Mexico: Can It Cope?

The peso had plummeted, the stock market was on edge, and foreign investors were furious. Everyone wanted to know what Mexico's new President, Ernesto Zedillo Ponce de Len, was going to do about the country's currency crisis. So they turned on TVs and radios for a scheduled 6 p.m. Jan. 2 speech and waited for Zedillo to lead them out of trouble. But he never showed. A group of labor and business leaders who for years had given rubber-stamp approval to government economic plans refused to endorse his harsh austerity measures.

When Zedillo finally did appear on television the next day, Mexicans did not like what they heard. The somber President told them to prepare for a year of great sacrifices. "The devaluation will mean a drop in real wages for workers that can only be reversed gradually," he said. In his campaign, he had promised 4% economic growth, a flurry of new jobs, and "well-being for your family." And here he was on TV, offering none of the above.

REVERSAL OF FORTUNE. At the same time, foreign investors were stunned by Zedillo's failure to offer them more than a few privatization crumbs, even though overseas creditors had scrambled to put together an $18 billion currency-rescue package. As a result, the peso and Mexican markets slid precipitously after the announcement. "His speech was really disappointing, almost shocking in its lack of substance," said one stunned foreign banker. "No one could believe it."

What a change from former President Carlos Salinas de Gortari, who for years had told Mexicans that prosperity was within reach--that they were a First World nation waiting to happen. Zedillo's task was to extend the benefits of hard-won modernization to all Mexicans. But in the past few weeks, Mexicans have seen a shocking reversal of fortune. With the value of their wages slashed, Mexicans' dreams of prosperity have been dashed. At the same time, Mexico has shifted from a sure thing to a risky, developing country in the eyes of foreign investors. While they will benefit from lower costs, even multinationals are worried about the sudden uncertainty they see in Mexico.

There's a growing feeling of unease north of the border as well--especially in Washington. As the peso tanked, Clinton Administration officials such as Treasury Under Secretary Lawrence H. Summers cancelled ski trips to cobble together the global rescue package. Government sources say the Administration may be forced to pony up even more if the first bailout package doesn't work. The peso debacle has once again revived doubts about whether hitching together such vastly different economies as the U.S. and Mexico under the North American Free Trade Agreement will ever really pay off.

But the biggest concern is the situation in Mexico, where Zedillo has made a disastrous start to what could turn out to be a tumultuous six-year term. Although he served in two Cabinet positions under the charismatic Salinas, Zedillo, 43, doesn't seem to have absorbed his mentor's political skills or knack for projecting an air of authority. One reason Zedillo missed his appointed TV address was to give business and labor leaders a chance to debate his proposals--something the imperial Salinas would never have allowed. "I don't think their government has shown in any way, shape, or form that they are in control in stabilizing the situation there," says Thomas W. Weisel, CEO of Montgomery Securities, an investment bank in San


Despite the market turmoil, many executives and economists believe the underlying economy is basically sound and that devaluation will make investments even more attractive. Six years of deregulation and modernization under Salinas cleaned out the weak players, and Mexico's budget deficit, at 1% of gross national product, is one of the world's smallest.

Zedillo had a chance to redeem himself, but the program he finally produced is technocratic and could be politically unworkable. Its realpolitik is simple: a big squeeze on the domestic economy to keep the powerful forces of global money at bay. The plan calls for price restraint from business and a tight lid on wages to avoid an inflationary spiral. At the same time it tries to restore investor confidence with an austerity budget aimed at slashing the current account deficit in half, to $14 billion. Investors are also to be offered a crack at ports, railroads, local phone service, and satellite telecommunications. The main idea is to put a lid on imports and domestic demand while giving the devalued peso time to spark export-led growth.

BIG GULP. Underpinning the plan is the stabilization package paid for by the U.S., Canada, and other industrial countries. Some $3 billion is to come from international banks including Citicorp and J.P. Morgan. Investment banks are being pressured to help.

After having swallowed huge loan write-offs on Mexican debt in the 1980s, some lenders are not happy about sinking more money into Mexico. But they feel they have to fork over their quota. "If we don't participate, you can be sure we'd be sitting on the sidelines in the future," says one foreign banker. At the same time, however, the banks are feeling queasy because of the big risks involved. If Zedillo doesn't get his act together "the markets will blow right by $18 billion as if it were a rounding error," says one Western banker.

And it's not at all certain that the harried Zedillo can make his plan stick. He is at war with all his main constituencies: Mexican business and labor and foreign investors. Business is lobbying him to allow up to a 30% pass-through of price increases on imported goods to compensate for the peso devaluation. One wonders whether executives will heed his call to trim profits for the good of the country.

Another big question mark facing Zedillo is how willing Mexican workers will be to hold wage increases to 10% or less this year when economists expect inflation of at least 15%. For years, wages have been squeezed to bring down inflation, and today they lag 10% behind 1980 levels. While angry, Benedicto Martnez, a leader of the Authentic Labor Front (FAT), a confederation of independent unions, thinks most workers will see no choice but to go along in a country that is still creating far fewer jobs than the 1 million new workers who come into the market each year. "There's no spirit to fight" when you could lose your job, he says.

Even if business and labor stay in line, Zedillo will need to rebuild his tattered relations with foreign investors, who feel badly burned by the Mexican authorities. One thing he must do immediately is free his talented Cabinet secretaries, so they can use their own, better-honed public-relations skills to stem the crisis. The key man is the new Finance Secretary, Guillermo Ortiz, the replacement for Jaime Serra Puche, who took the fall for the bungled devaluation. As manager of the government's privatization of state-run banks two years ago, Ortiz won praise from foreign bankers for his openness and frankness. His challenge now is to use those same skills to reassure creditors and investors.

Ortiz' mandate is to shift Mexico's source of funding from volatile short-term securities to longer-term investment. For starters, he has turned to Wall Street investment banks to help him design a new series of dollar-denominated notes. They will be offered in exchange for billions of dollars' worth of outstanding tesobonos, which are short-term debt instruments sold in dollars but payable in pesos at the current rate. Since the currency crisis began, investors have shown barely any interest in tesobonos, even though their yields have shot past 12%. "That's an absurdly low rate in this currency environment," says Bear Stearns & Co. Managing Director

Geoffrey E.J. Dennis.

PAYOFF. Investment bankers and money managers think the new notes will have maturities of two to five years and will pay substantially more than U.S. Treasuries--perhaps as much as 20% at the outset. Some fund managers want the notes to be backed by collateral, say a portion of Mexico's oil-export revenues or other hard-currency cash flows.

Ortiz is also expected to move the government toward more borrowing from commercial banks to replace short-term financing by fickle mutual- and pension-fund managers. "The banks can take a longer view on sovereign credits," says Mark J. Siegel, head of emerging markets at Putnam Investment Management in Boston. The banks, however, may be looking at a lucrative payoff. Some Wall Streeters think that J.P. Morgan and Citicorp, among others, will reap handsome profits in coming years by lending to Mexico while taking major roles in the new privatization programs.

But Ortiz will probably have to expand privatization beyond the skimpy menu Zedillo provided. Most of what Zedillo offered was already in the pipeline. The one new wrinkle being discussed, allowing 100% ownership of Mexican banks by foreign institutions, which are currently limited to 30%, isn't arousing much interest. Any bank available would probably be riddled with bad loans. But interest is growing in other, more attractive, sectors. Zedillo will come under continued pressure to open up petrochemicals, gasoline marketing, refining and electricity.

Ortiz and Zedillo need to regain the confidence of investors for more than Mexico's sake. Because Mexico had been regarded as the Rolls-Royce of emerging markets, any long-term crisis of confidence could prompt investors to abandon developing economies around the world in favor of the safety of the U.S. Already, some analysts are questioning whether equity financing--the cornerstone of many developing markets--will be as available in 1995 as '93 or '94. Indeed, with rising interest rates and a stronger dollar already drawing investors back into America, "a prolonged Mexican crisis could trigger a much broader sell-off," says Paul Sacks, president of New York-based Multinational Strategies Inc.

Corporate investors, by contrast, have a longer, more positive view. They're encouraged by Mexico's economic reforms and the solid base NAFTA provides for increased trade. "I don't think our long-term view has changed any," says Vann Bussmann, corporate economist of Chrysler Corp., which exports minivan engines, Neon subcompacts, and Dodge Ram pickups from Mexico. "For a company like Chrysler, it's a good place to do business."

To Chrysler and others, the devaluation could make Mexico a much more attractive place to manufacture--as long as the cost of local inputs such as labor outweigh the price of imported components. Lower labor costs will "flow right through to the bottom line," says Chrysler President Robert A. Lutz.

One manufacturer thinking of expanding its Mexican operations is Chicago-based R.R. Donnelley & Sons Co., one of the world's largest commercial printers. Senior Vice-President Ronald G. Eidell says several Mexican publishers, which have been printing in the U.S. and shipping back to Mexico, now may take some work to Donnelley's Mexican presses.

ENRAGED. Devaluation could inspire a similar shift in strategy at Dean Foods Co., a dairy and vegetable company in Franklin Park, Ill., that expanded into Mexico recently. CEO Howard M. Dean says the peso's slide has spurred negotiations for a joint-venture manufacturing deal with a Mexican dairy concern. Because of the currency shift, the company is better off making products in Mexico rather than shipping them in from its plants in the southwestern U.S.

If any executive has a right to be miffed at Mexico, it is Charles A. Hayes, CEO of Guilford Mills Inc. The Greensboro (N.C.) textile maker in November closed on a $15 million purchase of a 75% stake in American Textile, a Mexican producer. "It would have been 40% cheaper if we had done it today," he says. Still, he remains bullish on Mexico. He figures the cheaper peso will speed the building of an export economy and of a middle class in Mexico.

For that to happen, according to many economists, Zedillo must stabilize the peso and check inflation. Then, "after a period of duress, Mexico can grow again," says Nora Lustig, an economist specializing in Mexico at Washington's Brookings Institution. "If the crisis can be contained, the fundamentals of the economy can rise to the fore in six months."

Some Mexican executives are already seeing a faint silver lining to the crisis. The devalued currency will protect them from stiff import competition and make their exports more attractive. "This devaluation gives us a competitive edge," says Carlos Slim Helu, whose Grupo Carso conglomerate exports everything from copper tubing to auto parts. Makers of processed foods should benefit immediately, as the cheaper peso makes imports of such U. S. products as Cheez Whiz and Haagen-Dazs ice cream more expensive. Makers of electronics goods, auto parts, and home appliances also will benefit. But for exporters to fully gain the benefits of devaluation, says Juan de la Torre Henson, corporate treasurer for the Mexican auto-parts maker Corporacin Industrial San Luis, "many industries still need to improve their quality."

And there is no doubt that there is going to be real pain before a strengthened Mexican economy emerges. Zedillo's planned $5 billion budget cut will essentially induce a recession. Economists have pared growth forecasts from 4% to near zero for 1995. Slow growth combined with loan rates of over 40% could force many Mexican businesses into bankruptcy. Manufacturers of toys, textiles, and footwear, hard hit by imports, may collapse under the weight of their expensive debt.

"PRETTY ROUGH." Local banks are also vulnerable. In the past 18 months, nonperforming loans have ballooned from 4.5% to an average of 8% of banks' total portfolios, accounting for as much as 60% of their registered capital. Since the peso started collapsing on Dec. 20, interest rates on treasury bills have more than doubled, from 13% to 31%. That has pushed rates for business and consumer loans sky-high. As defaults mount, "banks are going to be hard hit," says analyst Susana Ornelas of Baring Securities Ltd.

Eager to avoid bank failures, Zedillo is planning to draft new regulations allowing foreign banks to take large stakes in Mexican banks--up to 100%. But it is unlikely that many foreign banks, which recently won the right to open their own subsidiaries in Mexico, would be interested in acquiring troubled Mexican banks unless they were practically given away.

The uncertainty will hurt foreign companies operating in Mexico as well. Fresh from an emergency meeting of the Canadian Chamber of Commerce in Mexico, Douglas Clark, director general of Northern Telecom de Mexico's wireless division, reports that "the next two to three months will be pretty rough." A common problem will be getting paid. Northern Telecom bills its customers in dollars, and Mexican companies are delaying payment. Clark expects a sharp slowdown during the first half of this year. "Right now, our customers don't know what their plans are," he says.

Any foreign company that imports into Mexico is likely to be hurt. The devaluation could crimp American car exports across the border. And retailers, such as Wal-Mart, that depend on imports could find themselves at a disadvantage. Jay Fitzsimmons, Wal-Mart's vice-president for finance, says the company's plans to open 25 stores with its Mexican partner Cifra this year, could be delayed.

But none of these companies is giving up on Mexico. They aren't happy taking losses, but they will put up with short-term hiccups to reap long-term rewards. Even long-term investors won't stay on board forever, though. If Zedillo's plan unravels, Mexico could enter a downward spiral, producing turmoil and social unrest that could spark a wave of immigration into the U.S.

Zedillo has a tricky task ahead of him. He has to play the tough fiscal administrator to calm the markets and preserve the gains from devaluation. But he also has to convince long-suffering Mexicans that yet another belt-tightening is in their interests. If he succeeds, the last few weeks of chaos will be forgotten, and the hard-working Mexicans and a strengthened Mexican corporate sector could join the North American economy on a more equal footing. In the next few months, we will see whether this harsh early trial has transformed a dour technocrat into a real leader.

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