Over the past few months, through a presidential election campaign and an inaugural ceremony, a debate raged in the upper reaches of Mexico's government. Faced with mounting trade deficits, never-ending political tensions, and increasing concerns among international investors, should Mexico bite the bullet and sharply devalue the peso? Despite arguments that financial markets would shake off the effects of a carefully constructed devaluation, both the outgoing President, Carlos Salinas de Gortari, and his successor, Ernesto Zedillo Ponce de Len, steadfastly refused to countenance such a move.
Then, less than three weeks into his term, Zedillo did an abrupt about-face when a new flare-up of political tension in the southern state of Chiapas put even more pressure on the currency. Only days after Finance Minister Jaime Serra Puche had told global money managers that nothing of the sort was planned, the new government tried to devalue the peso by 15%--and then, with hard-currency reserves running low, let it fall by more than twice that (chart).
For a country that had staked its reputation on sound economic management, a strong currency to combat inflation, and heavy inflows of foreign cash to sustain growth, the comedown is humbling. Admits one Zedillo aide: "No one realized to what extent the economy was being held together with pins."
"100% ERROR-FREE." The strains are hardly over. Faced with widening investor dismay and competition from high U.S. interest rates, Zedillo will now have to mount a crash campaign to keep the currency-market mess from fueling massive inflation, sandbagging the economy, and perhaps dealing a blow to the hard-won North American Free Trade Agreement. Already, corporate Mexico is shuddering at the thought of coming up with more pesos to pay interest on its $30 billion in foreign-currency debt. Short-term rates have shot past 30%. And economists are sharply scaling back estimates for Mexican gross domestic product in 1995.
Zedillo is expected to announce his economic plans by Jan. 2. They may include short-term stabilization aid orchestrated by the Clinton Administration and the Federal Reserve, as well as longer-term measures to keep Mexico on the reformist path Salinas had blazed. Mexico needs some $14 billion over the next six months to cover maturing government and bank debt denominated in foreign currency, plus $10 billion more to fund its current-account deficit, estimates Baring Securities Ltd. analyst Damian Fraser. And, admits one Mexican government official, "unless we come up with a program that's 100% credible and 100% error-free, we'll be facing a debacle."
Even if the program is error-free, international fund managers, feeling betrayed by the Zedillo administration's clumsy handling of the currency collapse, may provide Mexico with only modest sums. They're also calling for the resignation of Serra, who alienated many with his prickly demeanor through the crisis. "However attractive they make themselves, money just won't be available," says Mark Turner, Boston-based international bond guru for Putnam Investment Management. "The spigot has been turned off."
CHARACTER QUESTION. Sources in Mexico City indicate Zedillo's new reform plan will boost the pace of privatization and probably propose the sale of the state electrical utility CFE. It also is expected to include as much as a 10% cut in government spending and cancellation of budget increases that had been planned for education and other key social programs. Mexicans may also be told that curbs on salaries must continue.
Whatever reforms Zedillo attempts will require deft maneuvering. Salinas was sometimes criticized at home for being too solicitous of foreign investors. But the wooing was necessary to convince the world that Mexico was a dependable place to invest. Zedillo, an economist, is trying to prove to critics that he possesses political skills by splitting his time more evenly between foreign and domestic listeners.
Still, the market fiasco raises questions about the character of Zedillo and his financial team. Salinas and his advisers viewed their $17 billion trade deficit as a necessary inconvenience to modernize the country. Since domestic savings were insufficient for the huge investments companies are making to modernize, Mexico needed foreign savings.
The reasoning worked for most of Salinas' six-year term, but with one catch. Mexico proved more successful at attracting portfolio investment from mutual and pension funds than at garnering direct investment in factories. By the time the crisis broke, Americans and other foreigners held $50 billion worth of Mexican shares, some 26% of the total market.
But as political turmoil increased in 1994, investors became more and more picky. The August elections seemed to show that Mexico had turned the corner. The September murder of a leading politician spooked the markets again. Despite that, Zedillo and Serra behaved as if the economy were running on autopilot and that political concerns were most important. In fact, many observers say the entire currency crisis could have been avoided had Salinas and ex-Finance Minister Pedro Aspe taken advantage of low U.S. interest rates in 1993 to issue long-term government debt. Instead, they continued financing Mexico's current-account deficit via short-term paper.
When the Fed raised interest rates in 1994, Mexico was obliged to follow suit--and got squeezed, just like hedge funds that also were being fueled by short-term credit. Salinas could have devalued the peso or raised domestic interest rates last fall, when currency worries broke out anew. But he didn't want to be the third President in a row to leave office amid a currency collapse. And, some say, he didn't want to see higher interest rates imperil Mexico's growth.
COOLING TENSIONS. Zedillo faces a hard battle at home and abroad to restore the credibility of his month-old presidency. But Mexico, even in crisis, is still in fundamentally better shape than it was during the troubled 1980s. Its government budget runs only a modest deficit, and inflation has dropped from 160% in 1987 to 7% now. The cheaper peso also should improve Mexico's global competitiveness and give a major boost to exports. And tensions in Chiapas appear to be cooling.
In putting his 1995 plan together, though, Zedillo must mind one simple lesson: If your country wants a strong currency, you have very little room to make mistakes. At a time of huge international financial flows and mounting competition for capital, even one step off the straight and narrow may do you in.