despite softening world oil prices and a
dismissal of the PEMEX chief at midyear that disrupted new sales. Still,
higher imports and debt service costs pushed the current account deficit to
a record $11.7 billion. Even with the increase in merchandise imports, a
$28 billion budget deficit (12.5 percent of gross domestic product [GDP])
and tightening capital and raw material supplies boosted inflation to near
30 percent.
Success in securing foreign funds made Mexican policymakers reluctant to
deal forcefully with progressive overvaluation of the peso. Despite the
institution in October 1980 of a lagged crawling peg policy for the
exchange rate, authorities held the change in the value of the Mexican peso
relative to the dollar to less than 7 percent in 1981. Meanwhile, Mexican
inflation exceeded that in the United States by 18 percentage points.'
' For 1980, when the difference in inflation was 13 percentage points, the exchange rate had
been allowed to depreciate against the dollar by only 0.5 percent.
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Figure 1
Mexico: Economic Indicators
Real GDP Growth
Percent
Gross National Savings and Gross Investment
as Share of GDP
Percent 30
Consumer Price Inflation
Percent
Public-Sector Deficit as a Share of GDP
Percent
Oil Productiona Money Supply Growth
Thousand b/d Percent
Debt Service Payments
Billion US $
alncluding natural gas liquids.
b Estimated.
CProjected, assumes austerity adopted August 1982.
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C'onffidentiad
In the face of these cumulating pressures, Mexico City also refused any
other meaningful stabilization measures. In fact, seeking to end his
presidential term without slowing the economy, Lopez Portillo at the end of
last year presented a 1982 budget with a continued rapid expansion in
government spending and a $40 billion budget deficit (16 percent of
estimated GDP).
Financiall IPu?essuu?es In late 1981 Mexico City began to encounter mounting resistance from
and Devaduatuon foreign lenders. Factors in the growing concern were: the effect of the soft
world oil market on Mexico's oil receipts; the sheer size of the foreign debt;
and soaring budget deficits and inflation. As a result, Mexico City turned
more and more to short-term, high-interest loans to finance imports.
By the beginning of 1982 Mexicans, too, lost confidence in government
economic policies. As devaluation rumors mounted, they began converting
pesos into dollars. Massive capital flight in early February and the sudden
depletion of its international reserves forced the Bank of Mexico to float
the peso on 17 February and draw down its $200 million first tranche with
the International Monetary Fund (IMF). By the end of the month the peso
had depreciated 40 percent and was stabilized at about 45 pesos to the dol-
lar, compared with 26.5 before the devaluation. Since the end of February,
the Bank of Mexico has managed the float, allowing the peso to slip four
centavos each trading day, to the current 47 pesos to the dollar (see
figure 2).
Conflicting Statements As the economy has continued to deteriorate, Mexico City has begun
and Practices laying the groundwork for austerity, but without putting muscle behind
policy statements. During recent campaigning, de la Madrid has empha-
sized the need for stabilization and anti-inflationary measures. In mid-
March two of de la Madrid's close associates were appointed to key
economic posts, an indication of Lopez Portillo's willingness to begin
sharing economic policymaking authority. At the end of April Mexico City
announced its intention to move toward strict austerity. The particular
goals that Mexico City set include:
Trimming budgeted expenditures and boosting revenues through higher
prices charged by public-sector enterprises.
Cutting the 1982 public-sector deficit to 12 percent of GDP from 15
percent in 1981.
Tightening monetary policy by limiting public and private credit.
Holding net public-sector borrowing to $11 billion, down from $15 billion
last year.
Reducing the current account deficit by $3-4 billion by cutting imports
25 percent.
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Figure 2
Mex co-United States: Dollar/Peso Exchange Rates
I i i i i I i i i i I i i i i I i i i i I i i i i I i i i I I i i
1974 75 76 77 78 79 80 81 82
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Some of these targets-especially those for public-sector spending and
borrowing-were flatly overambitious considering ongoing programs and
political commitments. Not surprisingly, implementation thus far has been
disappointing.
Mexico's failure to deal resolutely with its financial problems has produced
a mixed economic situation. So far, public funding for only a small number
of highly visible construction projects has been cut. The attendant govern-
ment demands for credit to cover the burgeoning peso deficit have,
however, severely crimped private businesses' access to funds and slowed
private-sector growth to near 3 percent. Thus, in an accelerated version of
the pattern of recent years, public-sector spending has taken up a greater
share of overall economic growth.
Mexico City's policies have depressed private investment, buoyed consump-
tion, contributed to reductions in private-sector inventories, and tended to
spur imports. Although the substantially higher cost of imported goods
since the February devaluation has probably slowed new orders, past orders
have kept imports-and the current account deficit-up. Furthermore, the
wage settlements have actually reduced the relative costs of foreign goods
for many wage earners and given another spur to Mexican travel to the
United States and to border purchases.
This continuing expansion is a major part of Mexico's current financial and
liquidity problems. Questions among Mexico's private sector and the
international financial community about the government's willingness and
ability to move beyond tight monetary policies to cut government spend-
ing-the key to an austerity program-caused another round of heavy
capital flight in April and most of May.
The result was another foreign liquidity crunch. After rebounding some-
what following the devaluation, Mexico's foreign exchange reserves fell
steadily in April and most of May to below February's low level. At the
same time, loan syndications from private bankers became increasingly
expensive and difficult to obtain.
Mexico City managed to temporarily ease the financial crisis in late May,
mainly because of a sizable advance on a $2.5 billion syndicated loan and
some prepayment on oil exports. During the last week in May, these steps
more than doubled foreign exchange holdings to almost $4 billion.
Moreover, higher oil sales and tough talk by Mexico's financial policy-
makers boosted private-sector confidence and slowed capital flight. Oil
exports rebounded in May after the government slightly undercut OPEC
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oil prices and improved credit arrangements. The government announced
that shipments for May increased to 1.5 million b/d-up 400,000 b/d from
January-April levels.
With these moves, foreign reserves are probably adequate to get Mexico
past the presidential election on 4 July without another politically costly
liquidity crisis. Nevertheless, renewed currency speculation is possible.
Mexico City does not have the productive capacity to boost oil exports
much further this year, and the extra revenue it could get by exporting at
capacity would cover only one-fourth the debt service needs for the rest of
the year. If the tough talk is not backed up by policy initiatives soon,
Mexico City will run critically low on foreign exchange again by mid-July.
The Election Gauntlet Despite continuing economic pressures, Mexico City probably will not
change domestic policies before the election.
the government has thus far postponed taking the
harsh measures needed for fear that hitting the consumer with sharply
higher prices, labor with fewer jobs, and business with reduced public-
sector orders and closed projects would focus discontent on the ruling
Institutional Revolutionary Party (PRI). In recent television interviews and
speeches, Lopez Portillo has restated his unwillingness to fight inflation by
reducing demand and sacrificing jobs. Moreover, he has affirmed that
during this time of financial stress, the government has the obligation to
stand behind those who could least afford it by taking steps to assure that
consumption for the poor does not fall.
The government especially wants to avoid any reduction in organized
labor's support in the midst of an election campaign. Indeed, according to
US Embassy reporting, it was Lopez Portillo who overrode private-sector
objections to granting the recent large wage increases to labor. His decision
reflects an awareness that, for the last five years, workers have suffered a
loss in real wages and that, as the ruling party's largest sector, labor
traditionally plays a major role in mobilizing support for party candidates.
The lack of popular enthusiasm for the PRI presidential candidate de la
Madrid and growing public criticism of the government's recent economic
moves have reinforced party leaders' perceptions of vulnerability. Although
de la Madrid is certain to win the election, these leaders-mindful of the
difficulty he has had in establishing rapport with labor-are reported by
US Embassy officials to fear that additional austerity measures would
result in high voter absenteeism and a substantial protest vote for
opposition parties. This would seriously embarrass the government and
complicate the task of the incoming administration in grappling with
economic difficulties and other issues.
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Beyond the Ellectionn: If the government moves quickly following the July election and adopts
The 11982 Ontlloolk measures to implement the April stabilization strategy, lower growth in the
public sector-perhaps as soon as early fall-could take pressure off the
peso and contribute to a further slowing of imports. Among the steps that
the government will probably take first is putting aside or postponing
showcase development projects (such as the ambitious nuclear power
program and regional rural development projects). Also, sharp cuts in food
and fuel subsidies will be necessary.
Performance under this scenario for 1982 will look substantially worse
than for 1981:
Overall, real economic growth for the year would post about 3 percent.
Inflation-on the order of 60 percent-would be at least double that of
last year.
Unemployment would be up sharply, with increases in worker unrest
likely.
The major gain from these sacrifices will be a subsidence in the current ac-
count deficit from 198 l's $1 1.7 billion to under $8 billion.
The private sector would continue the slowdown that is now amply evident.
The squeeze from public borrowing, higher wages, and local currency
requirements for foreign debt servicing obligations have already slashed
the funds available to it for imports of raw materials and capital goods.
Construction and manufacturing will continue to be hardest hit. Mexico's
largest private company-Alfa Industries, a steel, chemical, and consumer
goods conglomerate-is in serious trouble and has already had to slash not
only its investment programs, but also maintenance expenditures and other
current spending.
Compared with 1981, consumer price inflation will almost certainly double
because of lower imports, the steep peso devaluation, vastly higher wages,
and the still large government deficit. During January-April prices were
already up 19.2 percent-69 percent on an annualized basis-and there is
likely to be no substantial change in spending and credit policies this
quarter. Even with the introduction of austerity measures in the latter half
of the year, reduced foreign borrowing will require Mexico City to rely
increasingly on expansion in the money supply to finance the budget
deficit. Regular wage adjustments and the large government-mandated
supplemental wage hike, designed to maintain workers' purchasing power,
have already boosted wages up to 75 percent above the level at the end of
1981. Efforts to slow inflation by broadening price controls have had
limited success and will be increasingly ineffective as the money supply
skyrockets and imports fall over the next few months.
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The soft world oil market is curbing the growth in export earnings this
year, despite an improved outlook for nonoil sales. If world oil prices stay
near the current low level and Mexico sustains the May record shipments
rate of 1.5 million b/d through yearend, petroleum export receipts would
only slightly exceed last year's $14.4 billion. Oil exports could not go much
higher even if a market could be found. As a result of sharp cuts in oil ex-
ploration and development spending since last June, neither production nor
export capacity will increase substantially during the remainder of the
year. In contrast, the realignment of the peso is encouraging exporters to
boost exports of manufactures, farm products, and minerals. For 1982,
these exports probably will increase by over $1 billion to $7.7 billion (see
table).
Mexico's import boom is ending as the government tightens import controls
and foreign borrowing lags. A record grain harvest last year is allowing
Mexico City to slash food imports by one-half from last year's $3 billion.
The import crunch is limiting investment because imported capital goods
have accounted for 70 percent of total investment in machinery and
equipment in 1980-81. This impact is falling disproportionately on the
private sector, which has received the bulk of capital goods imports in
recent years.
Until Mexico City begins to make real progress in stabilizing the economy,
foreign bank loans will become harder to get. Even if oil exports continue
to cover current merchandise imports, Mexico City still needs to line up al-
most $10 billion more this year to service its medium- and long-term debt
(interest and amortization). In addition, Mexico City has another $16
billion in short-term debt, which must be rolled over, rescheduled, or paid
off. To do this, Mexico City may well be forced to resort to the IMF. A
three-year, $4 billion IMF package could bring in $1 billion in 1982. More
important, it would encourage private and official creditors to be more
responsive.
The Cost of Mexico City faces a difficult road. If it fails to implement real austerity
Continuing Expansion soon after the July elections, the outlook would be substantially worse. At
the limit, higher economic growth-around the current 5 percent-could
be held for as much as six to nine months. For 1982 this would mean 80- to
100-percent inflation and a current account deficit at least equal to last
year's $11.7 billion.
The principal reason such policies could not last is that foreign creditors
would abandon Mexico. Even should it resort in the extreme case to
running down whatever exchange reserves remained and defaulting on
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Mexico: (Foreign Financing Gap
Million US $
1975
1980
1981-
1982 b
Trade balance
-3,119
-1,647
-2,224
4,500
Exports, f.o.b.
3,461
16,925
20,880
22,500
Oil and gas
460
10,306
14,400
14,800
Manufacturers
1,763
3,725
3,750
4,500
Agriculture
815
1,544
1,530
1,700
Minerals
423
1,350
1,200
1,500
Imports, f.o.b.
6,580
18,572
23,104
18,000
Net services and transfers
-574
-4,950
-9,481
-12,000
Interest
-1,437
-5,380
-8,217
-10,000
Current account balance
-3,693
-6,597
-11,704
-7,500
Debt amortization
1,058
5,984
6,310
7,000
Financial gap
-4,751
-12,581
-18,014
-14,500
Medium- and long-term
capital inflows
5,629
12,460
18,514
14,500
Net short-term capital
(errors and omissions)
-740
1,009
-1,500
NEGL
Changes in reserves
138
888
1,000
NEGL
Other financial items
External debt (at yearend)
17,600
48,800
67,500
78,000
Of which:
Short term
5,200
10,600
16,300
15,000
Debt service ratio 35.0 45.4 47.5 58.6
a Estimated.
b Projected.
debt, the Mexican Government would ultimately be forced to reduce
imports sharply. This would entail losses of critical producer goods and raw
materials, and production would contract drastically. Coming out of this
chaos would require the restoration of foreign creditworthiness, which
could only be achieved through the imposition of austerity more stern than
that now necessary and at the cost of much higher interest spreads.
The Pivotal 1982 If-as we expect-foreign creditors become increasingly sticky with
Borrowing Gap Mexico no matter what its policies, the prospects for continuing rapid
growth will be bleak under any scenario. Accordingly, any comprehensive
plan to deal with this year's remaining $10 billion foreign exchange gap
will entail some policy accommodations. To qualify for a broad-gauged
rescheduling exercise and a $1 billion emergency loan from the US
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Treasury and the Federal Reserve, Mexico City would first have to receive
formal IMF support for its stabilization program. The government will try
to avoid debt rescheduling because it would further worsen Mexico's credit
rating. On the other hand, any delay in repaying debts would raise the cost
of loans to Mexico and at the same time sharply limit new foreign credits
for at least the following two years.
Analyzing the Pattern The mix of policy choices available to Mexico City in meeting its financial
of Mexican Responses problems is wide and complex. For some time following the election, it may
be difficult to tell the path the government has chosen. An important drag
on economic initiatives will be the many claimants on the national income
stream-subsidized consumers and public-sector employees-who will
continue to resist austerity measures.
Mexico City could begin a serious austerity program by quickly mobilizing
aspects of the economic targets announced in late April. If it chooses to do
this, it is likely to announce a new list of specifics following the election.
Most important in this would be a major adjustment in the 1982 budget,
one which would map out a strategy to get control of the public-sector
wage bill and cut food and fuel subsidies. Lopez Portillo's apparent
willingness to ensure a smooth transition of power to his successor may
make such developments possible.
On the other hand, Lopez Portillo might decide that the political cost of
austerity is too high. In that case, he might choose to make noises to
impress international bankers but at the same time do little to rein in
public-sector demand. Indications of the adoption of this latter strategy
could take various forms:
Public Spending. Mexico City could further reduce the expansion of
some highly visible public works, but without taking the key steps of
sharply cutting food and fuel subsidies and government consumption or
of getting control of public-sector employment.
? Monetary Policy. Mexico City could keep the growth of the money
supply below inflation but continue the trend of diverting more and more
domestic credit from the private sector.
? Exchange Rate Policy. Despite the currency float, Mexico could let the
peso continue to strengthen to help keep imports up. Since February
Mexican inflation has exceeded the US level by almost 5 percentage
points per month, while the dollar/peso exchange rate has changed by
less than 2 percent each month.
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o Trade Policy. Though public-sector imports are off, almost the entire
reduction can be explained by lower food imports because of last year's
record grain harvest. At the same time, while all private-sector imports
are down, public-sector capital goods imports are up markedly.
TPro?pects for The new administration, which comes into office on 1 December 1982, will
the Longer Term have to face up to the serious longer term implications of Mexico's basic
economic problems. It must balance the need for austerity policies that
satisfy the international banking community with the need for domestic
economic growth to generate jobs.
De la Madrid will find it even more difficult to sustain subsidies and
political rewards on a basis commensurate with those of the last four years,
when economic growth exceeded 8 percent annually. With unemployment
and inflation surging, tensions between the government and labor would
mount. The PRI, locked into its historic platform of promising jobs and in-
creasing consumption, would begin to come under severe pressures,
possibly including increasing strikes, student demonstrations, and/or vio-
lent consumer protests.
Still, the government's ability to fund the kind of economic growth needed
to absorb the large increments to the labor force will be limited in the next
few years by the soft world oil market. Even with an all-out program to ex-
pand oil production capacity, the market will limit what Mexico can earn;
indeed, Mexico will do well just to maintain the purchasing power of its oil
earnings. If world oil prices fall further, the strains on the financial,
political, and social fabric will be magnified.
The competitive position of other export industries and tourism has been
seriously weakened in recent years by Mexico's rapid inflation. Even with
the devaluation, continuing depreciation will be required to maintain
competitiveness. Moreover, for the next several years, the high debt service
payments will take about half of foreign exchange earnings.
Avoiding chronic financial crises will require several years of sharply
slowed growth. This, in turn, would necessitate well-coordinated economic
policies and political resolve in the face of continuing rapid expansion of
the labor force. Mexico's difficulty in dealing with day-to-day financial
problems in the last few months raises questions about the government's
willingness to make more fundamental economic adjustments as the oil
dividend shrinks. So, too, does its laxness on domestic oil conservation
policies. Like the devaluation, the other major economic policy move of
hiking domestic gasoline prices in December 1981 was only halfhearted.
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After the hike, overall Mexican energy prices were still just one-third the
comparable US level, even though rising domestic energy consumption is
expected to eat into the exportable oil surplus late in the decade. Since the
devaluation, relative domestic oil prices in Mexico have slumped to just
one-sixth the US level.
Implications for From here out, US interests will be seriously affected no matter what
the United States Mexico does.
Whatever policy course Mexico adopts, managing its foreign debt will
require continuous banking support. The Mexicans will undoubtedly look
to the United States for backing if they encounter financial crisis. For their
part, US private bankers will almost certainly reduce new lending activities
in Mexico over the next two years, and may well be faced with restructur-
ing their credits and postponing debt service. If Mexico City needs to resort
to the IMF, it would probably also request drawings on $1 billion in
standing emergency loans from the US Treasury and Federal Reserve. On
the other hand, Mexico's financial requirements could make US access to
Mexico's oil and gas easier to negotiate.
US business operating in Mexico for the domestic market-the majority of
the $7 billion US investment-is in for a harder time. Heavy use of
devaluations and generous wage settlements are causing growing losses.
Expected sharp increases in the price of industrial fuels and other
intermediate goods could hurt even more. Even those US assembly
businesses processing goods on the border for reexport to the United States
will tend to stagnate because higher wages and input costs will offset much
of the beneficial effects of the devaluation.
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The economic slowdown will cut Mexican imports and per capita income.
As a result, over the next few years, US exports to Mexico robably will
run about $3 billion below the $17.8 billion for 1981.
Any perceived US insensitivities or inaction on financial and economic
policy issues could spill over into other bilateral political relations. At a
minimum, the increasing domestic and social tensions that attend slowed
economic growth may give rise to more frequent criticism of the United
States by the Mexican press.
There are also serious implications-not all bad-for Mexican participa-
tion in multilateral relations. The need for Mexico City to concentrate on
economic management will probably cause de la Madrid, at least initially,
to devote relatively less attention to international issues.
Approved For Release 2008/09/24: CIA-RDP83B00225R000100150001-4
 Confidenti Approved For Release 2008/09/24: CIA-RDP83B00225R000100150001-4
Confidential
Approved For Release 2008/09/24: CIA-RDP83B00225R000100150001-4