Tough Love In Mexico

For Treasury Secretary Robert E. Rubin, it was like being back on Wall Street. As co-chairman of Goldman, Sachs & Co., Rubin gained a world of experience structuring complex financings for foreign governments--which often balked at the stiff terms of overseas investors.

So when Mexican officials resisted Rubin's demand that they meet harsh economic targets as the price for $20 billion in Treasury loans and guarantees to stabilize their free-falling currency, Rubin played Wall Street hardball--holding up the package for weeks until the Mexicans on Feb. 21 grudgingly signed the deal on his terms. "The conditions are difficult, but there is no other way out," a senior Mexican Finance official said afterwards.

But politics still is Rubin's weak suit--and some experts are questioning whether he drove too hard a bargain. The plan provides Mexico with the long-term financing it desperately needs to bury most of its $21.5 billion in outstanding tesobonos--short-term bonds sold mainly to foreign investors--that were at the root of its liquidity crisis. But Rubin's tough terms, which effectively let the U.S. dictate Mexican economic policy, virtually assure that Mexico must endure a deep recession and raise the fear of political instability.

Many economists believe Washington had no choice but to impose stringent terms on a government that is widely viewed as fiscally profligate--and unwilling to own up to its mistakes. After Miguel Mancera, governor of Mexico's central bank, penned a defense of his government's monetary management in The Wall Street Journal on Jan. 31, Treasury Under Secretary Lawrence H. Summers erupted in a private session with Mexican officials, even threatening to curtail the plan.

BACKLASH. Given Mexico's spiraling economic problems, though, there's no guarantee the plan will work. "The Mexican economy hasn't hit bottom yet," says Leon Brand, global strategist for NatWest Securities Corp. "And it won't be easy for them to come out of the recession." Indeed, in their haste to dump Mexican stocks on Feb. 21 over fears that the plan would decimate corporate profits, traders put more downward pressure on the peso. That day, the bolsa was down 4.92% and the peso was off 4.0%, to 5.67 to the dollar. On Feb. 22, Mexico's 28-day interbank rate roared to 74.125%, from 49% just hours earlier.

This is the new reality for Mexico. Just weeks after Mexican newspaper headlines proclaimed "Viva Clinton" following the U.S. loan pledge--the centerpiece of a $53 billion international rescue effort--most Mexicans are waking up to the sobering details of the plan: Deep cuts in government spending, credit growth, money supply, and foreign imports, all promise hardship. While Mexican officials are still projecting growth of 1.5% this year, many private economists believe the economy is more likely to shrink by as much as 3%.

Prospects of a sharp downturn, coming on the heels of a devaluation of the peso that slashed most Mexican workers' earnings by 40%, could spark a backlash against President Ernesto Zedillo Ponce de Leon from voters who feel he's giving the U.S. government too much control over their country. In the wake of the ruling Institutional Revolutionary Party's larger-than-expected defeat in a recent gubernatorial election in Jalisco, Mexico's third-largest state, political experts believe the party could now lose upcoming gubernatorial races in Yucatn, Baja California, and Guanajuato. "The U.S. has taken the steps to save Mexico economically, but we could end up sinking Zedillo politically," says Delal Baer, a senior fellow at Washington's Center for Strategic & International Studies.

For their part, Clinton Administration officials argue that the strings tied to the loans--half of which will be made available by July--are necessary to ensure that taxpayer funds will not be put at undue risk. Rubin even retained a Mexico City law firm to ensure that Mexican officials couldn't exercise legal loopholes to escape the plan's tough terms. The Administration also wanted to make sure the plan doesn't stir opposition among skeptical members of Congress, who refused to approve an earlier $40 billion loan guarantee plan.

"CARPETBAGGERS." But in Mexico, economists believe that the Administration has demanded too much already to appease Congress. For example, Mexico agreed to try to keep money growth below the rate of inflation--and curb domestic credit demand--by pushing up short-term rates. The central bank acted Feb. 20, lifting its key rate to 50% from 40%. But the resulting turmoil will produce an 8% decline in business investment and a sharp rise in unemployment, to nearly 13% by 1997 from 9.6% last year, estimates WEFA Group, Bala Cynwyd, Pa. "The economy just can't manage these rates for the rest of the year without causing bankruptcies and defaults on corporate bonds," says Mexican economist Rogelio Ramirez de la O.

Other problems sure to irk Mexican nationalists are brewing. John E. Silvia, an economist at Kemper Financial Services Inc. in Chicago, predicts that Mexican companies will lose domestic market share to capital-rich foreign rivals--who may even try to take over the local businesses. "The risk is that you'll have all these carpetbaggers trying to gobble up Mexican companies for a song," Silvia says. That spells opportunity for Americans, perhaps--but it's more fodder for Mexican economic nationalists.

If that weren't enough of a headache, Zedillo is likely to encounter fierce public resistance to a U.S. requirement that the government raise $14 billion through the sale of state-owned assets over the next three years. The expected sale of some state-owned power plants, for one, will pit Zedillo against the powerful electrical workers union.

Anti-U.S. sentiment is also sure to grow over tough requirements that the buyers of Pemex oil, natural gas, and petrochemicals deposit their payments in the Federal Reserve Bank of New York rather than to the oil company. U.S. bargainers were so intent on obtaining this provision--which serves as collateral for U.S. loans--that they insisted on Pemex signing the loan agreement as a formal party to the deal. Rubin's objective was to make the payments automatic and to prevent Mexico from wiggling out of the deal on a technicality, such as by privatizing its oil giant. "It was vital that Pemex sign to make the condition as airtight as possible," says one U.S. official.

Still, the tough terms that Rubin extracted from Mexico serve as a warning for leaders of developing nations around the world. Washington has sent a clear signal that it won't coddle troubled developing nations if they run into economic difficulties. Now, all that remains to be seen is if Robert Rubin's form of tough love actually works.

Before it's here, it's on the Bloomberg Terminal.