MEXICAN IMF AGREEMENT: THE RISKS OF SPILLOVER

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T01017R000201450001-8
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 25
• Document Creation Date: December 22, 2016
• Document Release Date: February 23, 2011
• Sequence Number: 1
• Publication Date: September 18, 1986
• Content Type: MEMO

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DATE 9 I ZZI " Gl c i~
DOC N0_~ ac~~ I
DIRECTORATE OF INTELLIGENCE OIR .3
18 September 1986 P $ PD
Mexican IMF Agreement: The Risks of Spillover
Summary
On 22 July, Mexico and the IMF announced a ground-breaking agreement to
deal with Mexico's debt problems. The agreement provides $12 billion in new
funding, allows for annual real GDP growth of at least 3 percent through 1987, and
shields Mexico from the effects of further oil price declines. While this accord
appears to have diffused a volatile situation -- Mexico City reportedly planned to
deposit the interest owed to its foreign creditors in an escrow-like account at the
Central Bank until the foreign reserve position improved, in effect threatening to
stop payment -- the precedents established in the accord could create new risks
for the management of the LDC debt situation.
In our view, the major risks will be those stemming from the spillover effect
of this Mexican agreement on other debtors and negotiations. Other LDC debtors
believe their economic and political situations are similar to Mexico's and that they
deserve equal treatment. In requesting relief they will cite a variety of reasons. In
Latin American, some debtors -- notably Argentina and Brazil -- will cite prior
economic reform efforts. The adverse effects of falling commodity prices will be
used as justification by Argentina and Venezuela in particular. All will argue the
need for faster economic growth to justify debt concessions. In addition, Egypt
and the Philippines may cite their special relationship with the United States.
Despite the risks it has created, the agreement has shown a new flexibility on
the part of the Fund -- in the Mexico case allowing larger budget deficits and
tying further assistance to growth -- that may encourage other recalcitrant
debtors to stay within the case-by-case debt strategy and not go it alone as Peru
has done. Nevertheless, should key debtors fail to receive what they consider to
be equal treatment to that given Mexico, it is possible that they may adopt
unilateral measures to limit their debt service payments.
This memorandum was prepared byl
Economics Division, Office of Global Issues. Comments and queries are welcome and
may be directed to the Chief, Economics Division, OGI,
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Mexico has been the center of attention in the debt arena since the
beginning of this year. After suffering a decline in export revenues
and international reserves, a continued recession in 1985, and little
prospect for improvement this year, Mexican debt negotiators again
turned to their international creditors for relief. After lengthy and
often difficult talks, Mexico and the IMF signed on 22 July 1986 a
letter of intent that offers the de la Madrid Administration a less
painful solution to its chronic economic problems.
We expect other LDC debtors may use the Mexican-IMF agreement as a
model for their future negotiations with creditors. Many of these
debtors may put strong pressure on the IMF and commercial banks for
similar concessions because either they also face acute financial
difficulties or their belief that they deserve special consideration
because of strong economic adjustment efforts. In addition, some
debtors -- especially those countries that are more financially
hard-pressed or belligerent -- could model alternative payment schemes
after concessions granted in the Mexican agreement, and take unilateral
action to reduce debt payments instead of negotiating with creditors.
Mexico is not alone in being hard hit by export revenue losses due
to stagnant or falling commodity prices and lower import demand in
developed countries: Falling export earnings and rising debt service
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[TEXT BOX 1]
Major concessions of the IMF-Mexico letter of intent include:
o The amount of new financing. The agreement assumes over $12
billion in new money between now and the end of 1987, with half
coming from commercial banks, according to financial press
reporting.
MEXICO'S PRELIMINARY FINANCING PACKAGE
(Million US Dollars)
1986
1987
Commercial banks
$ 2,500
$ 3,500
$ 6,000
World Bank
900
1,000
1,900
IMF
700
900
1,600
InterAmerican
Development Bank
200
200
400
International
export credits
500
1,000
1,500
US farm credits
200
600
800
TOTAL
5,000
7,200
12,200
o Tying additional loans to commodity prices. A contingency fund
has been created under the letter of intent to insulate Mexico
from the further effects of declining oil prices. New money
would be made available automatically if oil prices fall below
$9 a barrel for more than 90 days during the first nine months
of the accord. But Mexico will receive less financing if oil
prices rise above $14 per barrel.
o An orientation toward growth. The accord in effect replaces the
IMF's traditional policy of supporting austerity reforms with a
new flexible approach that promotes efforts to foster
longer-term growth. The Fund agreed to let Mexico tailor an
economic recovery program that allows real GDP growth of at
least 3 percent starting in 1987. To assist Mexico, the letter
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of intent established a $500 million reserve to bolster domestic
investment if the economy fails to recover by the first quarter
of 1987.
o The longer-term creditor commitment. Mexico can seek
medium-term lending commitments from creditor banks beyond the
18 months covered by the IMF-supported program. In addition,
the letter of intent reportedly allows Mexico to automatically
renew the IMF package for another year at the end of the
program.
Although most of the official funding has been approved for the package,
Mexico's commercial creditors have yet to a ree to provide the $6
billion laid out in the accord.
The IMF agreement fails to force Mexico to adopt a stringent
austerity program but Mexico City is promising to make a renewed effort
to accelerate economic restructuring.
Mexico's strategy is to reduce government operating costs, encourage new
capital inflows, and stimulate trade. Mexico reportedly will try to cut
its budget deficit -- projected to top 16 percent of GDP this year --
primarily by increasing government revenues. Mexico has also promised
to sell or close about 300 nonstrategic parastatals, although no formal
timetable has been established. In addition, monetary policy will
remain tight with interest rates higher than inflation in an attempt to
reverse capital flight. Mexico will also encourage the entry of foreign
investors, particularly those in export-oriented industries that provide
modern technology, and meet GATT regulations as part of a expanded
policy of opening its trade doors.
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burdens are forcing many other LDCs to continue economic reforms and
austerity-related cutbacks in spending -- especially for investment --
to maintain financial solvency and foreign exchange reserves. In turn,
these developments are placing additional checks on growth and
development in the key debtors. In our judgment, these adverse
financial conditions will continue over the next 18 months, and may lead
to increased demands for Mexican-type concessions from several other
debtors.
LATIN AMERICAN DEBTORS
We believe several Latin American countries are candidates for
spillover. These debtors will base arguments for debt relief on current
financial hardships, the need for renewed economic growth, and
structural adjustment achievements. Moreover, some political leaders
have a"populist" outlook and are likely to demand lenient
debt-repayment terms to alleviate what they perceive as painful economic
burdens on their constituents. These countries have closely followed
the Mexican talks and are already positioning themselves to demand
similar concessions.
Larger Countries.
Argentina's year-old austerity program, the Austral Plan, sharply
lowered the inflation rate, reduced the government budget deficit as a
share, of GDP, and set the stage for short-term industrial improvement.
Even though the plan is unraveling now, Argentine officials will be
quick to point out their progress on reform and argue that such efforts
should be rewarded with debt concessions.
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[TEXT BOX 2]
In our view, major LDC debtors will likely use at least one of the
following arguments to support their demand for debt concessions:
o Bleak trade outlook. Export revenues in key debtors have fallen
sharply over the past two years due to low commodity prices, a
50 percent drop in oil prices, and slack import demand in
developed countries. Slowing OECD real GDP growth and continued
oversupply conditions make a sustained commodity price recovery
unlikely, especially for agricultural products. In addition,
many debtors -- frustrated by five years of economic austerity
-- are now more concerned with economic recovery than with debt
service payments, and are determined to boost imports and real
GDP growth. This combination of lower export revenues and the
need for higher imports is setting the stage for growing
financial gaps in many debtor countries.
o Prior economic reforms. A few key debtors, such as Brazil, have
undertaken significant economic reform measures, including
exchange rate devaluations and anti-inflation programs. Key
debtors in this category could demand lenient debt treatment as
a reward for these efforts, given their adverse impact on real
GDP growth and unemployment. They may also cite Mexico's lack
of progress toward economic adjustment, in contrast to their own
efforts.
o A special relationship with major creditors. Mexico is of
special concern to the United States, given the closeness of
economic and political ties between Mexico City and Washington
and Mexico's physical proximity to the United States. But the
United States has developed special relationships, based on
economic, political, and military factors, with other countries
such as Egypt and the Philippines. In addition, European and
Japanese creditors have maintained close ties with debtors in
their respective regions. We feel that some of these countries
will vociferously argue that Mexico used its special
relationship with the United States. as leverage to obtain
concessions and that they are entitled to similar relief from
creditors for the same reason.
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HAVE SHARPLY CUT KEY DEBTOR
EXPORT EARNINGS...
BUT MEXICO IS NOT THE ONLY COUNTRY HARD-HIT...
PERCENTAGE CHANGE 1984-86 A
NONOII CONNO01Tt
-tiC($
MOM
OUT S[NYICI
RATIO
IY/ONR
(f[AL (IMP),
AIO[NTIN?
-II
-lo
n
-IZ
-t,
rant
MEXICO
1
I
-1
PIIIL-rIMI2
-p
-I/
Y[II Qy[LnL
-T
..?
IH
-11
A. DEBT SERVICE RATIO CHANGE IS IN PERCENTAGE POINTS.
8. DEBT SERVICE RATIO HAS FALLEN DUE TO PAST DEBT
RESCHEDUUNGS.
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On the payments side, falling prices and flooding last fall in
agricultural areas could reduce 1986 export earnings by as much as $1
billion. Buenos Aires already has cited the US decision to subsidize
agricultural sales to the Soviet Union as wreaking further havoc with
their foreign payments position. In addition, boosting real GDP growth
is an announced government priority and renewed import growth must be a
prerequisite to higher real income levels. To realize these goals, we
believe that Argentina will seek $2 to $3 billion in new money over the
next 18 months or concessions on interest payments to meet financial
needs.
The Mexican debt agreement with the IMF already is playing a role in
Argentina's negotiating strategy. Buenos Aires delayed negotiations
with the IMF and commercial banks until the details of the Mexican
arrangement became clear, and press reports indicate that Argentina is
seeking to link debt repayment terms to agricultural export prices.
Brazil -- with a $102 billion foreign debt, massive debt service
payments, and a high debt service ratio -- also is a candidate for
spillover, despite its strong current account position and substantial
foreign exchange reserves. The Sarney administration has repeatedly
argued that foreign creditors should give Brazil the easiest financing
conditions in Latin America because of that country's superior economic
adjustment achievements. Brasilia can cite elimination of a $16 billion
current account deficit since 1982, tax reform, and budget
consolidation. More recently, the Cruzado plan -- Brazil's
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six-month-old austerity program -- has slashed the rate of inflation,
reduced interest rates, and set in motion market-oriented reforms that
could strengthen Brazil's economy. However, government spending has not?
been curbed, savings have sharply declined, and new business investment
continues to be sluggish -- signs that inflationary expectations may not
have been broken.
Brazil's case for major concessions is not as strong as that of
other Latin American debtors. Bolstered in part by higher coffee
prices, export growth is likely to resume this year after a slight
decline in 1985. Real GDP growth also remains strong. Lower oil prices
and greater domestic production will reduce petroleum imports, allowing
for higher imports of raw materials and other industrial inputs.
Finally, an agreement to restructure 1985-86 debt repayments has been
concluded, and press reports indicate that negotiations toward a more
comprehensive multi-year restructuring could begin before the end of
this year.
Chile's financial situation is nearly as bad as Mexico's. Export
earnings have stagnated since 1981 -- after a near tripling between 1975
and 1980 -- as lower prices (especially for copper) offset higher export
volume. A worsening balance of payments situation and sharp increases
in the level of foreign debt forced draconian import cuts. As a result
real GDP fell 14 percent in 1982 and has yet to completely recover to
1981 levels. Chile's debt situation is now so burdensome that principal
payments must be rescheduled and interest payments take up 40 percent of
export earnings.
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At the same time, Chile's economic management team has carried out
essential domestic reforms, including liberalization of trade and
capital markets, exchange rate devaluation, and efforts to stimulate
private saving while maintaining fair treatment of foreign investment.
These measures have been supported by strict adherence to IMF-supported
austerity programs, supplemented by new loans and rescheduling
agreements. These actions have allowed Chile to make interest payments
and achieve some resurgence in economic growth over the past two years.
Given the precarious financial situation and its economic reforms,
Santiago probably feels it has a strong case for debt relief. Embassy
reports indicate that Chile will seek rescheduling of payments due
through 1989 or 1990, and over $400 million in new funding during
1987-88. Negotiations are scheduled to begin in late September, but
progress may not be made until details of the Mexican agreement are
clear. Given competent economic management in the face of adverse
external factors, a perfect interest payment record, and full compliance
with IMF and World Bank adjustment programs, we believe that Chile can
lay a strong case for debt relief. The human rights issue, however,
remains sensitive and could delay approval of new loans or other debt
concessions, especially from official creditors.
Venezuela is likely to argue for debt relief on grounds of a poor
financial situation, the need to revive a stalled economy, and bank
reluctance to provide new funds. Falling oil prices will cost Venezuela
$5-6 billion in export revenue this year, and we forecast a 2-percent
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decline in real GDP. As a result, Venezuela almost certainly will
request a postponement of $3.4 billion in principal payments due during
1987-89.
Venezuelan leaders have been carefully monitoring the Mexican debt
negotiations, and Caracas has been
stalling its own negotiations in order to get equal treatment.
Moreover, Caracas' unilateral and short-lived decision to pay private
sector debt with long-term low interest rate bonds angered creditors,
and could complicate future debt negotiations. However, in our opinion
a rescheduling of public and private sector debt, coupled with the use
of foreign exchange reserves, will be necessary to cover the loss of
export revenue in the near-term.
Smaller Countries.
In our opinion Colombia will not press for concessions or
rescheduling over the next 18 months. We forecast a sharp increase in
export earnings this year due to higher coffee prices, and a reliable
source indicates that it is unlikely Colombia will need to draw on all
external funding that has been made available. A strenuous,
IMF-monitored economic stabilization program has led to economic
recovery; we forecast 4 percent real GDP growth this year, following
increases averaging 2 percent per year between 1982 and 1985. Moreover,
compared with other Latin American debtors, Colombian economic
performance during the past four years has been excellent.
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The sharp drop in oil prices will slash Ecuador's export revenues by
$500-600 million this year and increase the current account deficit to
$750 million, according to Embassy sources. In response, Quito has
negotiated increased financial assistance -- such as a $200 million
syndicated loan -- and on 11 August announced new economic adjustment
measures, including exchange rate reform and deregulation of interest
rates on savings and loan accounts at private banks. Given Ecuador's
proven record of making economic reforms and poor financial outlook, we
believe Quito has a strong argument for further debt concessions.
Peru's financial outlook has been clouded by a number of adverse
factors, including persistently low commodity prices. While progress
has been made toward curbing triple-digit inflation and boosting
economic growth, these benefits are likely to be short-lived. As a
result, we believe that a case for debt concessions can be made.
However, given Peru's hard line confrontational attitude toward debt
repayment, the de-facto debt relief that has been its result, and a near
complete lack of creditor confidence, Lima almost certainly will not
obtain major debt concessions from commercial banks or the Its' unless it
substantially moderates its position on debt repayment.
The Core Four Central American countries -- Costa Rica, El Salvador,
Guatemala, and Honduras -- may be candidates for spillover because of an
increased debt burden and continuing economic stagnation. We expect
total debt service to again weigh heavily on these small economies,
remaining near 40 percent of goods and services exports -- after more
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SELECTED CARIBBEAN AND CENTRAL AMERICAN DEBTORS:
IMPACT OF DETERIORATING TERMS OF TRADE
(percentage changes 1984-86)
Exports
Prices for
Nonoil
Commodity
Exports
Debt Service
Ratio*
Imports
Real
GDP
Costa Rica
12
27
12
1
-2
El Salvador
-2
7
0
-1
-3
Guatemala
-3
17
13
-22
-8
Honduras
27
5
11
6
-1
Jamaica
-28
-8
38**
9
2
Mexico
-36
1
-10
1
-1
* Change in debt service ratio is in percentage points.
* 1984-85
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than doubling between 1980 and 1985. In addition, we forecast only a
slight increase in real GDP this year, after falling 5 percent between
1980 and 1985. Despite an expected improvement in the trade picture
this year due to higher coffee prices and lower petroleum imports, we
expect most of these debtors to seek payment concessions and new
financing to compensate for five years of eroding export earnings, the
continued fall in per capita income, and the need to combat domestic
insurgent threats.
In the Caribbean Jamaica is in need of some special financial
arrangement because of bauxite revenue losses and real GDP declines.
Prime Minister Seaga, citing the need for growth after years of
austerity, abandoned IMF guidelines in May. With debt negotiations with
the IMF and other creditors currently at a difficult stage, and $70
million in arrears to the Fund, Kingston almost certainly will not
obtain major concessions or new financing in the near future. Seaga,
however, may feel that his good relations with the US government and the
potential for Michael Manley's reelection if the economy doesn't improve
may enhance his chances for concessions.
KEY ASIAN DEBTORS
In general, the potential for spillover is not as great in Asia as
in Latin America. Most of these countries have considerably stronger
financial positions. Moreover, Asian debtors generally are less
belligerent toward creditors and are more amenable to implementing
measures to permit full servicing of debt obligations.
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The Philippines is a marked exception, however. There the financial
and economic situation deteriorated in 1983, and the economy remained in
recession though 1985. Since 1984, Philippine export earnings have been
depressed by a sharp 40-percent drop in commodity prices, imports have
been slashed, and real GDP has fallen more than 2 percent. Since
President Aquino assumed power in February, however, economic adjustment
measures have been put into effect -- tax measures have been passed,
trade liberalization is underway, and reform of financial institutions
has begun. We believe, however, that Manila will need to demonstrate
that leftists do not dominate policymaking, that the Communist
insurgency can be arrested, and that the new government can implement
economic programs in order to restore the confidence of creditors and
investors.
In these circumstances, while Finance Minister Ongpin has reportedly
stated that Manila intends to pay all the country's debt -- even those
that the current government suspects were diverted for personal use by
the Marcos regime -- it may cite the alleged diversion of funds as an
argument for debt relief. Manila probably believes that the severe
political and economic problems faced by the new government puts the
Philippines in line for favorable treatment. Manila will particularly
cite the need -- especially to Washington -- to make resources available
to fight the insurgents while making life better in the rural areas -- a
key source of insurgent support. With renewed economic growth a top
government priority, Manila's approach is to seek the support of its
foreign donors and creditors for a growth-oriented economic strategy
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that includes a multi-year debt rescheduling and tolerates a high
government budget deficit.
Although in much stronger positions, Indonesia and Malaysia have
suffered economic and financial reverses during the past two years.
Lower oil prices and, for Malaysia, a sharp decline in commodity prices
have reduced export earnings for the two countries by $4-6 billion since
1984, and resulting import cutbacks have reduced the rate of real GDP
growth. In addition, the decline of the US dollar has sharply raised
debt servicing costs for both countries on the portion of foreign debt
that is non-dollar denominated.
We believe that these countries will need substantial amounts of new
funding -- $2 billion per year for Malaysia, and $5 billion per year for
Indonesia -- to boost real GDP growth and absorb labor force increases
unless oil and commodity prices rebound sharply. If these funds are not
forthcoming, debt concessions modeled in part on those in the Mexican
agreement could be requested.
Thailand's economic outlook has brightened this year, following an
economic slowdown in 1985. Exports have risen 19 percent in dollar
terms over the first half of this year, and lower oil prices have
slashed Thailand's oil import bill. In addition, while the cost of
servicing yen-denominated debt has risen--due to the depreciation of the.
US dollar--Bangkok is refinancing its dollar-denominated debt, and Thai
sources indicate that overall debt servicing costs could be lower this
year than in 1985. Unless oil prices rise sharply, we believe that the
chances for a Mexican-type debt agreement are remote.
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AFRICAN AND MIDDLE EAST DEBTORS
While there are several countries in these regions that are
candidates for spillover, Egypt is of the greatest concern. Export
revenues have been devastated by lower oil prices and a sharp drop off
in worker remittances; even with modest import cutbacks, we believe
Cairo will require substantial new funding to meet financial needs.
Although Embassy reports indicate that the Egyptians have recently met
with IMF officials, a formal IMF agreement remains unpalatable to Cairo
as the strict financial and economic guidelines of a fund-supported
program would almost certainly provoke political and social unrest.
Cairo will probably also point to a newly-formulated program of
economic reform as justification for debt relief. Embassy reports
indicate that the program is far-reaching and comprehensive, but
specific weaknesses remain in the areas of the budget deficit, credit
expansion, and exchange rate reform. Egypt has proven more adept at
proposing reforms than at implementing them, which has created a
credibility gap with commercial banks, creditor governments, and the
IMF, delaying agreement on a new standby accord.
Finally, Egypt will continue to cite its special relationship with
Washington as an argument for debt concessions. Egypt and the United
States share concerns on several major military and political issues,
and Cairo almost certainly assumes that the strong US commitment to
supportinga moderate regime in Cairo will provide the leverage needed
to win increased funding and debt rescheduling.
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Elsewhere, Nigeria could argue that its financial situation is worse
than Mexico's and that major debt relief is needed. Falling oil prices
will slash export earnings as much as $5 billion this year, and despite
initial moves such as a two-tiered exchange rate system, political
considerations will make meaningful austerity measures difficult. In
addition, efforts to obtain an IMF agreement have been blocked by strong
anti-IMF feeling within the government.
Nevertheless, Nigeria does not seem willing to press the issue of
debt relief. Lagos is aware that past actions -- such as accumulation
of large debt arrearages -- have left creditors with a dim view of
further lending. In addition, Nigeria does not demand the attention
from creditors that the Latin American countries receive. Creditors
appear split on offering new financing to Lagos, with most US banks
viewing Nigeria as-a poor credit risk, while European banks are still
willing to make new loans because of their historical relationship with
agreement on a package of debt concessions more difficult.
Morocco and Tunisia are in desperate financial straits and could be
candidates for spillover, given their financial condition, strategic
location at the entrance to the Mediterranean, and shared concern with
the United States over regional political matters. Export earnings have
fallen because of declining demand for phosphate, and foreign exchange
reserves for both countries are nearly exhausted. Cautious steps toward
economic reform are now being taken in order to secure increased
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funding, but progress has been limited by fear that these measures will
lead to a repeat of the bloody riots that followed the imposition of
austerity two years ago.
In Sub-Saharan Africa, a number of small countries -- including
Cameroon, Ghana, Ivory Coast, and Senegal -- have implemented economic
reform programs to rescue their battered economies, ensure continued
external funding, and create a more favorable long-term environment for
economic growth. However, these measures have not been without
opposition, and have potentially serious political and social
implications because already poor countries are being called on for
further sacrifice. As a result, these debtors may press for lenient
debt treatment as a reward for their economic reform efforts.
Creditor-debtor relations likely will become more complicated in the
wake of the Mexican package. Mexico is the first debtor to have
commodity export prices explicitly linked to the terms of a new IMF
agreement, setting the stage for other key debtors with narrow export
bases to demand similar terms. For example, debtors such as Argentina
and Malaysia could argue for linkage to a basket of commodity export
prices, while Indonesia, Nigeria, and Venezuela could demand terms
linked to oil prices. Press reports confirm Buenos Aires already is
making such an argument. Similarly, some key debtors already seem more
inclined to link debt payments to GDP. For example, Brazilian finance
Minister Funaro stated in off-the-cuff remarks to the press on 28 July
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[TEXT BOX 31
ALTERNATIVE PAYMENT SCHEMES
While we believe debtor demands for relief will be modeled after the
Mexican financial package, some alternative schemes have been proposed
-- and implemented. Some of these proposals could surface again as
debtor countries search for ways to ease their financial problems. Such
past actions have included:
o Tying payments to export revenues. President Garcia announced
on 28 July 1986 that Peru would restrict principal and interest
payments on public debt to 10 percent of export revenues for
another year, and that payments would be contingent upon
creditor inflows meeting or exceeding Peru's payment levels. At
the same time, Lima stated that new interest rate charges or
refinancing terms must meet the 10 percent payment limit.
Similarly, Nigeria announced on 31 December 1985 that it would
limit debt payments to 30 percent of export revenues, covering
roughly half the projected obligations due this year.
o Issuing bonds to service debt. Venezuela passed a new law --
FOCOCAM -- on 7 July 1986 that provided for repayment of a
portion of $7 billion in private sector debt in the form of
15-year, dollar-denominated government bonds carrying a 5
percent interest rate. Under this system, Venezuelan firms
would buy bonds from the newly created exchange compensation
fund in domestic currency and then turn the bonds over to
foreign creditors as payment for outstanding debt. Criticism
from creditors forced Caracas to abolish the legislation in
mid-August, and Venezuela will instead will alter the prior
private debt scheme through executive decrees to change the
exchange agreements, according to the US Embassy.
o Domestic currency deposit schemes. Mexican finance officials,
reportedly with the backing of President de la Madrid, drafted a
plan where interest payments due to foreign creditors would
instead be deposited in an escrow account at the Central Bank,
according to press reports. These funds were to bear interest
at the normal interbank rate set. in London, but could not be
transferred abroad as dollars until Mexico's foreign reserves
substantially increased. Although the need to implement this
plan has lessened with the signing of the IMF letter of intent,
its presentation to creditors showed the severity of Mexico's
threat to lower debt payments and signaled the end of its
previously moderate approach to debt negotiations.
Creditors have generally responded harshly to unilateral attempts at
reducing debt payments. Commercial creditors view such payment schemes
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as setting dangerous precedents and as obstacles to financial
negotiations, so they react accordingly. When such unilateral actions
are taken, banks first retaliate against an LDC -- as they did with
Peru, Nigeria, and Venezuela -- by cutting back short-term trade
financing. But they may also take more drastic steps: for example
banks threatened legal action against Venezuelan firms when the bond
system was first announced.
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that Brazil needs to limit its debt service to 2.5 percent of GDP to
support economic growth. Funaro and members of President Sarney's staff
subsequently explained that reducing payments was a goal Brasilia wanted
to negotiate with creditors and did not imply an intention to take
unilateral action.
A major risk of the Mexican package is a deterioration in the
conduct of debt negotiations. The Mexican package makes it politically
more difficult for other debtors to continue paying without extracting
concessions from creditors and while continuing to keep tight reins on
their respective economies. We, therefore, believe that debt-troubled
countries will be less willing to operate under the old strategy where
continued financing was contingent on an IMF-supported program. If a
debtor fails to receive what it considers adequate financing or payment
terms, or cannot find other orderly ways to reduce debt payments or at
least link them to export performance, there is a greater possibility
that it would unilaterally act to curtail payments. While we believe
the possibility of a debtors' cartel remains remote, there nevertheless
is now a greater chance that LDC debtors may act jointly if they are not
satisfied with creditors' responses to their plight.
We expect the question of spillover will grow in importance as the
future debt negotiations of major LDCs progress. Debtors will likely
increase contacts among themselves in an effort to receive comparable
treatment from creditors -- stepping up bilateral contacts, keeping each
other informed of current negotiating strategies, and exchanging
documentation. Troubled debtors may use this network to time
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announcements of alternative payment schemes to maximize their effect.
For example, in Venezuela, the main impetus for the bond program was
Caracas' understanding that Mexico was approaching confrontation with
its creditors and the time was therefore propitious to also take a tough
stance with banks
Only when Mexico decided to negotiate rather than
take unilateral action did Venezuela become more willing to negotiate a
mutually acceptable solution instead of maintaining its hardline
position.
There also is a danger that creditors, especially commercial banks,
will become more opposed to negotiating with debtors if the Mexican-IMF
accord becomes the standard. They view solutions that link debt
payments to commodity prices or GDP growth as unacceptable because
payment amounts are then subject to factors beyond their control and
ability to plan
commercial banks will remain hesitant to extend new longer-term loans to
most LDCs unless pressured to do so in conjunction with an IMF-supported
program. In addition, creditors would likely face a substantial need
for new funds if every major debtor is to receive a large Mexican-scale
agreement. Also troubling is the fact that involuntary bank lending
over the next few years will become more concentrated among the world's
larger banks -- increasing their risks and exposure -- as US regional
and smaller foreign banks will largely opt out of large new money
packages. Although most large money center banks are now in better
financial shape after building up loan loss reserves, lending to LDCs
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that are poor credit risks as well as the possibility of unilateral
payment stoppages or negotiated payment reductions places these
creditors -- especially some large international banks -- in greater
jeopardy.
Offsetting these increased risks is the fact that the Fund will be
perceived as having had a more flexible approach during negotiations --
by allowing larger budget deficits and tying further assistance to
growth and oil prices -- may encourage some recalcitrant debtors to stay
within the case by case debt strategy and not follow Peru's example and
go it alone. Nonetheless, should other key debtors fail to receive what
they consider to be equal treatment, or at least softer payment terms,
the spillover risks may become real, and it is possible that some
debtors will even adopt unilateral measures to limit debt service
payments.
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SUBJECT: Mexican IMF Ag
reement: The Risks
of Spillover 25X1
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18 September 1986
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Sec. James Baker
R. G. Darman
James W. Conrow
Robert Cornell
Thomas J. Berger
Charles Schotta
James A. Griffin
Doug Mulholland
Robert M. Kimmit
David Mulford
Sec. George Shultz
John C. Whitehead
Treasury
it
State
1 - SA/DDCI
1 - Executive Director
1 - DDI
1 - DDI/PES
1 - NIO/ECON
1 - CPAS/ISS
1 - D/OGI, DD/OGI
3 - OGI/EXS/PG
6 - CPAS/IMC/CB
1 - C/OGI/ECD
2 - OGI/ECD/IF
2 - OGI/ECD/IT
Morton I. Abramowitz
Jerome H. Kahan
Michael Armacost
Ralph Lindstrom
W. Allen Wallis
Elliot Abrams
Rozanne Ridgway
Dougles McMinn
Chester Crocker
Gaston Sigur
Richard Murphy
Harry Gilmore
Byron Jackson
Commerce
S. Bruce Smart
it
NSA
Steve Farrar
Stephen Danzansky
Randall Fort
Leo Cherne
David Tarbell
Edwin Truman
NSC
PFIAB
it
OSD (ISA)
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