Abstract

In the first years following the 1982 debt crisis, the Mexican authorities adopted significant financial and structural measures to redress the situation. Particular emphasis was placed on fiscal policy, with substantial cuts made to noninterest expenditure. This policy stance was not comprehensive, however, and the fiscal effort was insufficient to bring back confidence to financial markets. In the context of high public sector debt, accelerating inflation, and rising interest rates, interest payments rose substantially in relation to gross domestic product (GDP), and the overall public sector deficit remained high. Private sector confidence in government policies remained low and economic activity was stagnant.

In the first years following the 1982 debt crisis, the Mexican authorities adopted significant financial and structural measures to redress the situation. Particular emphasis was placed on fiscal policy, with substantial cuts made to noninterest expenditure. This policy stance was not comprehensive, however, and the fiscal effort was insufficient to bring back confidence to financial markets. In the context of high public sector debt, accelerating inflation, and rising interest rates, interest payments rose substantially in relation to gross domestic product (GDP), and the overall public sector deficit remained high. Private sector confidence in government policies remained low and economic activity was stagnant.

It became apparent that a more comprehensive effort was required to foster the conditions for sustainable economic growth. Thus, in December 1987 the authorities introduced an economic program, reinforced in late 1988, that is based on five key elements: tight financial policies; an incomes policy; significant structural reforms; innovative support from the international financial community; and, the implementation of policies aimed at protecting the economy from adverse shocks.

The results of this strategy, which was seen as risky at the time of the introduction of the economic program, have been impressive. The 12-month rate of inflation has declined from 159 percent in December 1987 to 19 percent in December 1991 while, after years of stagnation, real GDP grew in 1991 by around 4 percent for the second year in a row.1 Further, reflecting strong private sector capital inflows, the overall balance of payments registered a surplus of over $7 billion during 1991. Underpinning this performance has been a strong fiscal adjustment with the overall public sector borrowing requirement (PSBR) declining from 16 percent of GDP in 1987 to 1.5 percent in 1991.

The first part of this section presents an historical overview of the economic policies leading to the debt crisis and the subsequent strategy of economic adjustment during 1982–87. The second discusses the strategy used by the authorities since late 1987 to foster conditions for sustained economic growth in the context of a strengthening of the balance of payments. The third offers some concluding remarks.

Historical Overview

Between 1955 and 1970 Mexico experienced rapid industrialization and urbanization. Widely characterized as a period of “stabilizing development,” the country enjoyed high growth, low inflation, and moderate debt accumulation.2 This was achieved through the maintenance of a tight fiscal stance, accompanied by inward-looking policies.3 Sizable private sector investment was associated with strong economic growth, with the ratio of private sector investment relative to GDP increasing by over 8 percentage points of GDP to 20 percent, and with an average annual increase of real GDP of around61/2 percent. This allowed for an increase of real per capita consumption at an average annual rate of 3⅓ percent. At the same time, the rate of inflation was both stable and moderate (an average rate of 4 percent during the period). External debt remained below 20 percent of GDP throughout the period.

The strategy was highly successful in the beginning but not sustainable as it was framed by high protective barriers, focusing on import-substitution and rapid expansion of the domestic market. Correspondingly, economic inefficiencies became prevalent, with industrial growth mostly a result of capacity expansion with little productivity gains.4 With expenditure growing rapidly, the external current account balance changed from a surplus equivalent to 2 percent of GDP in 1955 to a deficit of 3½ percent of GDP in 1970, with the U.S. dollar value of exports growing only at an annual rate of 3 percent during this period.

In the early 1970s, the policy of private sector-led growth was replaced by a policy of “shared development,” with the Government adopting an active policy of public expenditure led growth.5 The PSBR increased from 2½ percent of GDP in 1971 to over 9 percent of GDP in 1975 (Table 1).6 At the same time, private sec-or savings declined and the external current account deficit increased by 1 percentage point of GDP to over 4¼ percent of GDP. External debt more than tripled to almost $22 billion by the end of 1975. While the annual rate of economic growth still averaged 6½ percent, the rate of inflation rose to 12 percent during this period and the real effective exchange rate appreciated markedly.

Table 1.

Public Sector Fiscal Balances

(In percent of GDP)

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Sources: Secretariat of Finance and Public Credit; and Bank of Mexico.

Public sector borrowing requirement.

In 1976, Mexico experienced a financial crisis, as capital flight accelerated in the face of mounting imbalances. A new government responded with economic measures, supported by a stand-by arrangement from the Fund, which included a devaluation of the peso and tighter fiscal policies.7 Financial policies were relaxed, however, after major oil discoveries were made the following year. Public sector revenue increased markedly with rising oil proceeds but was accompanied by even larger public sector expenditure that led to a sizable rise in the PSBR. From 1975 to 1982, the level of total external debt increased threefold to $88 billion, while private sector debt rose to $18 billion. Furthermore, short-term debt rose to one third of total debt outstanding.

During 1980–82, aided by the impact of increasing oil production and, initially, increased foreign borrowing, public budgetary expenditure rose by 10 percentage points of GDP to 42 percent of GDP and real GDP rose at a rate of over 5 percent (Table 2). However, with public sector deficits increasing during this period, the rate of inflation averaged 37 percent and the real effective exchange rate appreciated markedly; together with low controlled nominal interest rates, capital flight rose. The authorities sought to arrest the existing imbalances but were unsuccessful. In the context of weakening oil prices, the balance of payments was subject to considerable pressure that was aggravated by increased reluctance in international markets to lend to Mexico.

Table 2.

Public Sector Budgetary Revenue and Expenditure1

(In percent of GDP)

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Sources: Secretariats of Finance and Public Credit and of Programming and Budget.

Excludes nonbudgetary operations and financial intermediation.

In August 1982, the Mexican authorities announced their inability to service fully the country’s external debt. Subsequently, the Government imposed strict exchange and trade controls and nationalized the banking system, while Mexico began to develop external payments arrears on private sector debt service. The combination of a large public sector deficit and the lack of foreign financing led to a rapid acceleration of inflation, from an annual rate of under 30 percent in 1981 to almost 100 percent in 1982.

In late 1982, the new administration of President Miguel de la Madrid Hurtado adopted an adjustment program.8 Mexico obtained financial resources and a rescheduling of its external debt from official and commercial bank sources and the program was supported by the Fund with an extended arrangement covering 1983–85. The program called for a major strengthening of financial policies and for a liberalization of exchange and trade controls; it also provided for a large initial devaluation, followed by frequent adjustments in the exchange rate based on projected inflation. The program’s early achievements were considerable: internal and external imbalances were reduced greatly, inflationary pressures declined, and economic activity began to recover.

By early 1985, however, it became evident that the initial adjustment efforts were not being sustained. Moreover, the efforts of the authorities were hampered by emergency spending necessitated by the September 1985 earthquake and by the sharp drop in the price of oil (from $25 a barrel in 1985 to an average price of $12 a barrel in 1986). As a result, the fiscal and external positions weakened, with public sector revenues and export receipts plummeting by the equivalent of about 6 percent of GDP.

In mid-1986, the Mexican Government responded to the worsening economic situation by adopting a new economic program, which the Fund supported with a standby arrangement. Financial support was sought from all of the creditors that had financed Mexico’s development in the past, with a view to restructure Mexico’s external debt from official and commercial bank sources and to offset the loss in export earnings. Fiscal and monetary policies were tightened; the exchange rate was depreciated sharply in real terms; and substantial efforts were made to liberalize trade and privatize public sector enterprises. These efforts, aided by a marked increase in oil prices, led to a sizable external current account and balance of payments surplus and allowed Mexico to enjoy a period of moderate economic growth in 1987.

The strong improvement in the external position of Mexico in 1986–87 was accompanied, however, by a marked deterioration in price performance, with the 12-month rate of inflation accelerating from under 65 percent in December 1985 to 159 percent in December 1987 (Chart 1). Nominal interest rates were correspondingly high, which put additional pressure on the borrowing requirement of the public sector. The inflationary spiral, which was aggravated by the increased frequency of wage and official price adjustments, together with the crash in the Mexican stock market in October 1987, resulted in significant capital outflows late in that year. In response, the Bank of Mexico withdrew its support of the exchange rate in the free market, causing the peso to depreciate sharply.

Chart 1.
Chart 1.

Inflation and Interest Rate Developments

(In percent a month)

Source: Mexican authorities.

Strategy to Achieve Sustainable Economic Growth

It became apparent that a broader-based effort, building on the authorities’ previous policy stance, was required to achieve a sustainable recovery. Thus, in December 1987, the authorities introduced an economic program based on a pact with labor and business (the Pact for Economic Solidarity, or PACTO), which aimed at correcting remaining imbalances and, in particular, at bringing down the rate of inflation. Financial policies were tightened further and additional structural reforms were instituted.

The measures adopted were effective in reducing the rate of inflation from 159 percent during 1987 to 52 percent during 1988, while real GDP growth remained at around 1½ percent. The program was not without risk, however, and despite an increase in the primary fiscal surplus, continued economic uncertainties resulted in a substantial rise in real interest rates and, consequently, a large fiscal operational deficit. The external current account shifted by about 4½ percentage points to a deficit of around 1 percent of GDP in 1988, while net international reserves declined by $6.8 billion (Chart 2).

Chart 2.
Chart 2.

Fiscal and External Developments

(In percent of GDP)

Source: Mexican authorities.

In late 1988, under President Carlos Salinas de Gortari, the Mexican authorities broadened further their economic policies. While pursuing a continued reduction in the rate of inflation, more emphasis was given to fostering conditions for sustained economic growth in the context of a strengthening of the balance of payments.

The strategy was based on five key elements. First, strict financial policies, which had been in place for much of the decade and had been strengthened in late 1987, were to be maintained. Second, the incomes policy that was instituted in late 1987 was broadened. This was accomplished through a revised wage-price pact (the Pact of Economic Growth and Stability, or Pece), as well as a social welfare program (Pronasol). Third, significant additional structural reforms were put in place. Fourth, these policies were supported by assistance from bilateral, multilateral, and commercial creditors, including debt and debt-service reduction from commercial banks and an extended Fund arrangement approved in May 1989. Finally, emphasis was placed on implementing policies to protect the economy from any adverse shocks.

Fiscal Policy

Throughout 1982–87, financial policies were tight with particular emphasis on fiscal adjustment.9 The primary fiscal balance moved from a deficit of 5 percent of GDP in 1982 to a surplus of 5 percent of GDP in 1987 (see Table 1 and Chart 2). However, this fiscal effort was offset, mostly, by a spiral of high inflation and high interest rates with the result that the PSBR declined by only about 1 percentage point to 16 percent of GDP. Moreover, fiscal rigidities impeded the authorities’ ability to adjust quickly the primary balance to exogenous shocks.10

The foundation of the authorities’ present economic program has been a further strengthening of fiscal policy at the level of the primary balance aided by structural fiscal reforms. In combination with the other elements of the economic program, this strategy broke the inflation-interest rate spiral and allowed the fiscal effort at the level of the primary balance to be associated with significant fiscal adjustment at the level of the PSBR and operational balance.

Impediments to Fiscal Adjustment

After the 1982 debt crisis, the authorities’ ability to reduce the size of the PSBR was hampered by numerous and inefficient public sector enterprises, structural impediments to adjusting public sector revenue and expenditure, and the adverse impact of the sizable domestic debt in relation to GDP that existed at the beginning of this period.

The number of public sector enterprises had increased significantly during the 1970s and reached over 1,100 by 1982, with the overall deficit of these enterprises accounting for about one fourth of the public sector’s borrowing requirements. The growing deficit of the public sector enterprises, which was financed mainly by transfers from the federal budget, reflected a sharp rise in public sector investment, non-market-related pricing policy, and increasing inefficiency. By the end of 1982, the authorities had determined that the size of the public sector affected adversely both economic productivity and efficiency; moreover, it affected the ability to adjust quickly fiscal policy to meet economic objectives.

Impediments to increasing public sector revenue hampered fiscal adjustment efforts, with additional public sector revenue contributing only 1½ percentage points to the 10 percentage points of adjustment in the primary balance during 1982–87 (see Table 2). A dominant factor behind the poor revenue performance was a large decline in revenue from oil exports, with sales falling from over 8 percent of GDP in 1982 to an average of under 5 percent of GDP in 1986–88. This deterioration was partly offset by increased proceeds from the domestic sale of petroleum, reflecting adjustments in domestic prices to international levels. Another reason for the lack-luster revenue performance was the narrow tax base, high marginal income tax rates, and, for taxes collected with a lag, the negative effects of higher inflation on revenue collections in real terms.

The inertial element of fiscal imbalances that resulted from the link between debt, inflation, and interest rates also impeded fiscal adjustment during this period. In 1982, the total stock of domestic debt was already equivalent to 25 percent of GDP, while the average annual cost of debt financing was 20 percent.11 As a result, interest payments on domestic debt were equivalent to almost 5 percent of GDP, accounting for over one third of the borrowing requirement of the public sector. Despite the sizable fiscal effort at the level of the primary balance during 1982–87, the average overall public sector deficit during the period was equivalent to 13 percent of GDP. Reflecting a heavy reliance on the issue of money to finance the fiscal deficit during this period, total domestic debt declined to under 17 percent of GDP by the end of 1987. However, with the average cost of funds rising to over 90 percent, interest payments on domestic debt rose to over 16 percent of GDP. As a result, by 1987 a significantly larger fiscal effort at the level of the primary balance was required to maintain an unchanged borrowing requirement of the public sector.12

Road to Fiscal Adjustment

During 1982–87 the reduction of public sector non-interest expenditure was equivalent to almost 10 percentage points of GDP (see Table 2). This was accomplished by equivalent sizable reductions in non-interest current and capital expenditure, with the decline in capital expenditure shared between the Federal Government and the public enterprises. However, the cuts in current expenditure hurt the Government’s ability to meet certain social needs and maintain current services, while the reduced public investment caused infrastructural bottlenecks. The adverse effect of the cuts in expenditure may have been compounded by their impact on economic activity, which in turn would then have adversely affected the capacity of the Government to raise revenues.

In their efforts to reform the public sector, the authorities placed emphasis on the divestiture of public sector enterprises. The number of state-owned entities was cut from over 1,100 in 1982 to 420 by the end of 1988 through a process of mergers, liquidations, and sales. Since the end of 1988, the effort to streamline the public sector has continued with the number of state-owned entities estimated at less than 250 by the end of 1991; moreover, the recent divestitures have included some of the largest enterprises in the country, including two air-lines, a truck manufacturing company, two steel companies, and the Cooper Mining Company. More recently, the large telecommunications company and the commercial banks were privatized. This policy has allowed the public sector to concentrate its limited resources on priority sectors and has allowed the private sector to participate in the development of critical areas of the economy.

On the revenue side, in 1987, the authorities implemented a major reform of the tax system to correct distortions (especially the effects of inflation) and to enhance Mexico’s external competitiveness by harmonizing the domestic tax system with those abroad. The reform was accelerated in 1989–90 by widening the tax base and reducing marginal tax rates. In particular, the Government introduced a new minimum tax of 2 percent on firms’ assets; abolished tax exemptions granted to certain sectors of the economy; reduced the corporate tax rate from about 40 percent to 36 percent, while changing the system of taxing corporate dividends to discourage tax evasion and encourage reinvestment of profits; and lowered the tax rate on the highest personal income bracket to 35 percent.

In response to government policies, including an increase in the fiscal primary surplus from 4.7 percent of GDP in 1987 to 7.9 percent of GDP in 1989, the rate of inflation and nominal interest rates declined in both 1988 and 1989; moreover, private sector confidence began to recover as evidenced by a decline in 1989 of real interest rates in association with a net inflow of private capital. As a result, in 1989 both the PSBR and the operational deficit declined. Domestic debt, however, rose to almost 24 percent of GDP, reflecting the authorities’ determination to avoid central bank financing of the PSBR. In 1990, the improvement in the fiscal balances continued with the primary surplus remaining at 7.9 percent of GDP and the PSBR declining to 3½ percent (the lowest PSBR in ten years). In addition, the operational balance moved to surplus, resulting in a slight decline in the real level of domestic debt.

In 1991, the process was reinforced with declines in inflation, nominal and real interest rates, and the level of domestic debt. Domestic interest payments declined to 3½ percent of GDP (compared with 6.9 percent of GDP in 1990 and 13 percent of GDP in 1988), reflecting lower interest rates (an average of around 20 percent in 1991 compared with 35 percent in 1990), and a lower level of domestic debt (estimated to have declined by over 4 percentage points of GDP to 19 percent of GDP). The PSBR (excluding revenues from privatization) declined to 1.5 percent of GDP, while the operational surplus increased to over 2.3 percent of GDP. This was consistent with a decline in the fiscal effort at the level of the primary balance and allowed for some increase in public sector investment and current expenditure.13

Incomes Policy

A crucial part of the authorities’ overall strategy to achieve economic stability and a sustainable rate of growth has been the implementation of an incomes policy, including an exchange rate policy based on a preannounced and declining path of inflation (Chart 3). The incomes policy is comprised of two distinct parts. The first is an economic solidarity pact between government, business, and labor to control prices and wages within the context of the Government’s overall program aimed at economic recovery. The second is a government spending program aimed at eradicating extreme poverty and better integrating the poor into the process of economic recovery.

Chart 3.
Chart 3.

Real Effective Exchange Rate

(Base 1980 = 100)

Source: Information Notice System.

Wage-Price Pact

As part of the wage-price pact of December 1987, the minimum wage, the controlled exchange rate, and public sector prices and tariffs were, after an initial adjustment, frozen throughout 1988.14 A new pact of economic growth and stability (PECE) was announced in December 1988. Minimum wages and public sector prices and tariffs were adjusted while the peso was made subject to a daily preannounced schedule of depreciation against the U.S. dollar. The authorities have extended the PECE at unannounced, although fairly regular, intervals. The nominal rate of adjustments to minimum wages has declined with inflation; adjustment to public sector prices and tariffs has met microeconomic objectives; and the preannounced crawl of the peso has decreased steadily.15

In combination with tight financial policies, the wage-price pact has aided in reducing inflation. “A major component of inflation in many countries stems from what may be called the imposition of an external diseconomy by each firm and household acting in isolation as it seeks to protect itself against inflation.”16 Hence, even in the absence of pervasive indexation, inertial inflation may exist, which is costly to eliminate by using financial policies alone. The use of an incomes policy, in combination with tight financial policies, can reduce this inertial element and the degree of monetary and fiscal restraint needed to achieve lower inflation. In turn, the costs of adjustment are reduced.

Program of National Solidarity

The second element of the Government’s incomes policy has been the “Program of National Solidarity,” or “Pronasol.” This program was initiated in 1989 with the purpose of eradicating extreme poverty and integrating the poor into the process of economic stability and recovery, with an emphasis on specific programs rather than broad and costly subsidies. Pronasol seeks to expand and strengthen programs in education, nutrition, and health, as well as those related to the provision of drinking water, sewage, and electricity. The program is decentralized, with the Government acting closely with individual communities.

The amount of government resources targeted for programs within Pronasol has increased significantly since its inception. Social expenditure totaled 36 percent of total noninterest expenditure in 1989, of which 2.1 percent was within Pronasol. Social expenditure increased to 38 percent of total noninterest expenditure (2.6 percent within Pronasol) in 1990, 46 percent of total noninterest expenditure in 1991 (3.5 percent within Pronasol), and the 1992 budget programmed social expenditure at 51 percent of total noninterest expenditure (4 percent within Pronasol). With noninterest expenditure increasing somewhat in real terms as interest payments declined, social expenditure has increased in real terms by 16 percent in 1990 and an equivalent increase is estimated in 1991. This increased social expenditure, as well as its careful management, has helped improve social equity while Mexico undergoes its economic stabilization program.

Structural Reforms

In addition to reforming the tax system and divesting public sector enterprises (described above), Mexico took measures to liberalize its external trade and investment system, to enter into free trade arrangements, to liberalize and privatize its financial system, and to deregulate specific economic activities. Overall, the program of structural reform initiated in the mid-1980s and intensified since 1989 has paved the way for a more efficient and dynamic economy based on market signals while opening it up to international capital and competition. In combination with the other elements underpinning Mexico’s policy effort, these reforms have helped create the conditions for sustainable economic growth.

International Trade and Investment Liberalization

Mexico has liberalized its international trade and investment regimes in stages. In 1985, Mexico began dismantling its tariff and nontariff trade barriers and joined the General Agreement on Tariffs and Trade (GATT) in August 1986.17 Import substitution policies and reliance on oil exports for foreign exchange earnings were replaced with policies aimed at attracting foreign investment, lowering trade barriers, and generally making the country more competitive for non-oil exports. In 1989, foreign investment regulations were also liberalized. The new regulations simplified the procedures for authorizing investment projects, relaxed limits on foreign ownership, and reduced some barriers to entry by foreigners into the Mexican stock market.

The implications of this transformation into a highly open economy have been significant as the incentive structure has been reoriented while major distortions have been removed, leading to greater efficiency. Export growth has picked up, and exports have been diversified. Moreover, the economy’s productive base is being modernized as a result of the access to imports at international prices and greater amounts of foreign direct investment. Mexico is currently involved in the negotiation of four free trade agreements, one with the United States and Canada and three with Latin American countries.

Until the late 1980s, despite a period of gradual transformation and liberalization, the financial system in Mexico was characterized by interest rate restrictions, domestic credit controls, high reserve requirements, and fragmented financial markets causing inefficiencies in the intermediation between borrowers and lenders.18 Capital markets were not well developed, and firms often had to turn to informal markets. Moreover, the shallowness of the bond market and the existence of informal credit markets hampered the conduct of monetary policy by restricting the scope for open market operations and limiting the ability of the Bank of Mexico to monitor overall credit market conditions.

In 1988, the Mexican Government accelerated the process of financial reform. The objectives were to enhance efficiency through greater reliance on market forces, to promote the growth and deepening of financial markets, and to improve the effectiveness of monetary policy. In addition, the reforms sought to improve the capitalization of Mexican financial institutions with a view to preparing them for international competition.

Key liberalization measures included the freeing of interest rates and the elimination of direct controls on credit. In November 1988, quantitative restrictions on the issuance of bankers’ acceptances were lifted, and banks were allowed to invest freely from these resources. In April 1989, major reforms were introduced that eliminated controls on interest rates and maturities on all traditional bank instruments and deposits, as well as remaining restrictions on bank lending to the private sector. But the cornerstone of the institutional reform was the reprivatization of Mexico’s commercial banks, announced in 1990, and subsequently successfully implemented, which was part of a wider plan to promote financial integration through a universal banking system.

Deregulation of Economic Activities

Complementing the measures mentioned above, steps have been taken to deregulate specific sectors, particularly in the areas of transportation, communication, petrochemicals, fisheries, and most recently agriculture. These measures are enabling market forces in Mexico and abroad to take advantage of available opportunities. Most recently, an agricultural reform bill was introduced in Congress that would allow the owners of agricultural land to rent or sell their land, while putting an end to the distribution of land that has been in place since the rural reform in 1917. This change should allow for a substantial increase in agricultural productivity.

In the context of the authorities’ exchange rate and incomes policy, the structure of the balance of payments has changed dramatically in recent years. During much of the 1980s, improvements in the fiscal operational balance were related directly to improvements in the external current account balance. Since 1989, the current account balance has been linked directly to movements in private capital flows, with increased net private inflows resulting in growing private sector imports of intermediate and capital goods. The strong fiscal outcome during this period has strongly influenced the willingness of the private sector to make use of foreign savings for investment in Mexico and has been associated with rising current account deficits.

International Financial Support

The fourth element underpinning Mexico’s economic recovery is the form and extent of support that Mexico received from the international financial community. Since 1982, international financial support has been a critical aspect of the adjustment strategy. During 1982–87, there was increased coordination between Mexico and its international financial creditors with a strategy of striking an appropriate balance between concerted financing, debt rescheduling, and macroeconomic adjustment. Concern about the impact of the external debt burden led in 1989 to support from the international financial community that emphasized debt and debt-service reduction.

During 1982–87, Mexico undertook repeated rescheduling of debt-service obligations to both commercial banks and official bilateral creditors, in the context of adjustment programs aimed at macroeconomic stabilization.19 However, Mexico’s external debt grew from some $75 billion (45 percent of GDP) at the end of 1981 to $101 billion (57 percent of GDP) by the end of 1988. Of this amount, public sector external debt increased from some $53 billion at the end of 1981 to $86 billion by the end of 1988. Reflecting this increase, public sector debt service, before rescheduling, reached 77 percent of exports of goods, services, and transfers (46 percent, after rescheduling) in 1988, while there was a net resource transfer abroad equivalent to 3½ percent of GDP.20

A crucial element in support of the present economic program is the backing of the international financial community and official donors with an emphasis on reducing Mexico’s debt overhang.21 The Fund approved a three-year extended arrangement with Mexico in May 1989 for the amount of SDR 2.8 billion (equivalent to about $3.6 billion). Some SDR 800 million of the initial access under the arrangement was set aside for support for debt and debt-service-reduction operations and the amount of the arrangement was subsequently augmented by SDR 466 million (about $600 million) for this purpose.

Shortly after the approval of the Fund arrangement, the Paris Club creditors agreed to reschedule $2.6 billion of Mexico’s debt-service obligations on official debt falling due in the next three years. In June 1989, the International Bank for Reconstruction and Development (IBRD) approved sectoral loans to Mexico amounting to almost $2 billion (of which $760 million was ear-marked for debt and debt-service-reduction operations) and agreed to provide additional loans averaging $2 billion during the subsequent three years. In January 1990, the IBRD approved an additional $1.3 billion for financing debt and debt-service operations.

In support of their program, the authorities also asked for a multiyear financing package with commercial banks, which would involve debt and debt-service-reduction operations sufficient to produce a substantial decline in the country’s external debt. Negotiations were initiated with the commercial banks in April 1989; an agreement in principle was reached in July of that year; and the exchange of instruments under the agreement took place in March, 1990.22

The direct impact of the package on Mexico’s balance of payments has been to reduce interest obligations. On the basis of international interest rates prevailing during 1990, the gross saving on account of the bond exchanges amounted to some $1½ billion annually. After taking into account the cost of the collateral, the annual net saving on contractual interest amounts to around $¾ billion. More broadly, this operation has contributed to a decline in total public sector external debt service (after accounting for rescheduling) to an estimated 28 percent of exports of goods, services, and transfers in 1991 from 46 percent in 1988. The net resource transfer moved from an outflow of $6 billion in 1988 to an estimated inflow of $4 billion in 1991.

During this period, Mexico’s total external debt declined from 57 percent of GDP in 1988 to an estimated 39 percent of GDP in 1991, with public sector external debt declining from 49 percent of GDP to 31 percent of GDP. This decline in external debt and debt service has contributed importantly to the improved confidence in the economy and has been reflected in Mexico’s return to a voluntary access to foreign capital.

Insulating the Economy from Unexpected External Shocks

The authorities attached great importance to insulating their program from possible adverse shocks. Since the mid-1980s, they have taken progressive actions to minimize the risk of failure in achieving sustainable economic growth. The strategy has included prearranging external assistance to compensate for unexpected events, while adjusting economic policies, saving windfall gains resulting from favorable exogenous shocks, and restructuring the economy to minimize the impact of future shocks.

The strategy of arranging contingencies for possible future events was adopted in Mexico’s 1986–87 stand-by arrangement with the Fund. The program used a mechanism that linked some of the program targets and the amount of the required external financing package to the evolution of international oil prices. Under this mechanism, additional external financing was available if the price of oil dropped below a certain point; moreover, beyond a certain decline in the price of oil, adjustment in domestic policies would also help fill the emerging gap. The 1986–87 stand-by arrangement also contained a mechanism that allowed for increased external financing for public sector investment in selected projects if the Mexican economy did not grow by the targeted amount.

The strategy of insulating the economy from external shocks was further developed in Mexico’s 1989–92 extended Fund arrangement. In the 1989 economic program, the contingency mechanism was broadened to include possible adverse movements in both the evolution of international oil prices and interest rates. A combination of a decline in international oil prices and an increase in international interest rates would be met by a mixture of additional economic adjustment measures and some drawdown in net international reserves. In the 1990 and 1991 economic programs under the extended arrangement, the evolution of international interest rates was excluded from the mechanism because of the reduced sensitivity of the Mexican balance of payments to these movements. In both years, a decline in the price of oil beyond a certain threshold point would trigger automatically a full adjustment in economic policies.

The concept of saving windfall gains resulting from favorable external events also was first introduced in the 1986–87 stand-by arrangement with the Fund. Through the above-mentioned link between economic targets and the evolution of international oil prices, higher-than-anticipated prices beyond a certain threshold point resulted in a larger accumulation of net international reserves and less permissible domestic financing for the public sector deficit. This strategy was continued in the 1989–92 extended Fund arrangement, with a total saving of wind-fall gains from oil prices (and international interest rates in the 1989 economic program) above a certain threshold point. Moreover, the 1991 economic program provided for relevant quantitative performance criteria to be adjusted for the proceeds from the sale of public sector enterprises. In effect, at least 85 percent of these proceeds would be used to increase net international reserves or reduce external or domestic debt.

The authorities have placed considerable emphasis on managing the country’s economic and financial structure to reduce the impact of future adverse shocks. The impact of lower international oil prices has been reduced with the diversification of the export base (nonpetroleum exports have grown from 25 percent of the total in 1982 to an estimated 75 percent of the total in 1991). More recently, the possible impact of a recession in one of Mexico’s trading partners has been reduced by the diversification of the destination for Mexico’s exports (the share of exports to the United States declined from 76 percent in 1990 to an estimated 70 percent in 1991). Also, the possible impact of higher international interest rates has been reduced significantly by the results of the 1990 financial package with commercial banks. Finally, the authorities have engaged actively in the use of financial options (the use of puts and calls in the options market for oil) to minimize the impact of possible fluctuations in the price of oil on the Mexican economy.

Conclusion

Mexico introduced an economic program in December 1987, which was broadened in late 1988, to reduce inflation and foster conditions for sustained economic growth in the context of a strengthening of the balance of payments. The comprehensive strategy pursued by the authorities has been carefully planned and implemented. It is critical to the strategy’s success that it includes strict control of the public finances and credit aggregates, a broad-based structural reform, an incomes policy, innovative support from the international financial community, and the allowance of sufficient margin in the application of economic policies to absorb external exogenous shocks.

In May 1989, the authorities presented the country’s medium-term objectives for the period 1989–94. This plan set out to achieve a sustained economic recovery, with the growth of real GDP gradually increasing to an annual rate of close to 6 percent by the end of the period; a reduction in the rate of inflation to international levels, or close to 5 percent by the end of the period; and, equilibrium in the balance of payments. The plan projected the fiscal effort at the level of the primary balance consistent with these targets at a surplus of around 6½ percent of GDP during 1989–91 and 5 percent of GDP during 1992–94.

The authorities have made good use of this frame-work, adjusting economic policy as required to ensure success. These efforts have produced a significant reduction in the rate of inflation, a sustained pickup in the rate of growth of output, and the strengthening of Mexico’s foreign reserve position, while modernizing the economy and improving social policies. The authorities’ approach has sought to incorporate the interests of all segments of the Mexican population, reducing the costs of economic adjustment and gaining the confidence of the private sector. This strategy has turned the vicious cycle that existed during 1982–88 between large fiscal deficits and high inflation and interest rates into a virtuous cycle. Recently, this has allowed some real increase in government current and capital expenditure consistent with continued fiscal adjustment at the level of the PSBR and operational balance.

The success of Mexico’s economic strategy since 1989 has led to its gradually regaining access to voluntary international capital market financing after having been virtually excluded for much of the decade. This private sector access to capital, in combination with Mexico’s broad economic reform, augurs well for the achievement of sustainable economic growth in the medium term.

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1

Data for 1991 in this section are from Bank of Mexico, Informe Anual, 1991. Fiscal data exclude proceeds from the privatization of public enterprises.

2

The period of “Stabilizing Development” included the presidencies of Adolfo Lopez Mateos (1958-64) and Gustavo Diaz Ordaz (1964-70). See James Capel and Co. (1991) for a summary of political developments in Mexico.

3

Beginning in the mid-1950s, Mexico started to increase nominal tariff levels and to impose quantitative import restrictions and domestic price controls. The “inwardness” of Mexico’s industrial growth is contrasted with the “outward” policies of Korea and Taiwan Province of China in Lustig (1991).

4

See Lustig (1991) for a description of the relative importance of the supply factors of production and productivity changes on economic growth

5

The period of “shared development” was introduced by President Luis Echeverria Alvarez.

6

The high inflation rate that prevailed during much of the 1980s and the large outstanding stock of domestic debt complicated the assessment of fiscal policy. The Mexican authorities employed several measures of fiscal performance to deal with this problem. The traditional measure of fiscal performance is the PSBR, which measures the difference between total expenditure and revenue of the nonfinancial public sector. In an environment of high inflation, the concept of the PSBR contains a large element of debt amortization in its interest component. Thus, the concept of the operational balance is also employed, which corrects for this component. The operational balance was derived by subtracting from the overall balance the inflationary component of interest payments on the internal public debt denominated in Mexican currency and thus measures the inflation adjusted savings-investment balance of the public sector; this measure provides the best association, in conjunction with the savings-investment balance of the private sector, with the external current account balance. The operational balance also measures movements in the real stock of public sector debt. Finally, to assess the fiscal effort resulting from measures being implemented, the concept of the primary balance is employed. The primary balance can be viewed as an intermediate fiscal target and is defined as the overall balance, excluding all interest payments.

7

José López Portillo took over the office of the presidency from Luis Echeverria Alvarez.

8

The elements of the authorities’ adjustment effort following the 1982 debt crisis are reviewed in Kalter and Khor (1990).

9

Given the managed exchanged rate policy used by the Mexican authorities since 1982, monetary policy is largely ineffective in influencing prices and output; rather, for a given fiscal policy, monetary policy affects the domestic and foreign component of the total money supply. See Section III for an analysis of the respective role of fiscal, monetary, and exchange rate policy in meeting economic objectives in Mexico since 1982. It is concluded that fiscal policy was central in achieving the authorities’ macroeconomic objectives.

11

Total domestic debt including that held by the central bank was equivalent to 25 percent of GDP; while excluding that held by the central bank, it was only 4 percent of GDP.

12

As shown by Sargent and Wallace (1981), the effect on inflation of financing a fiscal deficit by bonds, instead of money creation, can be ambiguous. More specifically, it is possible for inflation to increase in response to lower money creation today, in anticipation of higher money creation tomorrow.

13

Nevertheless, higher private sector investment has been the main source of increased economic activity.

14

There were small adjustments to the exchange rate and wages early in the year.

15

The latest extension of the wage-price pact was announced on November 10, 1991. Actions included (1) a slower pace of depreciation of the peso with respect to the U.S. dollar, from an annual rate of 5 percent to 2½ percent; (2) an increase in minimum wages of 12 percent; (3) a lowering of the value-added tax to 10 percent from 15 percent (from 20 percent for some luxury items); (4) increases in the price of petroleum products of up to 55 percent; and (5) an increase in the price of electricity for home and industrial use of around 15 percent.

16

See Cline (1991), p. 14.

17

See Section IV. In addition to commitments to reduce tariffs and phase out quantitative restrictions, Mexico signed the GATT codes on licensing procedures, antidumping, customs valuation, and technical barriers to trade. In a number of instances, Mexico moved beyond its commitments in the context of the GATT.

19

See Section VI for an analysis of the evolution of Mexico’s approach to commercial bank debt restructuring since the 1982 debt crisis.

20

The net resource transfer is defined as the balance of goods and non-factor services.

21

These features of the backing by the international financial community are discussed in Kalter and Khor (1990).

22

The main features and results of the financing package are discussed in El-Erian (1991a).

The Strategy to Achieve Sustained Economic Growth