MEXICO: IMPACT OF LOWER OIL REVENUES

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP04T00367R000100440001-4
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 8
• Document Creation Date: December 22, 2016
• Document Release Date: March 30, 2010
• Sequence Number: 1
• Publication Date: November 14, 1984
• Content Type: REPORT

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Central Intelligence Agency
Washington. D. C. 20505
DIRECTORATE OF INTELLIGENCE
14 November 1984
Sifmmary
Mexico's economy could contract again if current oil revenue
losses are not reversed soon, according to our econometric
forecast. In the absence of a Mexican policy response, a 10
percent fall in oil revenues would reduce projected economic
growth from 2.0 percent to -1.5 percent next year; the economy
would contract another 5.3 percentage points in the unlikely
event oil revenues plummeted 25 percent. In either case, revenue
shortfalls would further constrain depressed government spending,
ability to pay for imports, consumer demand, and private
investment. Rather than accept economic contraction, however, we
believe Mexico City would lobby hard for more lenient IMF targets
on government deficit levels. This would allow the government to
increase its spending, thus limiting the dropoff in economic
growth. Even before the latest weakening of the oil market, we
believe that Mexico City was planning to ask the Fund for
spending relief. In addition to higher spending, our econometric
model suggests reserve drawdowns, lower imports and currency
devaluations would be necessary to offset most of the economic
losses caused by a sustained drop in oil revenues. Even with
This memorandum was requested by the Deputy Secretary of the
Treasury. It was prepared by
of the Middle America-Caribbean Division, Office of
African and Latin American Analysis. It was coordinated with the
Office of Global Issues. Information as of 5 November 1984 was
used in preparation of this paper. Comments and questions are
welcome and should be addressed to the Chief, Middle America-
Caribbean Division,
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such policy moves, prolonged difficulties in the petroleum sector
could prompt a new debt crisis.
Background
On 29 October, OPEC announced a 10 percent reduction in the
organization's production quotas in an attempt to defend its
light crude price. Shortly thereafter, Mexican officials
publicly stated that effective 1 November Mexico would reduce its
oil exports between 7 and 10 percent even though Mexico is not a
member of OPEC. Mexico could avoid real revenue losses if it
bases the announced cutback in oil exports on their average sales
of 1984 or 1983. We estimate that sales have already been
reduced 10 percent in the last six weeks by slack demand and
seasonally poor weather.
Regardless of what Mexico ends up doing, it is clear that
the government is concerned about the potential impact of falling
oil prices. Indeed, in strategy sessions preceding recent OPEC
meetings, Mexico played a prominent role. For example, Secretary
of Energy, Mines and Parastatal Industries Francisco Labastida
joined Saudi Oil Minister Yamani and his Venezuelan counterpart
on an unsuccessful visit to Lagos to request that Nigeria
reinstate the OPEC price.
This increasing coordination with OPEC is prompted by the
high financial stakes Mexico City has riding on a stable world
oil market. The government, for example, is currently
negotiating a $48.5 billion debt rescheduling package with more
than 500 banks that is based on assumption of steady oil
revenues. Moreover, the sharper the fall in oil revenues--either
due to export cutbacks or price decreases--the more difficult it
will be for Mexico City to meet debt obligations, maintain
growth, and adhere to IMF targets. Finally, such a revenue
crunch would be magnified by the ongoing reduction in foreign
investment that has resulted primarily, from the trend toward
greater state control over industry.
Methodology
In order to assess the potential impact that lower oil
revenues might have, we explored the quantitative ramifications
of these alternative oil revenue paths in our Mexican econometric
model. Specifically, we simulated 1985 crude oil revenues
remaining constant (Baseline Case), declining by 10 percent (Case
II), and falling by 25 percent (Case III). The baseline case
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assumes the IMF would allow Mexico some leniency in meeting the
1985 targets set two years ago. This scenario posits a 5 percent
increase in government spending, no change in international.
reserves, and oil exports at their former ceiling of 1.5 million
barrels per day (bpd) at $27.00 per barrel.* Moreover,- we assume
relief of $500 million in interest obligations caused by an
expected one half percent drop in LIBOR (London InterBank Offered
Rate) .
Cases II and III are deriv9d from the baseline but reflect
their respective declines in export revenues. In the first
running of the simulation, both cases assume no Mexican policy
response to offset the declines in order to demonstrate the full
potential impact of such contractions. Finally, another
simulation incorporates policy shifts (affecting government
spending, exchange rates, investment incentives, etc.) Mexico is
likely to implement in response to the declines in economic
activity forecast in Cases II and III. In these latter cases,
somewhat greater relief in interest rates could occur if OPEC and
Mexico were to reduce prices rather than volumes. By lowering
world energy prices such an action would reduce the component of
interest rates that reflect expected inflation.
Baseline Case: Oil Revenues Remain Constant
Mexico would be unable to expand its economy much next year,
even if nominal oil revenues remained constant. Reduced foreign
borrowing and tight IMF financial targets will continue to hold
down government consumption and investment, while financial
problems and weak business confidence will keep private
investment depressed.
As things now stand, we expect Mexico City to press the IMF
to loosen strictures on reflating the economy, even if oil
revenues do not decline next year. After three full years of
falling consumption, Mexico City is under strong pressure to ease
austerity and stimulate the economy. Indeed, with national
elections approaching next July,'the government may adopt even
more reflationary policies than the ones we posited. According
to US Embassy reports, officials of the ruling party are worried
that the recession generally has significantly eroded its voter
appeal.
* This is an avers a rice for light and heavy grades of
crude oil.
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Without any relaxation, our analysis projects a modest
economic decline in 1985. By boosting spending several
percentage points to 5 percent, however, the model indicates that
real GDP could grow. We believe Mexico City would have
difficulty selling reflation to the IMF without also adjusting
imports and the exchange rate. Increased government spending,
depressed imports, and boosting daily depreciation of the peso to
a 50 percent annual rate would keep inflation high. Taking all
of these policy adjustments into account, our model suggests that
the Mexican economy could expand by about 2 percent next year.
Case II: Moderate Decline in Oil Revenues
Lower revenues next year caused by a 10 percent drop in oil
export volume (equivalent to either a price fall of about $2.70
per barrel or 150,000 b/d sales reduction) would have a
substantial impact on the economy. Assuming all other policy
variables were held constant, such a drop would cause an economic
contraction, of 1.5 percent--3.5 percentage points below the
baseline.
Only by adopting dramatic, multifaceted policies would the
government offset the impact of lower oil revenues. Such a
response would almost surely require additional revisions in IMF
targets, including higher spending, drawdowns in international
reserves, further cuts in imports, and an increase in the daily
depreciation of the peso. Model results indicate, for example,
that just to maintain baseline economic activity, Mexico City
would have to raise spending another 3 percentage points, reduce
international reserves by $1 billion, and increase the annual
depreciation of the peso to 60 percent. The cumulative effect of
these actions would reduce imports 8 percent and boost inflation
substantially.
Case III: Oil Revenues Plummet
Our econometric analysis indicates that a 25 percent drop in
oil revenues next year (equivalent to either a $6.75 per barrel
price cut or nearly 400,000 b/d sales reduction) would have a
devastating effect on the Mexican economy. In the absence of
offsetting policy responses, this unlikely scenario would cause
GDP to decline 7 percent and would drive private consumption and
investment down dramatically.
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In these circumstances, measures needed to prevent economic
decline would require fundamental changes in economic policy.
Mexico would virtually have to abandon its IMF-sponsored. -
austerity program, for example, although our model suggests that
a substantial drawdown in reserves could temporarily delay any
unilateral actions to increase debt relief. Only when the growth
of government spending in the baseline case is more than doubled,
international reserves reduced by $2.5 billion and the annual
depreciation of the peso increased to 80 percent, does the model
simulate positive GDP. On the other hand, we estimate that these
measures would cut imports by 20 percent and push inflation back
toward triple-digit levels.
Outlook
Depressed oil revenues beyond next year would not only
torpedo the economic adjustment program, but'also probably
prevent Mexico from meeting rescheduled debt obligations. The
intensifying liquidity crisis would probably drive Mexican
economic decisionmaking toward more statist policies, rather than
inducing the government to lift its many restrictions on private
investment. Mexico City might again blame the economic decline
on the private sector and the US-led world economic system. Such
conditions also might encourage Mexico to reinstate a moratorium
on debt service.. These actions would greatly increase the
already strong resistance of bankers to new loans for Mexico and
trigger another strong surge in capital flight.
Lower oil revenues, disinvestment, and the cutoff of
international capital could plunge the economy into a stagflation
trap. Efforts to reinvigorate the economy would increase
government spending sharply to support consumption, unleashing an
inflationary explosion that would further cut real wages and
crowd out private investment. Rapid increases in the cost of
living and unemployment would sharply erode living standards and
prompt new highs in social tensions and illegal migration to the
United States.
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MEXICO: IMPACT OF REDUCED OIL EXPORT VOLUMES
1984 1985
PROJECTED
BASELINE
NO POLICY WITH POLICY
ADJUSTMENT ADJUSTMENT
NO POLICY WITH
ADJUSTMENT ADJ
POLICY
USTMENT
GDP
0.97
2.02
-1.52
1.70
-6.76
0.23
GDP DEFLATOR
65.50
60.78
61.67
64.37
62.99
71.75
PRIVATE CONSUMPTION
1.87
3.56
0.04
2.24
-5.19
-0.85
PRIVATE INVESTMENT
-4.78
3.43
-2.92
1.53
-12.33
-4.06
GOVERNMENT CONSUMPTION
1.00
5.00
5.00
8.00
5.00
12.00
GOVERNMENT INVESTMENT
2.00
5.00
5.00
8.00
5.00
12.00
FOREIGN EXCHANGE INCOME
30.84
32.80
31.30
31.28
29.06
29.00
PETROLEUM EXPORTS
14.92
14.78
13.30
13.30
11.09
11.09
OTHER MERCHANDISE EXPORTS
7.83
8.79
8.79
8.88
8.80
9.05
OTHER **
8.10
9.23
9.21
9.10
9.18
8.87
FOREIGN EXCHANGE OUTLAYS
31.29
32.67
32.01
33.00
31.02
32.05
DEBT SERVICE
17.06
17.08
17.08
17.08
17.08
17.08
MERCHANDISE IMPORTS
9.02
9.99
9.63
9.23
9.08
k
8.01
OTHER ***
5.20
5.60
5.30
6.69
4.86
6.96
FOREIGN EXCHANGE BALANCE
-0.44
0.13
-0.71
-1.72
-1.96
-3.05
CHANGE IN RESERVES
1.99
0.00
0.00
-1.00
0.00
-2.50
FOREIGN BORROWING REQUIREMENT
2.43
-0.13
0.71
0.72
1.96
0.55
MEMORANDUM ITEMS
TRADE BALANCE ****
15.33
15.26
14.14
14.64
12.48
13.80
CURRENT ACCOUNT BALANCE
4.52
5.12
4.32
4.83
3.12
4.60
* ASSUMES OIL GRADE MIXES ARE CONSTANT
INCLUDES SERVICE INFLOWS,
IN-BOND
PLANTS, AND
DIRECT FOREIGN INVESTMENT
*** INCLUDES OUTFLOWS FROM SERVICES AND CAPITAL FLIGHT
**** TRADE BALANCE = EXPORTS OF GOODS, IN-BOND INDUSTRIES AND TRANSPORTATION - IMPORTS OF GOODS
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Mexico: ,I
Baseline-
7-1
Case II
~~,~ Pew SO
Case III
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SUBJECT: Mexico: Impact of Lower Oil Revenues
Distribution:
Original - Requestor
1 - Executive Director, 7E12
1 - SA/DCI/IA, 7E12
1 - NIO/LA, 7E62
1 - NIC/AG, 2G40
1 -
1 - C DDI PE ,
1 - DDI/CPAS/ISS, 7G50
1 - D/ALA
2 - ALA/PS, 3F38
1 - ALA Research Director, 3F44
4 - CPAS/IMC/CB, 7G02
1 - C/MCD
1 - DC/MCD/CA
1 - DC/MCD/CU/M
1 - MCD Files
7 - MC/MX
1 - MC/MX Files
DDI/ALA/MC/MX
(14 November 1984) 25X1
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