The Mess In Mexico

The economic meltdown in Mexico over the last three months raises a number of important policy issues. Will the new [...]

May 1 1995 by Riordran Roett


The economic meltdown in Mexico over the last three months raises a number of important policy issues. Will the new economic stabilize the domestic economy and restore investor confidence in what was one of the “hottest” emerging markets? Was the U.S. policy response appropriate? What are the implications for other emerging markets if they should face similar difficulties as a result of the Mexican situation?

The Mexican government went into a damage-control mode following last December’s devaluation of the peso and the tumultuous impact on the emerging markets that resulted. Finally, on March 9, the government announced its economic recovery program. The program’s basic thrust envisions that Mexico will end 1995 with a budget surplus. To generate that surplus, the government will cut its budget about 10 percent while increasing revenue through tax hikes and higher prices for goods produced by some state-owned companies. This means Mexico will remain in recession throughout 1995.

Mexican Finance Minister Guillermo Ortiz said he expected the plan would reduce the country’s reliance on imports and spur exports to create a trade surplus by yearend. Annual inflation is expected to reach 42 percent, and salaries for minimum wage workers will increase by 10 percent. Other contract wages will be negotiated between unions and employers without government guidelines. The value-added tax will be increased to 15 percent from 10 percent.

As a result of the austerity program, it is estimated that 750,000 Mexican jobs will be lost. Thousands of businesses are expected to go bankrupt. Interest rates of 90 percent on mortgages, credit cards, and car loans will push many families into insolvency.

Finance Minister Ortiz acknowledged that neither the government’s original emergency measures in January nor the availability of more than $50 million of financial aid from the U.S. and other nations had been sufficient to keep Mexico‘s economic emergency from deepening. Nor will these measures guarantee that Mexico will avoid social discontent and even strife as the year progresses. It is a difficult political year, with four major gubernatorial elections scheduled and a strong probability that President Ernesto Zedillo’s governing Institutional Revolutionary Party (PRI) will do poorly.

In addition, the Mexican “meltdown” raises foreign policy concerns in Mexico, the U.S., and elsewhere. The Clinton administration used the Exchange Stabilization Fund to provide $20 billion in loan guarantees and solicited other funding from the G-7 countries. This rescue package appears to have helped stabilize the peso in the short term. But reverberations from the Mexican crisis have shaken the emerging markets. Brazil announced an emergency program to shore up its currency by changing the trading band of the Real. Other measures included increasing overnight interest rates to 6 percent a month. The government introduced a 1 percent tax on foreign investment in the stock market and cut to 5 percent a 9 percent tax on foreign investment in fixed income securities.

In Argentina, stocks have dropped roughly 38 percent since the Mexican devaluation. And an estimated $3 billion of deposits has been withdrawn from Argentine banks. Recently, four banks closed down, because they lacked sufficient funds, and the government hastily organized an emergency support program for other endangered banks. Finance Minister Domingo Cavallo asked the International Monetary Fund for emergency funds and has induced the Argentine Congress to pass a set of laws to help reduce the 1995 deficit.

What happens next? It is unlikely the U.S. Congress will agree to any kind of loan guarantee program for either Mexico or any other “submerging” market. The Republican majority has a different agenda, and using public funds to bail out greedy investors or incompetent Third World governments is not on it. Can the international financial institutions come to the rescue? Certainly, at the margin, the IMF will continue to play a significant role. But is there sufficient liquidity to launch rescue plans for Eastern Europe or other emerging markets in Latin America or Asia? And will one-or more governments decide to run the risk of testing Washington‘s resolve not to provide additional rescue efforts?

The step taken by the Clinton administration has opened a Pandora’s box. While administration officials have argued that Mexico is a special case, other countries may not find that of much comfort if the volatility of 1995 continues. The politics of managing the Mexican mess may dominate the next phase in Washington and other industrial nation capitals, where Mexico is seen as an American problem that got out of hand on Clinton‘s watch.


Riordan Roett is director of the Latin American Studies Program at the School of Advanced International Studies, Johns Hopkins University, in Washington.