by Roberto Salinas León
Executive Director
Centro de Investigaciones Sobre la Libre Empresa
This declaration is a tacit
admission that 1995 will be characterized by contraction in economic growth, rising
inflation and null access to credit. In business terms, this signifies a decline
in profit margins, acute unemployment, bankruptcies all across the private sector,
low stock market performance, and higher debt servicing costs. The financial crisis
brought about by the currency collapse in December 1994 has not diminished in
the wake of strong emergency initiatives to neutralize a nervous market, including
the availability of extensive credit lines supplied through the massive US$52
billion package. The second phase of austerity measures entail draconian fiscal
and monetary policy to neutralize inflation expectations associated with a lower
parity. This implies a severe contraction of credit. In a word, the challenge
in 1995 is: survive.
The Zedillo administration inherited
a strategic dilemma in exchange-rate policy. The growth of the current account
deficit, projected at US$31 billion for 1995 and higher thereafter, was assumed
a constant factor for forthcoming years in light of two variables: strong private
capital flows and trade liberalization under NAFTA. However, political turbulence
in 1994 had shifted an excessive reliance on high interest rates as the primary
mechanism to sustain strong capital inflows. This generated a decision-making
problem associated with the following alternatives:
The Zedillo administration opted
for the second alternative, but the strategy backfired. The collapse of confidence
forced the central bank to switch to a floating exchange-rate, thus effectively
bringing about a sharp 40% devaluation of the peso vis-á-vis the U.S.
dollar. The Wall Street Journal encapsulates the principal damage of
this phenomenon: "... with the devaluation, the government sacrificed its most
valuable, forward-moving asset: market confidence." According to the
central bank, the day after the decision to amplify the fluctuation band, the
country experienced the largest amount of capital flight observed in a 24 hour
period: some US$5 billion in cash.
The collapse of market confidence
caused uncontrollable panic in financial sectors and vitiated the positive results
obtained since 1989 in macroeconomic stabilization. In the first days of the
Zedillo administration, stability has been replaced by stagflation.
In retrospect, the financial crisis
engendered by the devaluation appears to have an origin in the simultaneous
combination of three fundamental errors:
The immediate problems involved
in the successful implementation of the austerity measures announced in early
March are three:
The success of the austerity measures
is a source of debate in private organizations worried about a drastic 4% to
5% fall in total net output. Despite the devaluation and the destabilizing effects
of the currency crisis, there are important structural and economic differences
from the 1982 collapse which yield a more reliable basis for the adjustment
program to absorb the effects in the financial markets and the macroeconomic
scenario.
To date, despite recession and instability,
foreign investment flows have improved. In the first semester, new foreign inflows
reached US$3.12 billion. The Zedillo administration continues to emphasize a
commitment to increase direct foreign investment by new privatization and property
ownership laws. This will help ameliorate the bitterness of the austerity program
and the harsh conditions imposed by the Clinton administration and the IMF in
order to guarantee the success of the US$52 billion bailout package. The strictness
is evident in the rubrics of monetary and fiscal policy:
The latest phase of the emergency
plan involves the following targets:
The international consensus expects
Mexico to come out of recession by early next year. The Zedillo administration
reports that the first semester registered a trade surplus of US$2.8 billion.
In addition international reserves rebounded from a low in January of US$3.4
billion to some US$14 billion by the end of July. The sharp fluctuations in
reserve figures owe to the impact of payments on public debt, amortizations
on outstanding tesobonos and funds diverted to capitalize emergency funds for
the ailing banking sector. The increase in international reserves and the conversion
of the trade deficit into a trade surplus has resulted in renewed optimism.
On the other hand, this optimism is substantially misplaced; a trade surplus
reflects the impact of large capital flight and the artificial advantages of
a cheaper currency, which are gradually short-circuited by rising inflation
and high interest rates. The last time the country ended with an annual trade
surplus was 1987 - a year better remembered for acute recession, unemployment
and the largest rate of inflation in the nation's history (159%).
On the other hand, earlier concerns
of a debt moratorium have been minimized. The concerns mostly surround the status
of the peso. Although technically undervalued, most analysts have expected the
peso to fall further because of sharply rising inflation levels. If the current
exchange rate target of 6=1 can be maintained throughout 1995, then the economy
will be able to preserve a level of competitiveness with the U.S. while keeping
inflation close to the 42% target. This is possible, according to the central
bank, because current monetary policy has been significantly restrictive and
inflation will fall off sharply after the first semester - thereby making independent
monetary policy the main anchor of macroeconomic stabilization. The new peso
futures contract in the Chicago Mercantile Exchange will help to minimize risk
and convert a future variable cost to a fixed cost, which will help to lock
in gains and add stability to a long-term planning.
Not surprisingly, mergers and acquisitions
is becoming a crucial mechanism to neutralize problems with increasing defaults
and past due loans in the second and third quarters. El Grupo Banco Bilbao Vizcaya
bought 70% of Probursa, setting a precedent to follow. The same Salomon Brothers
report claims there will be numerous mergers in order to consolidate and repair
the system. In effect, nonperforming loans among commercial banks were up by
45% for the first quarter. The total value of damaged portfolios is N$80 billion
pesos. In addition, quarterly bank earnings n the same period also witnessed
a sharp downward turn. Thus, net profits for Bancomer were down 38.2%, for Banamex
35% and for Bancrecer 94.2%. High interest rates continued to neutralize business
and the banking system. It is expected that six local banks will receive a total
of N$6.5 billion pesos from the government through the Procapte mechanism. This
program is designed to help the banks with capital shortages during this period
of high interest rates. Slated for aid in this program are the following banks:
The Economics of the Currency Crisis
The attempts to explain the intensity
of the financial crisis generally fail to note the role of one crucial but unquantifiable
variable: confidence. The major factor behind the volatile behavior of exchange
and financial markets in the first quarter of the year was the loss of credibility
with respect to the long-term reliability of the domestic investment regime. The
emergency program sought to remedy the short-term adjustments, but still require
a basis in a new parity regime and a long-term economic framework. The latter
has been produced in the form of the National Development Plan 1995-2000.
Problems and Prospects
The early failure to stabilize macroeconomic
indicators, as well as the exchange and financial markets, has led the Zedillo
administration to project three different consecutive outlooks for 1995. In general,
urgent stabilization is required before some of the principal long-term problems
can be properly addressed. So far, the administration has not produced a more
stable exchange-rate regime, although it foreshadows a managed band system similar
in spirit and structure to Chile's exchange-rate regime, where policy targets
a relatively undervalued real exchange-rate.
The immediate macroeconomic challenge
of this austerity program is to mitigate the contractionary economic consequences
of a tight credit policy. A promising strategy is tax simplification and future
tax reductions on income to offset the bitterness of the adjustment process. The
other is a commitment to broaden deregulation in transportation, labor markets
and business requirements. The broad-based plan to sell state-owned assets and
"concession" important public services to private parties is also encouraging.
The breakdown, in its first phase, is as follows:
The partial privatization of the railroad
system and the permits for private management of satellites required modification
in constitutional provisions governing state ownership of these services. The
Zedillo government plans to encourage private capital participation in the form
of joint ventures and other contracting out mechanisms consistent with exclusive
state ownership of energy assets.
A New Trade Scenario
The first quarter results place special
emphasis on the reversal of the trade deficit as a sign that the strict measures
of austerity and devaluation are "working out." Thus, the Zedillo administration
is citing success on the basis that the current account deficit, the alleged culprit
behind the devaluation and the ensuing financial and exchange-rate crisis, has
been transformed into a balance. On the other hand, a sharp drop in demand for
foreign goods is inevitable in an economy characterized by recession and rising
unemployment. So construed, a current account surplus is not necessarily a reflection
of a healthy economy. For instance, the auto industry, a standard barometer of
economic activity, has experienced its worst crisis in seven years: first quarter
sales are down 63.7% in comparison to 1994 -even despite the advantages of lower
trade barriers due to phase out periods in NAFTA. It is expected that 30% of all
dealerships will close down. This is equivalent to a net loss of 75,000 lots.
The Banking Sector
A precondition of recovery is the stabilization
of the banking system. Salomon Brothers reports that, according to an analysis
using FASB accounting standards, the entire banking system shows a status of insolvency
on an adjusted basis. In fact, according to Salomon Brothers, the third largest
bank Banca Serfin lost 3.3 billion new pesos or the equivalent of 81% of 1994
year end equity. The difference is that the Mexican accounting standards allow
for the creation of loan loss reserves against equity and deferred taxes instead
of subtracting from net profits on the income statement.
The National Development Plan
The 1995-2000 National Development Plan
has five parts: sovereignty; citizen's rights; democratic development; social
policy; and economic growth. The latter chapter is designed to promote a minimum
of 5% GDP growth every year, and includes fiscal reforms to increase domestic
savings, control of public spending and inflation, stabilize the peso, and address
fundamental macroeconomic issues. This chapter is pivotal for the overall success
of the plan. The country will not be able to improve its position vis-á-vis
sovereignty or social growth without stabilizing the economy and providing for
high growth. This, in turn, is based on the following set of reforms:
Institutions like Centro de Investigaciones Sobre la Libre Empresa (CISLE) usually restrict their range of activities to either academic goals or public policy goals. At CISLE, we do both. Academically, our aim is to foster a proper understanding of the market system. This is a long-term task. At the level of public policy, our aim is to propose solutions and creative strategies to transform the current system of mixed economy into a system approximating a market regime as far as possible. This is a short-term task, which concentrates on issues like privatization, deregulation, tax reform, legal reform, free trade, and the like.
