Mexico Hikes Rate of Interest to 49.7% : Economy: Move heightens fear that conditions of U.S. bailout deal will lead to recession. Government says drastic step is necessary to bolster peso, lure investment.

The Central Bank on Monday suddenly boosted interest rates to almost 50%, driving down the Mexican stock market and confirming fears here that a $20-billion bailout the government is about to sign with the United States is tied to restrictions that will fuel a recession in Mexico this year and compound President Ernesto Zedillo’s political problems.

The bank’s short-term interest rates were almost 10% higher than those set last week at the weekly treasury bill auction.

But officials defended the drastic measure as one in a series of steps to strengthen the nation’s currency, which gained in value against the dollar after the government applied the bitter medicine.

The peso, which has lost about 40% of its value in two months, closed Monday at 5.59 to the dollar after trading at more than 6.0 at the peak of last week’s slide.

But the stock market took a nose dive. Amid fears that soaring credit costs will push more Mexican companies into default and bankruptcy and further reduce lagging consumer demand, the Bolsa fell 64 points, or 3.51%, closing at 1,766. That was a 19-month low.

Zedillo’s economic advisers said they expect sharply higher interest rates to help lure back billions of dollars in foreign investment that fled Mexico’s political uncertainty and a looming guerrilla war in the southern state of Chiapas in the past two months. The massive capital flight has triggered the nation’s worst economic crisis in more than a decade.

Monday’s drastic interest-rate increase--the Central Bank offered three-day treasury bills yielding 49.75% interest, up from 39% to 40% last week--appeared to be aimed as much at helping finalize negotiations on the U.S-Mexico credit package as it was meant to help stabilize the battered peso, most independent analysts concluded.

In Washington, negotiations continued through a fifth day Monday between Treasury Secretary Robert E. Rubin and Mexican Treasury Minister Guillermo Ortiz on a proposal for the United States to provide Mexico with $20 billion in loans and loan guarantees.

U.S. Treasury officials refused to discuss the talks.

But White House Press Secretary Mike McCurry said officials “have been making progress toward finalizing the economic support package.” A final agreement could be announced as early as today.

Clinton Administration officials have said they are seeking guarantees that Mexico will take steps to curtail the growth of its money supply and that Mexican oil revenues will be diverted to the United States if Mexico defaults on the bailout plan.

The Administration’s insistence on a tighter money supply has contributed to the sort of politically risky increases in interest rates announced in Mexico on Monday.

To guarantee U.S. access to Mexican oil revenues, Administration officials said they are proposing that receipts from foreign purchases of Mexican oil flow through an account at the Federal Reserve in New York before continuing to Mexico. In the event of default, the United States would simply stop forwarding the revenue, using it instead to pay back the Mexican loans.

Talk of restrictions on Mexico’s oil industry caused an explosion of nationalist fury when they became the subject of widespread speculation last month.

On Monday, Petroleos Mexicanos (Pemex) already was on the defensive.

The company, Mexico’s largest single source of foreign earnings, confirmed that future oil exports will be used as collateral for the U.S. credit package. Stressing that similar conditions have applied to past loans, Pemex added, “The Mexican government will maintain at all times the unrestricted freedom to administer the resources that come from our oil exports.”

But just two weeks ago, Pemex Director General Adrian Lajous Vargas conceded at a news conference here that most of this year’s revenue from oil sales will be applied to repaying the credit package, which totals about $50 billion. That includes the U.S. share and more loans from the International Monetary Fund and the Swiss-based International Bank of Settlements.

Besides its expected political fallout, the most immediate effect of Monday’s rate increase in this nation--where annual interest on automobile loans already has soared to more than 60%, where scores of small- and medium-sized businesses already have filed for bankruptcy and where annual inflation is running at an estimated 40%--is a recession. It could become a depression before it ends, analysts warned.

“This is scary,” said Jonathan E. Heath, an independent Mexico City economist. “A recession is already unavoidable.”

Rogelio Ramirez de la O, another independent analyst, called the interest rate hike a “gimmick” meant only to send a signal to U.S. Treasury Department negotiators that Mexico will take harsh steps to stabilize the peso. “I don’t think it will impress anybody. The question is not whether Banco de Mexico can raise interest rates, it’s whether they have a credible currency regime,” he said, adding that the new rates will push even greater numbers of already deeply indebted Mexican businesses into default.

Ramirez said he believes that the government has no intention of keeping interests rates at such high levels. “This had to be a last resort. It’s not a policy they can sustain,” he said. “It’s not more than a token. It’s only a short-term measure. They are playing this to the foreign investors and lenders to demonstrate that they are willing to get tough.”

He also suggested that without a credible new exchange-rate system, “the $20 billion will evaporate very quickly.”

In the final analysis, Ramirez and other financial experts concluded Monday, Mexico’s economic recovery hinges not on credit packages but on the public perception of Zedillo’s government and his policies. “All the money in the world won’t help unless people believe the situation is going to stabilize,” said Vladimiro Brailovsky, head of Economia Aplicada, a Mexico City-based consulting firm.

Times staff writer James Gerstenzang in Washington contributed to this report.