MEXICO’S FINANCIAL CRISIS : NAFTA buoyed Mexican business and consumers. But now the : OPTIMISM IS FADING

Aurora Cruz is the embodiment of the post-NAFTA North American citizen. Or she was until three weeks ago, when the peso plunged.

Weekdays she works as a quality control inspector at a Mexican garment shop that exports blue jeans to the United States. Each weekend she would fill her shopping cart with imported goods at the Wal-Mart down the street from the factory.

Cruz’s new free-trade lifestyle, and that of countless other Mexican consumers and workers, has been rudely interrupted by the fiscal crisis that hit their country in the days before Christmas.

Today, the shelves at Wal-Mart and other import-oriented stores are nearly bare, picked clean by Christmas shoppers grabbing all the imported goods they could before the peso devaluation caused prices to go up.

And the goods that remain?

“We went to Home Mart and they have ‘sold’ signs on all the products,” said Rafael Martinez, a 43-year-old engineer.

“They won’t sell to you (because they intend) to raise the prices later,” added his wife, Ana Lorena Gonzalez, 36.

Although the North American Free Trade Agreement did not cause the peso crisis, its promises of stability and prosperity for the Mexican people helped create the euphoria that led to the current problem.

The long-term promise of NAFTA dwarfs today’s dislocation--and should also shorten its duration.

But as Mexicans stare ahead at months or years of double-digit inflation and reduced earning power, the first blush of NAFTA has turned pale. And the confidence it bred and capitalized on is nowhere to be seen.

For Mexicans such as Cruz, a slim 25-year-old with Orphan Annie curls and a ready smile, NAFTA had meant a big change in lifestyle. She and her fellow workers at Yale, a 42-year-old garment factory in the industrial suburb of Iztapalapa, had become part of the international work force.

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NAFTA not only had slashed already low Mexican import tariffs to bring more foreign goods into the country, it had encouraged businesses to open new factories and hire more people who then could start buying those imported products.

At the same time, Mexican manufacturers such as Yale--facing new foreign competition--were forced to modernize. And that often meant buying costly foreign-built machinery for their plants and components for their products.

Some of the changes in the ways Mexicans such as Cruz and firms such as Yale began to live and work--with government encouragement--contributed to the currency crisis that has sent the peso plummeting 40% since Dec. 20. Between them, Yale and Cruz contributed to the surge in sales of imports at all levels, from consumer goods to capital equipment.

Ironically, that surge reflected domestic and international confidence in Mexico as a country worthy of investment--confidence that, given training and time, Mexican labor could make world-class goods at jobs that would pay enough to improve their living standard.

The phenomenon was multiplied among workers and manufacturers throughout Mexico. And, as money rushed out of Mexico to the countries producing the goods Mexican citizens and companies were buying, a yawning trade gap left Mexico critically dependent on foreign investment.

The post-NAFTA economy needed international investors to pour record amounts of money into capital-hungry Mexico, investments that would buy the country time until potential exporters such as Yale could begin selling enough abroad to pay for all the imports.

Yet, just as NAFTA aggravated the trade deficit, it also helped to attract the foreign investment to offset the gap: The trade pact built investor confidence that Mexico’s free-market economic reform would continue.

“Foreign investment is largely attributed to NAFTA and to anticipation of NAFTA,” said Mauro Leos, vice president of CIMEX-WEFA, a Philadelphia economics firm that studies Mexico. “It attracted additional investment that helped to finance the growing trade deficit.”

At the time, many economists warned that those funds were highly liquid. They were proven right early last year, when domestic turmoil--in the forms of Indian unrest and political assassinations--prompted nervous investors to start pulling their money out of Mexico.

By last month, just weeks into Ernesto Zedillo’s presidency, the outflow of funds had become a hemorrhage and the trade deficit was unsustainable, putting pressure on the peso that resulted in its devaluation.

“You cannot put the blame on NAFTA, but imports increased more than they would have because of it,” said Leos.

Yet NAFTA supporters say Mexico’s currency crisis would have been far worse without the trade agreement. Ultimately, they say, the free-trade climate that fosters direct investment in plants that can export goods to the world is the best solution for Mexico.

That had already begun to happen in NAFTA’s first year, these analysts point out.

Since NAFTA, Mexico’s sales to the United States have risen at a 22% clip--twice as fast as American imports from the rest of the world. In fact, Mexico may overtake Japan as the second-largest U.S. trading partner after Canada.

And it’s useful to have partners. The NAFTA partners were the first to offer standby loans that turned into an $18-billion emergency package from international lenders to support the peso through its crisis.

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To understand the letdown the peso crisis has caused, one must understand what NAFTA has wrought in just a year’s time, in fact and in expectations.

The stores, for example.

Before the crisis, the long-awaited free-trade pact had made Mexico a “retail market of opportunity,” as one analyst put it. U.S. retailers such as Wal-Mart were encouraged to build large stores in Mexico and to stock their shelves with products from all over the world. The new stores had broader selections and lower prices than many Mexican retailers could offer.

For the U.S.-based retailers, the lure of lower tariffs was equaled or exceeded by favorable demographics, noted J. P. Morgan Securities analyst Debra Wang Smith: “In Mexico, 37% of the population is under the age of 14, and an impressive 59% of the population falls between the ages of 15 and 64.”

Mexico veterans Sears, Roebuck & Co. and F. W. Woolworth Corp. changed their formats to offer more imported goods. They were joined by Price Club and Home Depot, which recently opened stores near the capital. Dillard’s Department Stores, Office Depot and Saks Fifth Avenue are scheduled to open outlets next year.

Though Wal-Mart says the peso crisis could slow its planned expansion, none of the retailers announced cutbacks because of it. However, working-class Mexicans such as Cruz who happily took their business to the new U.S.-owned stores with their wide aisles, vast selections of goods, friendly clerks and free parking lots may find they can no longer afford to shop in them.

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The reasons are two: The prices of U.S. products in pesos have risen about 40% and wages will be severely eroded by inflation. What is expected, in effect, is a 9% pay cut.

Before the devaluation, machine operators at Yale said that they took home between $76 and $85 a week, depending on their skills. Their take-home pay will be reduced, in effect, to a maximum of $55--assuming a promised 7% raise in the face of 15% inflation.

And what of Yale, whose joint venture supplying garments to J.C. Penney Co. was driven by NAFTA’s promise?

It is here that the Zedillo government’s rescue plan is supposed to take root, by making the products of companies like Yale more competitive abroad. Indeed, Yale should see a 40% surge in profits from its exports to the United States, just based on the peso-dollar reversal.

But that heady increase, just like wages, will be deeply eroded by the steep inflation now forecast. Meanwhile, the prices the company pays for foreign-made equipment--machinery it needs to become more efficient--will also rise, along with the interest rates on the money borrowed to buy it.

That contrasts sharply with the promise that the company believed NAFTA offered.

Before NAFTA, Mexico--like the rest of the world--was subject to quotas assigned to countries under the Multi-Fiber Agreement, which limited the amount of clothing they could sell to the United States. Those limits were a constant source of friction between Washington and Mexico City, since Mexico was allowed to send to the American market less clothing than many small Caribbean nations.

Under NAFTA, Canada and Mexico are exempt from such quotas. Any Mexican garment maker can sell products in unlimited quantities in the United States, as long as someone is willing to buy them.

Yale’s executives realized they needed help reaching the international market. The company had no export experience and had never even applied for a share of Mexico’s export quota. The family company had grown into a $90-million business with three factories by manufacturing for the domestic market under license from well known U.S. firms such as Lee and Union Bay, as well as by selling its own brands.

When NAFTA was passed, Yale president Mateo Beja, a 38-year-old Wharton School graduate, hired an import-export director. Steven Nar, born in Panama and raised in Florida, set about turning Yale into an international garment company.

“Mexicans are used to making $5 on a pair of pants while U.S. companies expect (to pay) a $1 profit,” said Nar. “They are coming in with orders for huge quantities. We, as an industry, are accustomed to production runs of 200 dozen. They want 200,000 dozen.”

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Despite those difficulties, Yale has begun exporting for Union Bay and has landed contracts from Gloria Vanderbilt and J. C. Penney. Last year, Yale stitched 40,000 pairs of Penney’s house brand Hunt Club jeans. Next year’s order is half a million pairs. Yale also is negotiating with Esprit and Bill Blass.

But Yale, like many manufacturers, in order to export first had to import. Getting the new business has required more sophisticated equipment, new work procedures and new factories in both the United States and Mexico, all of which demanded--and will continue to demand--major investment.

In order to meet J. C. Penney’s standards, Yale had to update its laboratory. For example, it bought an expensive machine to test materials for color fastness. Previously, workers had just rubbed the cloth by hand to see whether it faded. The company has ordered other new cutting and stitching machinery from Europe, Asia and the United States.

Such purchases across all industries became a significant factor in the dreaded trade deficit. And the imports represent a major investment for firms like Yale, which the Mexican manufacturers financed in part with bank loans.

Now, Mexican banks that made those loans are worried their customers will not be able to pay them back, said Jose Madariaga, president of the Mexican Bankers Assn. Measures taken to control inflation stemming from the devaluation virtually guarantee higher interest rates for already strapped companies.

What the tighter credit policies will mean for Yale’s plan to fill 1,500 new jobs in its Tlaxcala factory, 70 miles from the capital, is not yet clear. Yale had planned to build its own laundry facility to control the quality of the wash--a crucial step in turning out jeans.

And, while the government’s stabilization plan aims to attract still more foreign manufacturing investments, each deal and each industry is affected differently by the peso devaluation.

U.S. sneaker maker Nike, which has been sending shoes to Mexico from Asia, last week announced that the peso’s fall has prompted it to start producing shoes in Mexico. That foreign investment and those jobs for Mexicans are direct payoffs of the devaluation.

Similarly, IBM Mexico announced a $26-million investment in a new Mexican headquarters building in the fashionable Santa Fe commercial and office complex on the fringes of the capital.

But it works both ways.

Mexican truck maker Dina and Italy’s Fiat Spa announced last week that they are reconsidering their $100-million joint plan to build the Fiat Uno subcompact auto in Mexico. The companies said that with the sharp decline in the peso, the Uno’s price might not be competitive because it would contain many imported parts.

The question that remains is whether the portions of the Mexican economic rescue package meant to lure back foreign investment will be as successful as NAFTA was at attracting capital.

Still, Zedillo’s rescue plan generally follows the free-market spirit of NAFTA.

NAFTA’s relaxation of foreign investment laws and trade restrictions, for example, attracted the biggest names in U.S. and foreign banking. Ten U.S. corporations--including American Express and First Chicago--are among the first 17 foreign firms allowed to establish financial subsidiaries in Mexico.

Under Zedillo’s emergency plan, that process will be liberalized further. Nor does the crisis seem to have frightened off the banks: Chase Manhattan Corp. says it will open its first full-service Mexican office Monday, as scheduled.

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Meanwhile, other sectors where foreign investment is now prohibited or strictly limited--railroads, ports, airports, satellites, telephones and others--also will be opened in an attempt to attract investment, according to the government plan announced last week.

But for workers and consumers such as Cruz, the new message is more like medicine than the celebration that followed the advent of NAFTA.

“Mexico’s development demands that we recognize realistically that we are not a rich country, but a nation with serious needs and shortages,” Zedillo said in his televised address announcing the plan.

“Let us realize that our reality, and even more so the present circumstances, make it essential for us to concentrate on our efforts and on savings. This task imposes greater responsibility on those of us who are better off.”