Miguel Mancera, the Governor of Mexico's Central Bank, argues that the fall-out from the peso crash was not all bad news

Mexico suffered one of the greatest crises in its modern history following the peso crash in December 1994. Much has been written about this economic crisis, most of it highlighting its most negative aspects. This has meant that many important features of the Mexican economy have been overlooked or glossed over, despite the fact that many of these features represent a solid foundation from which the country's economy can take off in the not too distant future.

The depth and severity of the crisis, as well as the evident flexibility and efficiency of the economy, are perhaps best reflected by the virtual disappearance, in the space of a few weeks, of Mexico's external deficit. Few countries in recent history have experienced such a marked turnaround in the current account of their balance of payments - Mexico's, which in 1994 posted a deficit of nearly 8 per cent of GDP, was practically balanced (with a deficit of US$654 million, less than 0.3 per cent of GDP) in 1995.

A salient feature of the restoration of equilibrium in the current account is that it was brought about by a robust expansion of non-oil exports, rather than by a collapse of imports. Notwithstanding the depth of the Mexican recession, imports from the US during 1995 were above levels registered in 1993, the last pre-NAFTA year. In fact, 90 per cent of the change in the current account was down to improvements in the trade balance and close to 70 per cent was derived from the growth of merchandise exports. In contrast to past episodes of balance of payments difficulties in Mexico, the government did not resort to protectionist methods in order to contain imports, but held fast to its commitment to trade and capital account liberalisation. Even when confronted with a major crisis, the Mexican government, far from turning its back on liberal policies, has taken measures to strengthen these policies. This underlines the permanence of the structural changes which have been undertaken. The responsiveness of exports indicates both the appropriateness of these policies, as well as Mexican firms' greater efficiency and increased ability to compete in international markets.

In order to avoid an excessive dependence upon internal saving, the government has established the promotion of domestic saving as one of its priorities. In this regard, the reform of the Mexican Social Security Institute now under way is an important step. The reform consists of three main elements: fully-funded individual pension accounts; private management of investments made with resources from pension funds; and the separation of the pension system from the provision of social and health services.

The external sector is being supported by a clear commitment to a floating exchange rate regime. Intervention by the Bank of Mexico in the foreign exchange market has been sporadic and only designed to reduce unwarranted volatility, not to interfere with the market's role in setting the fundamental value of the peso.

An important role for the Bank of Mexico in the aftermath of the peso's devaluation in December 1994 has been that of lender of last resort and provider of liquidity to the banking system, both in pesos and in dollars. The challenge has been to fulfil this role without affecting the monetary programme at the heart of the stabilisation effort. In this regard, the joint efforts of the Bank of Mexico, the Treasury and the National Banking and Securities Commission have prevented the collapse of the banking system. A series of programmes has been launched to provide liquidity to troubled banks and to help them comply with their capitalisation ratios. Moreover, the central bank has been able to grant support to the banking system without producing an expansion of net domestic credit.

Mexico faced another daunting challenge in 1995: to pay off maturing short-term dollar-denominated securities (known as Tesobonos) which amounted to US$30 billion at year-end 1994. Although Tesobonos were classified as domestic debt, a good part of these public debt securities were held by non-residents. In order to fully comply with its obligations, Mexico negotiated an international financial support package with the US, Canada, the IMF, BIS and other international finance organisations. A total of some US$50 billion was committed. Using only a portion of these funds, Mexico was able to amortise the outstanding balance of Tesobonos and extend the maturities of its external debt. It must be emphasised that Mexico's foreign currency-denominated debt held by foreigners has not increased as a result of having used the financial resources from the international support package to pay off maturing Tesobonos. What has occurred is simply a substitution of external creditors. Furthermore, as a percentage of GDP, Mexico's total net public debt, including the accounts of the Central Bank, fell from 45.8 per cent in December 1994 to 43.4 per cent at the end of 1995.

An analysis of the historical trends of Mexico's debt shows that the prudent external public debt management policy implemented over the last few years, together with the excellent performance of exports, has reduced the overall burden of servicing that debt. Interest payments on external public debt, as a percentage of annual exports, declined from 20.7 per cent in 1987 to 7.9 per cent in 1995. Mexico's debt indicators compare favourably with those of other Latin American countries and many OECD nations.

Another encouraging fact is that international capital markets have recognised Mexico's strong adjustment policies. This has allowed the country to tap the international capital markets once again. The Mexican government and its agencies were able to secure fresh capital from these markets only five months after the eruption of the crisis. After raising US$4.7 billion during the second half of the year, the government began 1996 with about US$2 billion in new placements.

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Despite the deep recession of 1995 and associated loss of revenue, fiscal policy has remained tight and the budget posted a slight surplus. The government's main objectives were to increase public savings in order to avoid exerting pressure on domestic financial markets and to counteract the inflationary effects of the devaluation. Public spending was redirected to helping those sectors most severely hit by the crisis. The surplus in the primary balance allowed the public sector to cover all its interest payments and the cost of the Debtors' Support Programme for 1995 without relapsing into an overall deficit. For 1996, Mexico's budget programme aims at a primary surplus equivalent to 4 per cent of GDP and a balanced overall budget.

Mexico has continued with its liberalisation and privatisation programme, extending it to traditionally excluded sectors such as transport, telecommunications and energy. Significant progress was made in 1995 in preparing state-owned enterprises for privatisation. The government focused on establishing the legislative and regulatory framework for privatisation, and later awarded the first concessions for port operations and long-distance communications.

Mexico's stabilisation policies have been successful in containing inflation and producing a general downward trend in nominal interest rates. The Brady Bond Market has responded positively to these policies, suggesting improved investor confidence. Peso volatility has fallen, the stock market shows positive trends and there are signs of an economic upturn. Undoubtedly, some uncertainties remain. However, given the political will in Mexico to persevere in the adjustment effort, I am confident that the Mexican economy will emerge from this crisis stronger than before.

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©Kensington Publications 1996