Mexican Economy-Creative Financing to the Rescue

September 25, 2007

Last August, Mexico ran out of foreign exchange to service its huge external debt and pay for im- ports. The government had to re- quest emergency loans from West- ern governments in order to avoid ers for a three-month moratorium on the $10 billion due in principal payments. An extensive rescue op- eration was quickly undertaken by Western central bankers and gov- ernments in return for Mexico's promise to work out an austerity plan with the International Monetary alone. Fund (IMF). To discourage capital "I can affirm," said former Presi- flight, exchange controls were dent Jose Lopez Portillo, "that in re- implemented for the first time. cent years a group of Mexicans led, Mexico's problems did not arise counseled and supported by pri- overnight. As early as the end of vate banks, have taken more 1981, it became clear that the coun- money out of the country than all try would have trouble meeting payments on the external debt, half of which was scheduled to fall due in less than a year. A precarious sit- uation turned into an acute crisis once wealthy Mexicans and for- eigners started taking their money out of the country by converting it to more stable currency. According to Creative Financing To The Rescue conservative estimates, they have deposited $14 billion in Eurobanks, $12 billion is held in foreign cur- rency accounts within Mexico and at least another $25 billion invested in real estate in the United States the empires that have exploited us since the beginning of our history." Nationalization of Banks To the anger of the domestic banking and business community, and to the surprise of everyone, Mexico nationalized its private banking sector in early September in an effort to contain the uncontrol- lable drain of foreign exchange. A communique from the Mexican Business Coordinating Council called the move "a definite coup against private business and a clear sign of the country's entry into so- cialism." In a situation where three-fourths of the $80 billion debt is owed by the public sector, this consolidation of power in government hands is welcomed by some U.S. banks, at least for the period of acute crisis. Despite their philosophical commit- ment to private ownership, the view of many U.S. bankers was reflected by a spokesperson for Bank of America: "This is a positive step in that it puts the Mexican government clearly behind its banking system." The Bank of America has $3 billion in loans outstanding to Mexico. Claudia Dziobek is a German econo- mist who is preparing her dissertation, "International Commercial Bank Lend- ing to Third World Countries in the 1970s," at the University of Massachu- setts at Amherst. NAC AReport Tourists in Mexico City change dollars for pesos after the government temporarily suspended dollar trading in August. Qupdate * update . update update "Q 0. Mexico City residents pause at a newsstand in August to check the latest exchange rate for pesos to dollars, Some of the Mexican Left and the pro-government Labor Congress celebrated the nationalization as a victory. Luis Jose Dorantes, head of the Labor Congress, applauded the decision to allow bank employees to unionize. In Mexico, the bank nationaliza- tion is not as radical a step as a sim- ilar act would be in the United States. Even before the takeover, the public sector accounted for 50% of the nation's gross domestic product. And half of the Mexican banking system had been trans- ferred to the public sector in the mid seventies. The effectiveness of government control over the banks in containing capital flight and ad- ministering the debt restructuring Jan/Feb 1983 remains to be seen. Said one banker, "Many of those who are taking dollars out of the country were in Congress hypocritically ap- plauding the President's decision." Creative Financing Breaking with established tradi- tions, the international financial community, composed of private banks, central banks organized through the Bank of International Settlements (BIS) in Switzerland and the IMF, rushed to package a rescue operation for Mexico. The Mexican collapse was the sleeping giant that nobody was prepared to confront. Billions of dollars were poured into the country under a va- riety of quickly fabricated methods, referred to as "creative financing" by the bankers. It included such novelties as paying for Mexican ex- ports before they had even been produced. The resources made available in- cluded: * $1.85 billion through the BIS, the central bank of the central banks, half of which was to be provided by the U.S. Federal Reserve; * $1 billion in advance payments from the U.S. government for oil de- liveries for its "Strategic Petroleum Reserve"; * $1 billion in loans guaranteed by the U.S. Commodity Credit Corpo- ration to finance food exports to Mexico; * $300 million in prepaid oil ship- ments from Spain; * $4-5 billion from the IMF to re- place the BIS loan as soon as the IMF had raised the money and agreed on the terms of an austerity plan with Mexico. In addition, $10 billion in principal payments to private banks were deferred for 90 days (and most likely longer) and bankers agreed to restructure Mexico's private debt, that part of the external debt owed to private banks. 41update * te ete update * update In similar acute foreign exchange crises, other third world countries have been subjected to several years of IMF-imposed austerity measures only to gain meager sup- port from the Fund and few if any concessions from the banks. In 1976, for example, Jamaica was forced to get by without any new foreign exchange loans until the IMF mission could detect "evi- dence of economic recovery." Clearly Mexico's case was excep- tional. Bankers viewed it as a serious threat to the stability of their own existence and of international financial markets. "Gang-Up" Possible? Currently about 15 third world and Eastern European countries, heavily indebted to private com- mercial bankers, are in serious fi- nancial troubles. Their reschedul- ing agreements involve economic adjustment programs lasting sev- eral years. Many of these countries continue to be in deep economic austerity (and most probably be- cause of it). Turkey, for example, has rescheduled its $3 billion debt owed to private banks three times in a row and is currently requesting another rescheduling. Traditionally, bankers have in- sisted that debt-servicing difficulties are due mainly to mismanagement and corruption rather than struc- tural constraints and the world re- cession faced by countries through- out the developing world. Before the Mexican disaster, to prove their point bankers cited Brazil, Mexico and Argentina as examples of heav- ily indebted third world countries "competently" managing their economies and external debts. With Mexico insolvent, Brazil ac- cepting IMF credits and Argentina in arrears, bankers uneasily take notice of the fact that third world and Eastern European countries 42 are now all in the same boat, open- ing the possibility of a "gang-up" against the banks. Previously at- tempted joint actions by the "South" against the "North" to solve the debt trap once and for all had failed precisely because Brazil and Mexico, although in principle in solidarity with the Group of 77*, re- frained from demanding debt relief from any of their creditors. But that was in 1976 at the UN Conference on Trade and Development IV, when neither Mexico nor Brazil thought they would ever fall on their knees before the IMF. The IMF was to Mexico what welfare is to the middle class. The bankers' insistence on rigid, IMF-supervised austerity programs have provoked protests, riots and deep resentment throughout the third world. This includes not only workers and peasants but politi- cians and some industrialists as well. Externally imposed, IMF pro- grams are seen as public humilia- tion. International bankers now des- perately try to avert the obvious conclusion, namely that a common solution to the third world debt crisis is necessary. Ball-Out of the Banks? More than two-thirds of Mexico's debt is owed to private banks. U.S. banks alone account for about 30% of that, with the Bank of America ($3 billion), Citibank ($2.5 billion), Chase Manhattan ($1.75 billion) and Chemical Bank in the forefront. A loss of the loans outstanding to Mexico would be disastrous. Citi- bank, for example, is reported to have loaned 50% of its capital base to Mexico, making it highly vul- nerable. Because of the psychological na- 'seeking to speak with one voice on trade and development matters, the Group of 77 developing nations was formed in Algeria in 1967. The group now includes over 120 countries. ture of the financial markets' stabil- ity, quick action to sweep the Mexi- can problem under the carpet, or at least make it look "manageable," is of prime importance. Bankers have made public "no cause for con- cern" speeches a regular institu- tion. In an article called "Banking Against Disaster," Citibank Chair- man Walter B. Wriston stressed what he saw as the positive side of the disaster. "One by one, those countries are finally breaking through the vicious circle of pov- erty. This is a new and positive de- velopment, and one which gives great hope for the future of the de- veloping countries in the remaining years of this century." The new loans to Mexico were put together by the United States and Western European govern- ments and central banks. Private banks held off and waited for gov- ernment action before attempting to raise new funds for Mexico them- selves. Given the country's poor credit rating, raising new funds in the Eurodollar market would be dif- ficult. Bankers would have a hard time convincing potential deposi- tors to invest their money in a bail- out operation for Mexico. Central banks and governments were then forced to jump in, using taxpayers' money for the rescue operation. Though officially labeled support of the Mexican economy and government, many begin to suspect that it is equally a bail-out for the private banks. Central bank- ers are eager to deny such charges. "The private banks caused this mess and they've got to help us clean it up," said one senior central bank official involved in negotiating the BIS package. "There is no way we can lend of- ficial money to Mexico so that it can repay the banks." Yet actually imposing sanctions against the banks may be difficult. IACU Reportupdate * update . update . update Ia Mexicans line up to exchange currency in Juarez as the rate fell to 100 pesos to the dollar in September. Bankers will insist on Mexico meet- ing interest payments. Otherwise they would have to write off the loans as losses which would bring several U.S. banks to the brink of default. With Mexico out of foreign exchange, the obvious conclusion seems to be that interest payments are being taken directly from dol- lars flowing in from the IMF or U.S. taxpayers. Rescheduling Private Debt Private bankers agreed to a re- structuring of the Mexican debt pat- terned after rescue operations for other third world countries. The Mexican plan includes an IMF-ad- ministered austerity program aimed at increasing exports and thus foreign exchange earnings through devaluations. The scheme is also designed to cut internal spending by curtailing the govern- ment budget and lowering real Jan/Feb 1983 wages. New taxes will be imposed, charges for public services will in- crease and 106 out of 740 state- owned companies and govern- ment agencies will be closed. Though they had called for 50% wage hikes, workers in some in- dustries cancelled the strikes they had threatened. Faced with the al- ternative of unemployment (with no benefits), workers settled for a pay raise of 12%, far below the 100% inflation rate. If the country com- plies with the policies prescribed by the Fund and continues to service its external debt (without contract- ing new credits), banks will stretch out the debt and the IMF will grant support loans. In most cases of reschedulings, private bankers do not lose a penny. Funds made available by the debtor country through the aus- terity programs are used to con- tinue servicing the debt. The inter- nal "savings" are complemented by foreign exchange infusions from the IMF. This mechanism works even in times of slow growth inter- nationally and negative growth in- ternally. Theoretically, the squeezing out of internal wealth and income to make it available to the foreign creditors would best be accom- plished by taxing the rich, cutting imports of luxury items and limiting the amount individuals may hold in foreign exchange accounts. But in practice, wage cuts and cuts in vital imports-both disruptive of the whole economy-are usually the primary source of funds. Addition- ally, prices of export items such as oil are raised internally to discour- age consumption, freeing up the items for export. However, this does not always work well, particu- 43update * update . update e update larly in times such as now, when oil is cheap and there is a wave of pro- tectionism in the Western world. Cambridge Versus Chicago IMF officials derive their wisdom from the University of Chicago economists who teach how to cure through bloodletting. An alternative cure is suggested by Mexico's ad- visers from Cambridge University who adhere to more humane-and reasonable-theories. Mistrustful of the "free market" solution, Cam- bridge supported exchange con- trols and strict monitoring of im- ports to ensure that only crucial im- ports were given priority. Addition- ally, the production of oil and other export goods should be increased so that payments could be made out of a growing pie rather than squeezing money out of a shrinking economy. In every way, this is a more rea- sonable long-term plan of action. But the IMF does not allow for ex- perimentation. That third world economies are usually set back decades in their development by the austerity programs is not of consequence. Maintaining "per- forming loans"-the term for loans being serviced-on the banks' balance sheets seems to be a higher concern. Political Disaster The IMF austerity program that Mexico is agreeing to will not easily be implemented. It will no doubt bring intensified social tensions. Unemployment or underemploy- ment is already estimated at 45%. Almost one million workers were sent home in the first eight months of 1982. Devaluations will acceler- ate inflation as imported goods get more expensive. This in turn will cause real wages to fall, which will not be accepted easily. Devalua- tions will also mean the curtailment of some imported goods. PEMEX, the state-owned oil giant, said it planned to fire 10,000 workers by the end of the year. ALFA, the biggest Mexican con- glomerate built around the steel in- dustry, is laying off one-fifth of its employees and has to sell off half of its assets to avoid worse measures. With an economy structured so that imports are crucial to most indus- tries, disruptions will be felt in many production sectors. To make things worse, ailing local businesses will have to watch foreign investors take their place because they can offer the country attractive foreign exchange. Given this outlook, the imple- mentation of IMF policies may be politically impossible to carry out even for a pro-Western leader such as President Miguel de la Madrid Hurtado. The execution of drastic cutbacks is not simply a technical problem to be solved by budget specialists. Resistance will be met at each step along the way, similar to the opposition to budget cuts in this country under the "balanced budget" Administration of Ronald Reagan.

Tags: Mexico, debt, bank nationalization, emergency loans, IMF

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