All Mexico Needs Now Is Good-Faith Investors : Debt Deal Already Shows a Ripple Effect

Mexico’s recently concluded agreement with its commercial bank creditors is no panacea for the country’s economic problems, and President Carlos Salinas de Gortari may have oversold it for domestic political gain. But in focusing on the large discrepancy between the Mexicans’ initial negotiating position and the final outcome, critics have underestimated the deal’s significant economic payoffs for Mexico.

The most important short-term consequence of the agreement has been a sharp drop in the interest rate paid by the Mexican government on its internal debt, from 56% in June to 34% at present. With the resulting savings, equivalent to 4% of total gross domestic product, Salinas should be able to hold the public-sector deficit to 8% of GDP in 1989, and to reduce it to 4% next year, without another round of socially painful and politically debilitating austerity measures.

Public-deficit reduction on that scale will diminish the danger of a new inflationary spiral as Mexico’s economy begins to grow again. We can expect inflation--now running at 17% per year--to continue dropping as the government deficit is pared. Moreover, to the extent that high real interest rates have deterred productive investment by Mexico’s private sector in recent years, this impediment to economic recovery should also be removed.

There is still considerable uncertainty about how much interest-payment relief and new money will ultimately result from the deal. However, under plausible assumptions about which of the three options offered under the agreement will be chosen by each of Mexico’s 500 creditor banks, Mexico’s net transfer of resources abroad will be reduced by $1.5 billion per year. This amount is equal to an oil-price increase of more than $3 per barrel, or more than half of Mexico’s net annual earnings from tourism.

Should Mexico have held out for a better deal from its commercial bank creditors, and what could have been done to achieve it? It is now known that in the last stage of the negotiations the Salinas government went to the brink with the banks, setting a two-day limit for concluding an agreement and threatening to take “other courses of action” if that deadline were not met. Salinas’ well-known propensity to take large risks in pursuit of his key objectives undoubtedly lent credibility to the threat of a suspension or unilateral reduction of external debt service.

It is by no means clear that, in the absence of much stronger pressure on the banks than the Bush Administration apparently was willing to apply, Mexico could have achieved much more from this extremely difficult and protracted negotiation. By contrast, it is certain that Mexico’s incipient economic reactivation of 1989 and the stronger hoped-for recovery of 1990 would have been jeopardized by failure to reach an agreement with the banks in the second half of this year.

The internal political clock was also running strongly against further delay. The July, 1991, mid-term elections will be another watershed in Mexico’s transition to a more competitive political system. The ruling party’s control of the federal legislature will be at stake, as will Salinas’ project to reform and modernize the party. The government is also finding it increasingly difficult to maintain labor peace after more than eight years of declining real wages. A necessary--though by no means sufficient--condition of success on all of these fronts is a growing economy with price stability, and the foundation for such an economic recovery must be laid this year.

Much now depends on the behavior of Mexico’s private sector. Those businessmen who have long complained about the cloud of uncertainty hanging over the economy due to the lack of a debt deal no longer have that pretext for withholding new investments. Salinas’ debt deal, combined with new tax regulations that encourage the return of flight capital, has put the ball back into their court.

The Salinas administration is counting heavily on the psychological multiplier effect of getting an agreement to compensate for the lack of more substantial debt relief. There had been widespread skepticism that Salinas would be able to wrest significant concessions from the foreign bankers. Many Mexicans holding flight capital in U.S. accounts and big corporate investors in Mexico and abroad will remain skeptical, until they are convinced by the final numbers and by a clear and consistent turnaround in macroeconomic indicators. Already, however, some confidence seems to have been restored. More than $800 million in flight capital has returned to Mexico, either since the debt agreement was struck or in the days immediately preceding it, and new investments by transnational corporations totaling more than $1.8 billion have been announced.

The foreign bankers’ none-too-generous treatment of their “model debtor” country has done little to inspire confidence in the applicability elsewhere of U.S. Treasury Secretary Nicholas Brady’s plan for defusing the Latin American debt crisis. But within Mexico, the modest relief that the banks reluctantly granted can serve as the catalyst for repairing the immense damage that seven years of debt-induced recession and government austerity have wrought.