Mexico Interest Rates Soar; Investors Continue to Flee

Investors repudiated Mexico’s economic austerity program on Wednesday, pushing interest rates above 90% on some bonds and deserting the peso in a response that threatened further economic collapse.

The government had to offer the astronomical interest rates to get investors--chiefly foreign--to buy its bellwether bonds at auction. And even at those rates, many investors chose to take their money out of the country.

The latest rates are expected to drive interest charges on home mortgages, business loans and consumer credit--which are tied to the government bonds--above 100%.

Interest rates on the 28-day cetes, as the bonds are called, reached 82.38%--nearly 25 points above last week and a seven-year high. The auction of 14-day cetes, the first time those bonds have been offered since 1989, produced interest rates of 92.5%.

Although government officials had warned Mexicans not to expect that last year’s level of international investment would return soon, they were still not prepared for the overwhelmingly negative reaction to the first auction of government bonds since the austerity program was announced.

“We have the backing of President Clinton,” one frustrated government economist said. “We have the backing of the International Monetary Fund. What more do they want?”

The continued flight of capital is a setback not only for President Ernesto Zedillo’s austerity program but could further undercut support for President Clinton’s $20-billion bailout plan, which is under fire in Congress.

The austerity program offered March 9 ordered deep cuts in government spending, tax increases and big hikes in the price of gasoline and electricity. It also projected an annual inflation rate of 42%.

The government had hoped that tighter credit and resulting higher interest rates would persuade investors to accept the risk of leaving their money in Mexico.

But despite the high interest rates, designed to keep international capital in this country, pesos were sold off, forcing the currency as low as 7.33 pesos to the dollar before the rate closed at 6.93, down 32 centavos.

The peso’s volatility helped fuel Wednesday’s surge in interest rates.

Investors would not even consider Mexican investments without the higher rates. Lawrence Goodman of Salomon Bros. in New York noted that even though cetes were paying 90% in annual interest, the bonds are held for only 14 days--meaning investors’ return for the period is just 2%. And that could be more than wiped out by steep declines in the peso over the same period.

“When there are swings in the peso far in excess of that in a single day, the risk-return trade-off is not there,” he said.

While the interest rates were not enough to keep money in Mexico, they were enough to have dire consequences for the economy.

The higher cetes rates, for example, seemed sure to worsen the already bulging bad-loan portfolios of Mexican banks as debtors are unable to make payments.

Despite Wednesday’s events, the Mexican Stock Exchange index posted a 20.66-point gain, or 1.3%, closing at 1,611.73.

The stock market was riding a wave of gains in Latin American stocks, and higher interest rates had already been factored in, Goodman said.

Other analysts are becoming worried about the political impact of the higher rates, particularly if they do not stabilize the economy.

Anger at banks and brokerages has grown to the point that the Mexican Stock Exchange building has been closed to the public because of security concerns.

Holders of government debt--largely foreign investors--and Mexico’s commercial banks will be the main beneficiaries of the U.S. rescue package arranged by Clinton, according to Finance Ministry documents.

The documents show that the money will be used to buy back dollar-backed government bonds called tesobonos and to restructure capital-short banks. That package imposes many of the harshest conditions of the economic austerity program.

Because Zedillo had touted the rescue package as a way to exchange short-term debt for long-term debt, the offering of 14-day bonds--a reminder of a bygone crisis--raised eyebrows.

Mexico had offered 14-day bonds during the debt crisis of the 1980s as a way to attract money to finance the federal budget deficit.

Dropping the short-term bonds in 1989 was a sign that government spending was under control.

Reviving the short-term bonds when the government is running a budget surplus--as Mexico is still doing, despite its huge trade deficit--was a major concession to investors.

* UNPOPULAR PLAN: Most Californians oppose U.S. aid package to Mexico. D1