Download Chapter 25: Mexico: Part IV

CHAPTER 4:
THE DEBT CRISIS OF THE 1980s
In October, 1982, Mexico shocked the world by announcing that it could not pay the amount
due on its debt to foreigners (mostly foreign banks). This announcement signaled the beginning of
what has come to be called the "debt crisis". As noted in the previous chapter, Mexico's foreign
debt rose extremely rapidly after the mid-1970s. In 1977, the total foreign debt was about $34
billion. By 1988, it had reached about $110 billion (in proportion to GDP, this would be equivalent
to the United States owing foreigners about $3 trillion). Mexico was the second largest of the Third
World debtors, behind only Brazil. Throughout the 1980s, almost half of the earnings from
Mexican exports were needed just to make the payments on the debt, with most of this money
going for interest. Most large American commercial banks had loaned considerable amounts to
Mexico (nearly three-fourths of which was loaned to the Mexican government). Over time, the
banks were able to diversify their loans and thereby reduce their vulnerability to default by Mexico.
The "debt crisis" was a real threat to the solvency of the commercial banks in 1982; by the mid1980s, this was no longer true. The debt crisis led to a decade of severe economic depression in
Mexico, known as "la crisis". If nearly half of the export earnings were needed to pay Mexico's
obligations on its debt, not much can be left to pay for imports. To force the required reduction in
imports, the Mexican government, under the influence of the IMF, imposed a series of severe
austerity measures. These will be described below.
Living standards fell back to the level of the 1960s. To reverse this situation and generate
economic growth, there needed to be increased investment spending on new capital goods. (It was
estimated that, just to absorb all of the new workers coming into the labor force, Mexico's Real
GDP must grow at about 6% per year. Accomplishing this requires that 26% of GDP be spent on
investment in capital goods. In the 1980s, only 16% of GDP was spent on investment in capital
goods.) But the funds to pay for this investment spending in new capital goods were simply not
available.
How did Mexico get itself into this predicament? There are four major reasons that Mexico
borrowed so much money from the foreign banks. First, there was the desire of the government
to increase its spending on economic development and social programs in the l970s (this was
discussed in the last chapter). Since the government could not raise sufficient tax revenues, it had
to resort to borrowing for much of the money it desired. A second reason for the high amount of
borrowing was the oil boom. Much borrowing was done to raise money to develop the oil
industry. In its original projection, the Mexican government assumed that oil prices would be
stable at $25 to $30 per barrel (many people at the time were predicting that the price might
rise as high as $50). Had the price been stable, Mexico would have had sufficient revenues from
the sale of oil to pay its debt obligations. One major reason for Mexico's predicament was the
dramatic fall in the price of oil (reaching a low of about $10 in 1986 before rising to nearly $20).
A third reason for the substantial amount of borrowing by Mexico was the large amount of
capital flight. This was explained in the last chapter; to briefly review, it involved large-scale
speculation due to an overvalued peso and a "lack of confidence" in the government's ability to
control inflation. Mexican citizens would buy dollars from their banks, who would get them from
the Mexican central bank. The central bank, in turn, would borrow them from American
commercial banks. The cumulative amount of capital flight from Mexico was equal to at least
half of the entire foreign debt. It is important that so much of the foreign debt financed capital
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flight, rather than productive investment in capital goods. If one combined the assets held in the
United States by Mexican citizens with the debt to the United States banks by the Mexican
government, the debt problem for Mexico was relatively minor. But in order to be able to use these
assets to meet its debt obligations, the Mexican government had to find some way to reverse the
capital flight (i.e., encourage Mexican citizens to bring their money home). A fourth reason for
the large amount of foreign borrowing is that, in the late-l970s and early-l98Os, real interest
rates on loans from American banks were actually negative (i.e., the nominal rate was less than
the inflation rate). This means that, in terms of purchasing power, a person borrowing $100 would
pay back less the $100 borrowed. The second and fourth of these reasons support the view that
Mexico's borrowing was rational. Had oil prices and real interest rates stayed as they were when
the loans were negotiated, Mexico would have been able to manage its debt. On the other hand, the
first and third of these reasons were indications that Mexico was borrowing to cover some serious
problems with the populist polices of Etcheveria and Lopez Portillo. It is important to note that
Mexico seems to have gotten very little from all of its borrowing.
The view that Mexico's borrowing was rational, given what was known at the time, is supported
by the fact that the commercial banks were so willing to lend. There are five reasons that the banks
were so willing to lend. First, in the l970s, the price of oil rose over 700%. Oil transactions
are conducted mainly in dollars. Large amounts of dollars went into the oil-producing countries of
the Middle East, more than they could use domestically. These petrodollars, as they were called,
were then placed in accounts in American banks. The banks were literally awash with money to
lend. Second, there was a low desire to borrow those dollars in the United States. The United
States experienced a major recession in the mid-l970s and again from 1979 to 1983. It also
experienced record-high inflation rates. Given the economic instability in this period, businesses
and consumers were reluctant to borrow. As noted above, real interest rates in the United States
were negative for much of the 1970s. The banks needed new borrowers. Third, Mexican
borrowers would agree to accept "variable interest rates", rates which would adjust as world
interest rates changed. American borrowers would only accept fixed interest rates, which are
more risky for the banks. Fourth, the banks believed that the oil revenues would be more than
sufficient to enable Mexico to meet its debt obligations. This view was widely shared at the
time. Banks also believed that "a country could not actually fail", as a private business can. And
fifth, banks acted as syndicates in organizing the large-scale loans to Mexico. In this capacity,
they charged syndication fees. These fees were high enough to make the lending profitable even if
the loans themselves turned out to be less profitable than expected.
If Mexico's borrowing from the commercial banks seemed rational both to the Mexican
government and to the banks, what went wrong? At least four events occurred in the early 1980s
that were not expected. First, there was a dramatic fall in the price of oil. At this time, oil
accounted almost 70% of Mexico's exports and a large part of the government's revenues (since
Pemex was owned by the government). Second, beginning in 1979, there was a major recession
in the United States which spread to much of the world. In this recession, the countries affected
reduced their buying of everything, including goods produced in Mexico. Mexico's non-oil exports
fell considerably. Third, accompanying the U.S. recession, there were very high real interest
rates. Remember that Mexico had accepted "variable interest rates" on its borrowing. Therefore,
the amount Mexico required to meet its debt obligations rose. Fourth, Mexico experienced severe
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inflation, as noted in the previous chapter. This was the result of very high government spending
financed with money creation. Inflation created a situation in which the peso was overvalued
at the existing rate of 23 pesos equals $l. The overvalued peso led to a large rise in Mexican
imports, which reduced the amount of money Mexico had available to pay its debt. The
overvalued peso also led to a large amount of capital flight, with over $20 billion leaving Mexico in
18 months. Mexicans would buy dollars to "bet" that the peso would fall in value.
The "crisis" came in 1982 when the American commercial banks announced that they
would no longer lend to Mexico. The Mexican government reacted to the crisis first by
decreasing its investment spending and subsidies for energy and food products. It let the
peso "float", which led to a massive depreciation in its value. By the end of 1982, it took 148
pesos to buy $l, compared to the 23 pesos that had existed in 1981. Believing that high imports
were a cause of the problem, strict controls were put on imports. Also, believing that capital
flight by the wealthy was a cause of the problem, the government suspended convertibility of the
peso (one could not freely change pesos into dollars) and nationalized the Mexican private
commercial banks. These policies were short-lived however, as Mexico inaugurated a new
President in December of 1982.
President Miguel de la Madrid was both a technocrat and a neo-liberal (See the Appendix to the
last chapter). His neo-liberalism was reinforced by the policies of the IMF, who made the
implementation of neo-liberal policies the condition on which it would grant loans to Mexico. The
neo-liberal policies of the de la Madrid administration can be grouped into four categories:
changes in relative prices, a reduced public sector, trade liberalization, and austerity. The
main goals of these policies were reducing inflation and meeting the debt obligations. The goals of
economic growth and reduction of poverty were all but forgotten.
(1) The IMF was especially concerned with "getting the prices right". "True" relative prices
could only exist if prices were determined in "free markets". To generate freer markets, the
Mexican government considerably reduced subsidies on basic consumer products. For
example, subsidies for food fell by 80%. Gasoline prices doubled. The price to ride on the Mexico
City subway rose 2000%. The government also reduced its controls on exchange rates and on
interest rates. As a result, the peso depreciated from 148 pesos equals $1 in 1982 to over 3400
pesos equals $1 by 1993. And interest rates rose to over l00% in 1986 and 1987, before falling
somewhat. By raising the costs of importing and of borrowing, these changes are largely
responsible for the very high inflation rates.
(2) The neo-liberals also believed that a main cause of Mexico' s economic problems is the large,
bureaucratic, corrupt government sector. Thus, it is not surprising that the de la Madrid
administration acted to reduce the size of the government sector. Government expenditures were
cut significantly as a percent of GDP. This involved cutting government investment, social
programs, and the real wages of government employees. Also, many parastatal enterprises were
"privatized". Of the 1155 parastatal enterprises that existed in 1982, only 496 were still stateowned in 1988. Budget deficits as a percent of GDP fell as a result of these actions. The high
official deficits of the l980s were totally the result of the extra interest that had to be
paid to cover the inflation. Fiscal policies in the l980s had the effect of reducing total spending,
thereby making the recession worse.
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(3) On international matters, the neo-liberal position stressed "free trade" and "export
oriented industrialization". The second term means that economic growth is to be led by
increases in exports. To achieve freer trade, the de la Madrid administration substantially reduced
the proportion of imports subject to licensing (from 75% in 1982 to 21% by 1988 and 9.1% by
1991). Tariff rates were also reduced considerably, from an average of 27% in 1982 to 13.1%
by 1989. Mexico entered the GATT in 1986 and entered into a trade liberalization agreement
with the United States in 1987. It provided tax exemptions and easier credit for exporters. And it
allowed the peso to continue to depreciate.
(4) To earn dollars to meet its debt obligations, Mexico must export more than it imports. With
falling prices of oil and agricultural products, export revenues actually fell. Thus, meeting the
debt obligations required a reduction in imports. Since imports were mainly capital goods, this
reduction in imports led to lower rates of economic growth. Under the neo-liberals, this
reduction in imports could only be achieved by a general reduction in spending by Mexicans
(called "austerity"). If people are forced to buy less of everything, this will include being forced
to buy fewer imported goods. Reducing spending was achieved by the reductions in
government spending, as mentioned above, by a small increase in taxes, by reduced growth of
the money supply and the accompanying rise in interest rates, by setting minimum wages so
that wages rose slower than prices, and by the depreciating the peso. Despite these measures,
inflation rates remained high, in large part because the policies under "getting the prices right" were
so inflationary. But real GDP fell considerably and unemployment rose. The 5.2% decline in
real GDP is greater than occurred in the United States in any year of the Great Depression of the
1930s. Real wages fell to less than half of their previous value causing the standard of living
to fall back to the level that prevailed in the l960s. Unemployment rates were high and
inequality increased. Capital flight continued. Debt payments consumed a large part of export
earnings and of government tax revenues. Yet, Mexico did not consider defaulting. Mexico's
problems were exacerbated when a devastating earthquake hit Mexico City in 1985.
In 1987, Mexico was forced to change its policies from those that had been based on pure neoliberalism. The Economic Solidarity Pact of 1987 maintained the policies of austerity and trade
liberalization. However, it also included other policies such as wage controls, price controls,
and exchange rate controls. These policies were likely responsible for the dramatic drop in the
inflation rate that finally occurred in 1988 and 1989. These policies will be discussed in the next
chapter.
The "debt crisis" also had serious effects on the economy of the United States. First and most
obviously, the debt created problems for the American commercial banks. In the early l980s,
there was a worry about the possible bankruptcy of the large commercial banks; that worry ended
by the mid-1980s. There is a secondary (resale) market for Third World debt; Mexican debt sold in
this market for about $.50 on the dollar. (This means that the markets believed that only half of the
Mexican debt was collectible.) Second, to meet its debt obligations Mexico, as noted, reduced
its imports considerably. But most of Mexico's imports are American exports. American
agriculture was hurt most by the loss of these exports. It has been estimated that 400,000 to
800,000 American jobs were lost due to the reduction in these exports. Third, to meet the debt
obligations, Mexico had to increase its exports. Like most Third World debtors, it exports basically
primary products (natural resources and agricultural products). When all of the debtors increase
their production of these products and try to sell them, the prices of these products fall. This hurts
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those American companies who also sell these products and helps those American companies who
buy them. Again, the American industry most hurt was agriculture but American oil producers
were hurt as well. Fourth, the increased poverty in Mexico has undoubtedly led to increased
migration to the United States. And finally, the "debt crisis" seriously affected American
foreign policy. On the one hand, the United States has been able to use the debt to force changes
on Mexico that are in the interest of the United States---trade liberalization, openness to
direct foreign investment, privatization, etc. On the other hand, the debt raised the specter of
political instability in Mexico; this came to be realized in 1994.
Because the debt of Mexico is basically denominated in dollars, the cost of supplying these
dollars must fall in some way on the United States. The main goal of the United States government
was to protect the commercial banks from bankruptcy. The commercial banks saw the problem as
a liquidity problem (the Third World debtors are temporarily short of cash) and refused to
acknowledge any losses until 1987. As a result, the approach of the U. S. government and the
banks had three components. First, the debt payments should be rescheduled (i.e., the amount
currently due should be reduced and the payments stretched over a longer period). Second, new
loans should be made to Mexico (either from international financial institutions or from the
American commercial banks) to help Mexico make the payments currently due. Third, the
rescheduling and the new loans should be contingent upon Mexico enacting "market oriented
reforms" (i.e., neo-liberal policies) that were expected to increase economic growth rates.
One example of this approach was the rescue plan that followed the collapse of oil prices in
1986. In this plan, the commercial banks agreed to loan Mexico $6 billion. The IMF added
another $1.6 billion. The World Bank and the Inter-American Development Bank added yet
another $2.3 billion. In addition, the IMF agreed to increase its lending if the price of oil fell below
$9 per barrel. In return, Mexico agreed to sell many of its state-owned companies, to liberalize
trade, to try to attract more foreign investment, and to reduce its government budget deficit to 3%
of GDP. Besides the new loans, Mexico also got a grace period and a longer period of time in
which to pay the loans due.
This approach, associated mostly with former Secretary of the Treasury Baker, was criticized for
several different reasons. Some critics argued that the approach only postponed a real solution to
the problem; these critics believed that postponing a solution would only make the problem worse.
Other critics argued that the imposition of "market-oriented reforms" was a violation of the
sovereignty of Mexico. Some Mexicans believed that the problem was caused by external events,
such as the drop in oil prices and the world recession. Since these events were outside of their
control, they believed that it was unfair to make Mexico bear all of the burden of adjustment. It is
clear that, at least by the end of 1988, there had been no long-term debt relief, no reduction in the
debt service burden, and no stimulation of sustained economic growth in Mexico.
On March 10, 1989, the new Secretary of the Treasury, Nicholas Brady, announced a new plan.
This plan would focus on debt reduction instead of new lending. Under the plan, the commercial
banks would exchange the old loans for new loans at a discount. As mentioned, Mexican debt
traded in the secondary market at about $.50 to the dollar. So, for example, under the Brady Plan,
the commercial banks might trade their old debt for new debt worth half as much. Why would they
do this? The answer is that the new debt would be guaranteed by the World Bank and the IMF,
which would create special funds for this.purpose. In addition, the Treasury Department would ask
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Congress for changes in regulatory, tax, and accounting rules to ease the burden on the banks from
the losses on these loans. The commercial banks would have exchanged debt that was partially
worthless for debt that would be paid. As in the Baker Plan, to be eligible, Mexico would have
to undertake "market-oriented reforms", although it was not clear who would judge whether
Mexico had properly complied with this provision.
During 1989, considerable bargaining took place between the Mexican government and the
commercial banks. By summer, it appeared that the commercial banks were trying to put pressure
on Mexico's foreign exchange reserves, which were dwindling rapidly. With this pressure, Mexico
might be forced to accept debt-for-equity swaps. Under a debt-for-equity swap, an American
company buys the debt of Mexico from a commercial bank at a discount. It takes this debt
to the Bank of Mexico and exchanges it for the equivalent number of pesos. These pesos are then
invested in a plant in Mexico. There were many companies who desired to use these procedures to
build plants in Mexico. The commercial banks believed that, if Mexico were forced to agree to
debt-for-equity swaps, the demand from these companies will push-up the price of Mexico's debt.
Instead of getting $.50 to the dollar, as under the Brady Plan, they might get $.60 or $.70. This
stalled the negotiations, as the Mexican government would not agree to the debt-for-equity swaps.
In the summer of 1989, an agreement was reached between the Mexican government, the
commercial banks, and the international institutions (IMF and World Bank). This agreement
followed the principles of the Brady Plan. The agreement with the commercial banks (finally
signed in February of 1990) reduced Mexico's debt by about $7.19 billion, deferred the
principal on about $48 billion of Mexico's debt, reduced interest payments on about 45% of
Mexico's debt (by about $1.6 billion per year), and swapped some of the debt for new bonds.
These bonds were guaranteed by the IMF, the World Bank, and the American and Japanese
governments. It also provided for a small amount of new money for Mexico ($6 billion) from 1990
to 1992. It was the first negotiation that actually reduced the debt, rather than just restructured it.
This agreement created the foundation for the enormous changes that occurred during the
administration of Carlos Salinas de Gortari from 1989 through 1994, as we shall see in the next
chapter. Because of this agreement, net external debt of Mexico fell from 57% of GDP in 1987
to 27% by 1991. And interest payments on the debt fell by $1.629 billion, to 18.5% of all
exports in 1991 compared to 43.6% in 1982. Transfers of resources out of Mexico because of the
debt fell by about $4 billion, from about 7% of GDP to about 3%. It was estimated that for Mexico
to realize the growth rate of 6% per year for the l990s necessary to absorb the new entrants into the
labor force, the debt service had to be reduced to about 2% of GDP. By 1990, external interest
payments were 2.4% of GDP. So the agreement came close to this goal.
DATA APPENDIX
Year
1982
1983
1984
1985
1986
1987
1988
Year
1982
1983
1984
1985
1986
1987
1988
Year
1982
1983
1984
1985
1986
1987
1988
Year
1982
1983
1984
1985
1986
1987
1988
Year
1981
1982
1983
1984
1985
1986
1987
1988
GDPGrowth
(%)
-0.6
-4.2
3.6
2.6
-3.6
1.7
1.4
GDP Per
Capita
-2.9
-6.3
1.4
0.4
-5.9
-0.3
-0.6
Wage (1982 = 100)
100.0
68.5
63.5
66.9
61.1
59.5
47.6
Inflation Rate GovtSpending
(%)
(% Change)
98.8
-8.0
80.0
-17.3
59.2
0.8
63.7
-6.1
105.7
-13.3
159.2
-0.5
51.6
-10.3
% Change in Real Wages
-1.3
-21.0
-6.7
1.6
-5.6
0.7
-1.0
Annual Growth of
Consumption Private Investment
-1.9
-15.1
-4.2
-22.1
3.8
7.9
3.1
12.2
-2.0
-10.4
-0.5
6.8
1.7
10.2
Annual growth of
Exports
Imports
21.8
-37.9
13.6
-33.8
5.7
17.8
- 4.5
11.0
4.2
-12.4
10.7
5.0
5.0
37.6
Private Investment
(% of GDP)
14.4
11.9
10.4
10.7
11.7
10.9
11.5
12.4
:
Government Investment
-18.8
-36.0
4.1
0.9
-14.2
-12.3
- 4.2
Terms of Trade (1971 = 100)
108.4
99.0
97.1
91.9
66.2
73.1
66.1
Government Investment
( % of GDP)
12.1
10.3
6.2
6.3
6.2
5.5
4.5
4.4