Chapter 11 for Mexico

Mexico may weather its latest economic storm. But the rescue package that will prevent Mexico’s defaulting on its $97-billion foreign debt this year postpones the crisis without erasing it. Longer-term measures are in order.

The rescue was led by Paul A. Volcker, chairman of the U.S. Federal Reserve Board, and Jesus Silva Herzog, Mexico’s finance minister. The two are not only close friends but are also probably the only ones who could have put the package together.

As he had in August, 1982, Volcker intervened when it became clear that Mexico and its creditors could not agree on a debt extension. Silva Herzog and Mexican President Miguel de la Madrid were warning that the alternative was for Mexico to stop debt payments for a time, despite the unsettling effect that this would have on the world economy. The creditors thought that Mexico was bluffing; Volcker did not. Flying to Mexico City, he laid the groundwork with Silva Herzog for $6 billion in new loans from a pool of the International Monetary Fund, the World Bank, the Paris Club of national banks, the Japanese government and commercial banks.

The money will pay most of Mexico’s interest this year. In exchange, Mexico agreed to press economic reforms that the IMF thinks are needed to shore up Mexico’s economy: cuts in Mexico’s domestic budget deficit, expansion of opportunities for foreign investment in Mexico and the sale of state-owned enterprises to private buyers.

But Mexico has made such promises before, only to be overtaken by events. In 1984 and 1985 the country promised to try to reduce its deficit from 10% of the gross domestic product to 5%. Then came the dramatic drop in world oil prices that wiped out billions of dollars in revenue. Mexicans with capital, alarmed by their economy’s nose dive, continued to sneak money needed for investment out of the country and into bank accounts in the United States. Despite its promises and good intentions, Mexico’s deficit now stands at 12% of the gross product.

Volcker and Silva Herzog have turned the trick once more, but it may be the last time that it can be done with traditional methods. Mexico must think now in terms not of rescue but of rehabilitation along the economic ground rules of the IMF.

The changes that the IMF wants will require fundamental shifts in Mexico’s economic and political systems, which have been closely linked since Mexico adopted its constitution in 1917. Changes in such a longstanding system cannot be made abruptly without risking economic and political upheaval. Mexico should not be asked to bear all the risk of dramatic change. The international financial community, which insists on the new directions, should share the risk by providing a cushion for change. One way to do that would be to allow Mexico to declare a “conciliatory default.” In that way the banks could treat Mexico like a private company that files for a Chapter 11 bankruptcy, allowing it time to reorganize, to write off some of its debt, in effect to start over.

The process would not have to be called a default of any kind. The Mexicans and their bankers could call it anything that they wanted to as long as the act itself gave the Mexican people renewed confidence in their economy and government. A quiet default would especially help the average Mexicans suffering through an austerity program so harsh that their standard of living has been cut to what it was 25 years ago.

A conciliatory default would give the Mexican economy years of breathing space rather than a few weeks or months. If default seems out of the question, the world banking community must look for alternatives. The most likely alternative is that if the pressure stays on in Mexico, the nation may very well collapse into total default. That should make a soft default look good.