IMPLICATIONS OF MEXICO'S FINANCIAL CRISIS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP85T00176R001200010001-8
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 12
• Document Creation Date: December 20, 2016
• Document Release Date: May 29, 2007
• Sequence Number: 1
• Publication Date: September 3, 1982
• Content Type: SNIE

I)irector
( entral
Intelligence
I
Implications of Mexico's
Financial Crisis
Secret
SNIE 81-82
3 September 1982
Copy 408
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SNIE 81-82
IMPLICATIONS OF MEXICO'S
FINANCIAL CRISIS
Information available as of 2 September 1982 was
used in the preparation of this Estimate.
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THIS ESTIMATE IS ISSUED BY THE DIRECTOR OF CENTRAL
INTELLIGENCE.
THE NATIONAL FOREIGN INTELLIGENCE BOARD CONCURS.
The following intelligence organizations participated in the preparation of the
Estimate:
The Central Intelligence Agency, the Defense Intelligence Agency, the National Security
Agency, and the intelligence organizations of the Departments of State, the Treasury, and
Energy.
Also Participating:
The Assistant Chief of Staff for Intelligence, Department of the Army
The Director of Naval Intelligence, Department of the Navy
The Assistant Chief of Staff, Intelligence, Department of the Air Force
The Director of Intelligence, Headquarters, Marine Corps
The Department of Commerce
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SCOPE NOTE
This Estimate examines Mexico's financial crisis and the political
and economic implications for both Mexico and the United States
through the first six months of the de la Madrid administration. It does
not address the implications of the crisis for the stability of the
international financial system.
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KEY JUDGMENTS
Mexico is facing its most severe financial crisis in living memory, a
crisis that could have grave implications for domestic political stability.
Austerity measures needed to cope with the crisis will be shaped largely
in response to the demands of the IMF and the international banking
community. The government will be under strong pressure to cut public
spending, restrain wages, and slash subsidies on food, fuel, and trans-
port. These measures will inevitably:
- Go against nationalist tenets strongly held by all sectors of
Mexican society.
- Strike additional blows against the already hard-hit interests of
organized labor, a major component of the ruling party.
- Undermine living standards both of the middle class and of the
very poor.
- Taint incoming president de la Madrid with an "antipopular"
image, possibly casting a shadow over the next six years of
Mexican political life.
Mexico faces a very bumpy period of adjustment to external
demands and intense factional jockeying over economic issues in the
next 90 days. A strong signal of this turmoil was Lopez Portillo's state of
the union speech on 1 September. The nationalization of domestic
banking-accompanied as it was by economically damaging but politi-
cally helpful rhetoric-reflects President Lopez Portillo's penchant for
seeking scapegoats and avoiding harsh austerity measures. It will
present considerable-but not necessarily insurmountable-problems
for negotiations with the IMF.
Nevertheless, we believe that the new administration that comes to
power on 1 December will give public support to an austerity program
strong enough to satisfy the nation's creditors. The labor leadership will
come around to supporting this plan in exchange for relatively minor
concessions on wages and prices, but some wildcat demonstrations and
strikes by labor rank and file may take Place 5X1
Economic growth will 5X1
be negative during the period of the Estimate, and unemployment will
reach record levels. Opposition parties of the left and right will attempt
to make political profit from the crisis but will fail because of their shal-
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D
low roots in Mexican society. Although the potential exists for spontane-
ous action and unorganized protests, widespread revolt is unlikely
during the period of this Estimate. The Mexican political-economic
system will survive in roughly its present form.
Most of the implications of the Mexican crisis for US interests are
negative. Although we believe that US banks with loans in Mexico will
get most of their money eventually, individual banks could be under
considerable stress in the immediate future. US exports to the important
Mexican market will fall sharply, and the economies of US border cities
will be especially hard hit. The devaluations of the peso and the
necessary austerity measures will strengthen both pull and push factors
behind the flow of illegal migrants. On the more positive side, US
owners of assembly plants in Mexico should see their exports and profits
rise because of the devaluations.
The course of the Mexican crisis as already described is the most
likely case. Any deviation from the scenario will probably be for the
worse, not for the better. Recognizing that fact, we have included a
"worst case" scenario describing how the present crisis could-but is not
likely to-lead to a collapse of the Mexican system. We have also
included a detailed checklist of indicators that should give the observer
early warning of any change from the "most likely" scenario.
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DISCUSSION
1. Mexico is in the midst of what its press describes
as "the greatest crisis" since the Revolution of 1910. As
of mid-August, two politically damaging devaluations
in six months had failed to halt massive capital flight,
foreign exchange reserves had fallen to only three
days' import cover, foreign debt had reached a stag-
gering $80 billion, and inflation had soared to almost
70 percent. The crisis comes at a time when the
deepest recession since World War II has sharply
increased already high rates of unemployment and
underemployment and threatens numerous private
firms, including some of the largest, with bankruptcy.
Moreover, the crisis falls during the politically sensi-
tive period between the election and the inauguration
of a new president. As has been the case during past
transitions, rumors of presidential "disappearances"
and military coups are beginning to surface. Such
rumors can be expected to continue and grow at least
until 1 December, when President-elect Miguel de la
Madrid is to take office.
2. At stake is the continuation of what has appeared
to be one of the Third World's most successful and
durable political-economic systems.' For more than
half a century, Mexico has had stable governments and
regular and orderly changes of administration. This
long period of political stability-unique for a major
Third World country-has been a major factor allow-
ing economic growth to average between 6 and 7
percent since the mid-1930s-another unique achieve-
ment. A crumbling of the Mexican system would bring
Third World instability to the US southern border,
with all of the political, social, and economic problems
that that implies for the United States. It would also
have widespread political and economic repercussions
in Latin America, and it would seriously unsettle the
international financial system.
3. While many factors have come together to create
the current crisis, its roots are to be found in Mexico's
1976 economic crisis and President Jose Lopez Portil-
lo's response to it. At that time, largely because of the
ill-considered populist measures and antibusiness rhet-
oric of then President Luis Echeverria, Mexico was
suffering large-scale capital flight and inflation had
risen into the 20-percent range-high by Mexican
standards. Echeverria responded by devaluing the
peso in September and again in October-Mexico's
first devaluations since 1954. The effect was traumatic
politically and, because of the manner in which the
measure was applied, of little immediate help
economically.
4. Lopez Portillo, taking office in December 1976
with a reputation for economic competence, made
politically unpopular austerity his first priority. Early
in his administration he established a plan calling for
two years of retrenchment, two years of "consolida-
tion," and two years of rapid growth. Labor was called
upon to accept several years of declining real wages
with the understanding that the losses would be made
up in the last two years of the six-year presidential
term. With the rapid expansion of oil revenues, the
plan worked even better than expected. From 1978
through 1981 economic growth averaged better than 8
percent. Unfortunately, this led Lopez Portillo to
overcome his natural caution and expand his horizons.
In the late 1970s, intoxicated by seemingly endless
increases in oil earnings and with international bankers
only too eager to make large loans to Mexico at
favorable rates, Lopez Portillo established his "global
plan" to transform Mexico's economy and society by
the end of the century.
5. Although world recession and declining oil prices
in the early 1980s made his dream impossible, Lopez
Portillo refused to recognize that fact; there were signs
as early as mid-1981 that his strategy was coming
apart. Driven in part by the promises he had r2a5glo
labor and to the Mexican people, he continued to
increase government spending and borrowing. He was
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determined that his administration, which had begun
in austerity, would end in growth and prosperity.
Thus, he waited far too long to take the actions that
might have avoided or mitigated the crisis. And those
reluctant actions that he did take-such as the Febru-
ary 1982 devaluation followed by sharp wage in-
creases-were contradictory and only added to the
fears of sophisticated Mexican and foreign investors.
Loans became increasingly difficult and capital flight
intensified.
6. The crisis came to a head in early August. A
second major devaluation on 6 August failed to halt
massive capital outflows. During the first two weeks in
August liquid reserves fell from $2 billion to $200
million-only about three days' import cover-and by
13 August the government was forced to close the
exchange market. Jesus Silva Herzog, Secretary of
Finance and Public Credit, went to the United States
to seek emergency aid from the US Treasury and
begin discussions with the International Monetary
Fund. A four-part program was set in motion, includ-
ing: (1) US Government prepurchase of $1 billion
worth of oil for the strategic reserves; (2) Mexican
agreement to negotiate a strong economic adjustment
program with the IMF; (3) US Government assistance
in organizing multilateral short-term financial support
from central banks and treasuries; and (4) Mexican
commitment to begin talks with foreign banks on the
orderly restructuring of Mexico's debt with such banks.
7. By the end of August, new US commitments
totaled $2.9 billion-not including a continuing $700
million Fed swap line that was drawn down earlier in
the month. In addition, other elements of the interna-
tional financial community committed some $10 bil-
lion in both debt relief and new support.
8. The following figures give some idea of the
dimensions of Mexico's financial straits:
- Foreign debt at more than $80 billion, with more
than $30 billion to be repaid within 12 months, is
the largest among developing countries.
- Debt service obligations total almost $1.6 billion
each month, or about 80 percent of export
earnings.
- Unless short-term debt continues to be rolled
over, debt service obligations will more than
double to $3.4 billion monthly.
- Despite massive devaluations, total export earn-
ings are no more than $2 billion a month ($1.4
billion of which comes from oil sales) and are
unlikely to rise much before there is a general
upsurge in the world economy.
9. For the moment, the 90-day deferment on re-
payment of debt principal granted by the commercial
banks takes some pressure off the Mexicans. Beyond
the 90 days, however, Mexico City will have to come
up with at least $1 billion a month in new money to
meet interest payments. This underlines the impor-
tance of the IMF agreement, which is a precondition
for rescheduling Mexico's foreign debt.
10. It also underscores the central importance of the
attitudes of foreign private bankers, who have grown
increasingly concerned since late 1981. A number of
banks have adopted a deliberate policy of reducing
their exposure in Mexico and may refuse to roll over
loans as they come due. Despite recent successful
negotiations with a number of the more important
banks, any one of the more than 1,000 banks-as well
as numerous individual holders of Mexican bonds-
that have provided funds to the Mexican Government
or private sector could raise the crisis to a new level by
declaring the borrower in default and attempting to
seize assets. (See tables 1 and 2.) This is more likely in
Mexico than in the rest of the Third World because of
the greater incidence of direct transactions by individ-
ual banks over which the financial system as a whole
exerts only limited influence. An important aspect of
this set of problems is already covered by the apparent
willingness of major banks to exert pressure on smaller
banks to avoid declarations of default.
Coping With the Crisis
11. The economic options open to the govern-
ment-both internationally and domestically-will be
Table 1
Mexico: Debt Service Obligations, 1982
(Billion US $)
Amortizations
7.5
Public long-term
6.6
Private long-term
0.9
Interest
12.0
Public long-term
6.3
Private long-term
1.5
Short-term
4.2
Total
19.5
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Table 2
Mexico: External Debt, 30 June 1982
(Billion US $)
By Borrower
Government and govern-
ment guaranteed 12 48 60
By Creditor
Commercial Banks 65
United States 25
Japan 10
Canada 6
United Kingdom 5
France 4
Other 15
Other 15
Bonds 6
Multilateral 5
Bilateral 4
determined largely by the IMF and the international
banking community. The present and future adminis-
trations will find this both distasteful and politically
costly. Measures strong enough to reassure foreign
bankers and domestic capitalists will inevitably go
against nationalist tenets strongly held by all elements
of Mexican society; strike additional blows against the
already hard-hit interests of organized labor, a major
component of the ruling party; undermine living
standards, most notably for the middle class and for
the underemployed marginados of the urban shanty-
towns and rural hamlets, the latter constituting at least
30 percent of the population; and taint incoming
president de la Madrid with an "antipopular" image,
possibly casting a shadow over the next six years of
Mexican political life. Yet, in the absence of strong
measures, the government will be seen as indecisive or
inadequate to the economic task, and this would create
other political as well as economic dangers.
12. The foreign banking community will demand
not only action but also the appearance of action. A
decision by the Mexican Government simply to hold
unpublicized talks with the IMF, make private prom-
ises to major banks, or quietly apply new restrictions to
labor and consumers would not be seen as satisfactory.
The Critical Issue of Timing
As Mexico City reaches for solutions to its financial
crisis, we believe timing will be of the essence. Until
an austerity program is in place and IMF support is
assured, we expect foreign creditors to remain nervous
and the Mexican financial situation precarious.
The very process of developing and negotiating a
policy package will, we project, be time consuming.
Mexico's success in fostering long periods of rapid
economic growth without central planning and the
consultative nature of its political system suggest to us
that policy adjustments will be slower and more
difficult for it than for most other LDCs with troubled
economies.
Several important action-forcing dates face the
Lopez Portillo administration as it assembles its stabili-
zation package and sells it to the public:
15 October - Target date for agreement with the
IMF.
21 November - End of 90-day standstill in com-
mercial bank debt repayment.
In addition, there will be ongoing labor negotiations
concerning the annual 1 January wage increase.
High-level public statements that the government is
willing to meet foreign demands for domestic austerity
would be necessary to restore international confidence.
Neither outgoing President Lopez Portillo nor incom-
ing president de la Madrid will want to be publicly
associated with such measures; we expect, however,
that both may be forced to take public stands before
the change of administration.
13. What, precisely, will the government do? On
the international trade side, Mexico City will try to
boost oil and gas exports by $5 billion-to $20 bil-
lion-next year. This will require the maintenance of
nominal world oil prices, some increases in production
(probably in the neighborhood of 300,000 barrels per
day), and a reduction in domestic consumption. We
expect Mexico to be at least partially successful in
these efforts, although a sharp fall in oil prices-which
some analysts project-could seriously undercut this
goal. Most of the impact of these measures will be felt
after the period of this Estimate-beyond mid-1983.
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14. Elsewhere on the international trade front, the
devaluations will bring a boost to tourism and to
border industry exports. Unfortunately, most other
major Mexican exports are priced in dollars and will
not be boosted by the devaluation in the near term.
Although the use of open or hidden subsidies to boost
exports will almost certainly be restricted by any
agreement that Mexico reaches with the IMF, the
government will come to the aid of important export
industries in every way possible-most specifically
through tax breaks and favorable exchange rates for
private debt repayment. Imports will, of course, be
restrained by the higher cost of foreign currency as
well as by more direct restrictions.
15. For political as well as economic reasons, a
major goal of the Mexican Government will be to
reestablish a unified and stable exchange rate. The
psychological cost of the recent devaluations and the
imposition of exchange controls cannot be overempha-
sized. In the past, no economic statistic has been more
politically sensitive than the peso-dollar exchange rate.
To the average Mexican, government statistics on
inflation, employment, and economic growth are sus-
pect; the exchange rate, however, can be verified by
the man on the street. Devaluations-which have been
extremely rare-and exchange controls-which are
unique to the present instance-are associated with
"South America" and all the political and economic
instability that that implies to the Mexican mind. Any
government that fails to maintain the exchange rate
and free convertibility is likely to be judged as having
failed in its economic policies, no matter what other
successes it achieves.
16. The "temporary" exchange controls announced
in the state of the union speech on 1 September are
seen by Lopez Portillo as necessary to prevent contin-
ued capital flight leading to the wholesale dollarization
of the economy and are clearly measures of last resort
that will have a political cost. Whatever effectiveness
they have will be limited to the short term, and it is
unlikely that they will be continued by de la Madrid.
The new head of the Bank of Mexico, Carlos Tello, is
considered a supporter of exchange controls and al-
most certainly will not survive the change of
administration.
17. On the domestic side, the demands of the IMF
and the foreign banking community will center on
solid cuts in real government spending and on wage
restraints. Capital spending, which has already been
slashed, will be cut further. The rate of price subsidies
on food, fuel, and other goods and services will be
allowed to fall. The government probably will not
completely eliminate subsidies on such politically sen-
sitive items as corn, cooking oil, gasoline, and public
transportation, but the nominal cost of such items may
be increased to several times the present levels. While
some efforts will be made to reduce federal employ-
ment, such efforts are unlikely to be long lasting, as the
new administration will need to consolidate its support
and co-opt its potential enemies with government jobs.
Although labor will press for wage adjustments and has
in prospect a substantial increase on 1 January, real
wages probably will continue a downward trend
throughout the period of this Estimate.
18. The nationalization of domestic banking-ac-
companied as it was by economically damaging but
politically helpful rhetoric-may have been necessary
to prevent the fall of a large number of the weaker
Mexican banks. It reflects Lopez Portillo's penchant
for seeking scapegoats and avoiding harsh austerity
measures, and will present considerable-but not nec-
essarily insurmountable-problems for negotiations
with the IMF.
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