MINING IN MEXICO — Mexican economy shows continued strength

Mexico’s’s current performance reflects the country’s long efforts to wrestle with financial imbalances, reduce its debt burden, control inflation and implement sustainable economic reform.

During 1955-70, real gross domestic product (GDP) increased at an annual average rate of 6.5%, prices rose by 3% a year and the external debt burden was moderate. In the 1970s, successive governments put into place a strategy of public sector-led growth, which further boosted output and employment. Notwithstanding a significant increase in oil revenues after 1975, this resulted in large financial imbalances, which were covered by external borrowing.

The expansionary fiscal policies culminated in the financial crisis of 1982, when inflation neared 100%, international reserves were virtually depleted, and the Mexican authorities imposed strict exchange and trade controls, nationalized the banking system and announced a partial moratorium on external debt-service payments.

In late 1982, Mexico embarked on a medium-term program centered on fiscal austerity, reduced reliance on foreign commercial borrowing, and adjustments in the value of the peso. The program showed encouraging results in 1983-84, but the fiscal stance was relaxed in 1985 and this, combined with a sharp oil price decline and increased external debt-service payments, led to resurgent inflation and new balance of payments difficulties.

In mid-1986, the Mexican government introduced a new economic program supported by a 1-year, stand-by arrangement from the International Monetary Fund (IMF) and a somewhat broader refinancing and new money package from the commercial banks. The economic program involved a major tightening of fiscal and monetary policies and a further depreciation of the peso; it emphasized structural reforms, particularly trade liberalization and divestment of public enterprises.

The stabilization measures led to an improvement in the balance of payments in 1987 but also prompted sizable increases in wages and prices. In December, 1987, the government responded by further tightening fiscal and monetary policies, freezing wages and public sector prices and pegging the exchange rate in the context of a pact among labor, business, and the government. The incomes policy contributed to lower inflation. But despite a substantial increase in real interest rates, uncertainty over the exchange rate policy led to capital flight and a sizable loss in international reserves. Soon after assuming office in December, 1988, President Salinas de Gortari unveiled a medium-term economic program to consolidate the gains already made and lay the basis for sustained economic growth and balance of payments viability. The program sought to increase public sector savings and to consolidate structural policies to foster economic efficiency and higher investment.

Because a significant reduction in Mexico’s net resource transfer abroad was crucial to the program, authorities began negotiations for financing with commercial and bilateral creditors. The government agreed on a commercial bank debt-reduction package in mid-1989 and concluded

a multi-year rescheduling agreement with Paris Club creditors. In May, 1989, the IMF approved a 3-year extended arrangement for Special Drawing Rights (SDR) 2,797 million; in January 1990, the arrangement was augmented by SDR466 million for debt-service-reduction operations. In May, 1992, it was extended for another year.

The centerpiece of the medium-term program was a substantial reduction of the overall public sector deficit. The government took steps to reduce disincentives in the tax regime and to bring the system more in line with international standards. To this end, the tax rate on the highest personal income bracket was lowered, and taxes on dividends were eliminated. The rate of the value added tax was halved from 20% to 10%, and several excise taxes were lowered.

To increase the equity of the tax system, the tax burden was reduced substantially for individuals earning less than five times the annualized minimum wage. To compensate for any revenue loss from these measures, the government levied a minimum tax of 2% on the assets of all firms and eliminated tax exemptions for certain industries.

With a view to deregulating the financial system, the program removed controls on interest rates and maturities of bank instruments and deposits, and restrictions on bank lending to the private sector. It also discontinued mandatory lending by commercial banks to the public sector at below-market interest rates. In 1991, the system of compulsory liquidity ratios, which earlier had replaced legal reserve requirements, was abolished. To facilitate monetary control, the program expanded the range of available government securities, and the central bank began to place more emphasis on open-market operations.

Despite four rescheduling exercises since 1982, Mexico’s external debt burden was still fairly onerous in 1988. The agreement reached with commercial banks in mid-1989 enhanced private sector confidence. It reduced external debt by about $17 billion (or about 18%), lessened future interest obligations and changed the maturity of the remaining commercial bank debt. Mexico financed the debt package in part by using resources from the IMF, the World Bank and Japan.

During 1989-92, the privatization gained momentum as some 800 public enterprises were sold, including two airlines, the steel and copper mining companies, and the government’s controlling interest in the telephone company. During the same time, the commercial banks were reprivatized, which was critically important in bolstering business confidence and greatly contributed to increased capital inflows.

The medium-term program extended the pact between labor, business and government. The pact provided for the depreciation of the peso against the dollar according to an announced daily schedule, adjustments to minimum wages in line with projected inflation and increases in public sector prices and tariffs to maintain relative prices. In late 1991, the exchange rate policy was modified by the introduction of a band within which the peso could move freely.

The pact also called for close collaboration between the government and individual communities to lessen the adverse effects of poverty and to integrate the poor into the process of economic recovery. This included the expansion of education, nutrition and health programs and the provision of drinking water, sewage facilities and electricity to poorer communities. During 1989-92, Mexico introduced significant changes in its foreign investment regime and consolidated the gains from the trade liberalization. In 1989, it simplified procedures for authorizing investment projects, relaxed limits on foreign ownership, and reduced barriers to foreign participation in the Mexican stock market. Most importantly, the government signaled the irreversibility of the trade reforms through the negotiation of the North American Free Trade Agreement (NAFTA) with Canada and the United States. Mexico also signed a trade agreement with Chile in 1991 and has been negotiating similar agreements with several other Latin American countries. The results of the economic program have been very encouraging. Average real GDP growth accelerated from 1.5% a year in 1987-88 to 3.5% a year in 1989-92, outstripping population growth and resulting in an increase in real GDP per capita of about 1.5% per year.

Growth was led by real private investment, which, facilitated by large private capital flows, increased by about 8% a year in 1989-92. Real consumption, however, also registered a strong rise, as private savings declined.

The 12-month rate of inflation declined from 52% in 1988 to nearly 12% in 1992 — the lowest rate in 17 years. Real wages in the manufacturing sector increased by almost 7% a year during 1989-92, partly offsetting the real wage declines in 1982-88.

The primary surplus of the public sector increased from an average of 5.5% of GDP during 1987-88 to an average of 8% in 1989-90. With a sharp increase in social expenditures, the surplus returned to the lower level in 1991-92. This strong performance and the decline in the nominal and real interest rates resulted in a shift in the overall public sector balance from a deficit of 13.2% of GDP in 1988 to a surplus of 0.6% of GDP in 1992. Over the same period, the operational balance — the change in the real net debt position — shifted from a deficit of 4.5% of GDP to a surplus of 3.3% of GDP. The liberalization of the financial system and increased confidence in the economy prompted a resurgence of financial intermediation in 1989-92. Private sector claims on the financial system grew at an average rate of 14% a year in real terms compared with about 2% a year during 1987-88. The strengthening of the public sector balance and the repurchase of government debt with the privatization proceeds led to a substantial increase in bank credit to the private sector, which rose 31% a year in real terms during 1989-92. Decelerating inflation and financial reforms caused real interest rates to decline sharply in 1989-92. Measured on an ex-post basis, the real interest rate on one-month treasury bills fell from a yearly average of 16% in 1988-89 to 3% in 1992, before rising to an average of about 6% in the first half of 1993.

Mexico’s net international reserves rose by close to $12 billion during 1989-92. The reserve gain reflected significant private capital inflows as the external current account deficit rose from 2.2% of GDP in 1988 to 7.1% of GDP in 1992. Imports (in U.S. dollar terms) more than doubled from 1988 to 1992, largely as a result of industrial upgrading and modernization. Total exports increased at an average annual rate of 9%, with non-oil exports rising by about 10.5% a year.

The balance on the private capital account shifted from net outflows in 1987-88 to a net inflow in 1989, reaching $24 billion a year in 1991-92. Direct investment accounted for about one-fourth of total private capital inflows in 1991-92, whereas portfolio investment represented about one-half. Because of the effects of the commercial bank debt-reduction agreement and the rise in the central bank’s net international reserves, net external public debt declined from about 50% of GDP in 1988 to about 23% of GDP in 1992. With the re-entry of Mexican firms into international financial markets, private sector external indebtedness doubled from $15.6 billion in 1988 to $31.5 billion in 1992.

Economic performance in early 1993 continued to be positive. Inflation declined to 10% during the year that ended May 1993 — the lowest level in 20 years. Preliminary data also show real GDP growth at an annual rate of 2.5%, roughly the same pace as in 1992, while net international reserves continued to rise. Data through March indicate a continuing strong fiscal performance and a marked slowdown in bank credit expansion to the private sector. As a result, import growth has decelerated markedly, and, combined with the continued expansion of non-oil exports, has resulted in a narrowing of the external current account deficit.

The government continues to consolidate the structural reform process in 1993. It has proposed broadening the range of treasury securities; allowing foreign financial assets to be traded in the Mexican stock market; and bringing stock market regulations in line with major industrial countries. The Mexican Congress approved a constitutional amendment granting independence to its central bank. The Congress is also considering a new foreign investment law that will institutionalize many of the reforms that the executive branch had introduced in 1989.

— This article, written by the Mexico/Latin Caribbean division of the IMF’s Western Hemisphere Department, appeared in a recent issue of “IMF Survey.”