The Mexican Rescue Is Dangling From A Cliff

Two managing directors from Soros Fund Management made the rounds in Mexico City recently, quietly consulting with politicians, bankers, and a vice-governor of the country's beleaguered central bank. Among their questions: How would the market react if Mexico defaulted on its more than $20 billion in tesobonos, the dollar-denominated bonds whose repayment has been at the root of Mexico's worsening financial crisis?

It would be disastrous for Mexico to revert to its rogue-debtor status of the 1980s, most people told the Soros directors. But as Mexico continues to flounder, such a dire event--inconceivable a few months ago--no longer seems out of the question. While only a few analysts believe default is the likely scenario, gloom is setting in as even the U.S.-led $53 billion rescue package fails to restore confidence. Mexico, it appears, has not hit bottom yet. Says Rogelio Ramrez de la O, an economist who heads consulting firm Ecanal in Mexico City: "The writing is on the wall about how difficult it is going to be."

The crisis is building on three main fronts. As Mexico and the U.S. face off over terms of the bailout, Mexico's economic plight is worsening by the day. Meanwhile, the Mexican government fears that as much as $13 billion of the package may be delayed or withdrawn because of the tough conditions attached and reluctance by commercial banks to pony up their share of the funds. To top it off, Mexico's banking system is fraying badly--and may need as much as $9 billion to shore up capital and make up for past-due loans.

STRICT GUIDELINES. Such fears are stirring real worries that the bailout program might not be enough to contain Mexico's economic crisis--and that default is a possibility. As the depth of Mexico's worsening recession becomes clear, analysts wonder whether the country will be able to service its $153 billion foreign debt obligations--at least $45 billion of which must be paid this year (table).

This big chunk of debt--three times the amount paid last year--is falling due at a time when tax revenues are plummeting because of the recession. And Mexico won't be able to print money to pay the bills as it is under strict constraints from the International Monetary Fund and the U.S. Treasury. The falling peso further aggravates the payments crunch by raising the cost of servicing dollar debt for both corporations and the government.

Government officials express concern. "I think today it is very difficult to have a precise idea of what the government will be able to roll over," says Alejandro Valenzuela, Director General for International Affairs in the Mexican Finance Ministry. "We have to assume [the markets] will remain pessimistic for the next few months."

Facing a myriad of economic and political woes, President Ernesto Zedillo Ponce de Len spooked the markets by delaying the announcement of his economic program. The failure of a Mexican bank, Banpas, and its takeover by the government sparked fears of more bank failures and sent the peso plummeting 14%, to as low as 7.3 pesos to the dollar on Mar. 6.

Mexican officials are increasingly alarmed that the U.S. bailout package is trickling to Mexico too slowly--and that it won't stem the panic. Of the amount initially promised, Mexico has received only $10.5 billion--$3 billion from the U.S. and $7.5 billion from the IMF. And officials in Washington have made it clear that the next $7 billion of the $20 billion in total funds from the U.S. Treasury will not be forthcoming until Mexico complies with a series of strict requirements.

The first such test comes at the end of March, when IMF and U.S. Treasury officials descend on the central bank to pore over its books. "The main problem is timing," says one frustrated Mexican official. "We would be seeing a different story today if they had given us the money the day after the agreement was signed. Then the market would have perceived it as real money."

The delay may make it difficult for Mexico to comply with the U.S. Treasury's tough fiscal and monetary guidelines, officials say. "It's the chicken and the egg," fumes one government source. "We can't comply with the economic goals if we don't get the money soon, and we can't get the additional money unless we comply with the goals." Among the goals are a curb on the growth of money supply and 19% inflation for the year. But in February, inflation was running at an annual rate of 55%.

TROUBLED BANKS. Mexican officials also worry that some banks and institutions may hold back part of the package. A $10 billion bridge loan promised by the Geneva-based Bank for International Settlements may come too late to do Mexico any good, officials fear. And $3 billion pledged by a group of international commercial banks is unlikely to be disbursed, officials say, because the banks are wary of tossing fresh money Mexico's way.

Finally, Mexican officials say privately that they may have to spend heavily to rescue a number of troubled banks. The Mexican government already has spent about $1.2 billion to rescue two banks that failed late last year--Banca Cremi and Banco Unin. For the much bigger Banpas, the bailout cost has not yet been established. And bad loans may drag down other banks. Some even report that financially sound corporate clients are refusing to pay. They prefer to cough up a minor penalty and instead invest their spare cash in high-yielding fixed instruments until the crisis passes.

In the meantime, the Mexican government has been depending heavily on several U.S. investment banks, especially J.P. Morgan & Co., for help in negotiating terms of the U.S. bailout package and coming up with alternative schemes for refinancing tesobonos.

While the government struggles to contain the economic turmoil, political turbulence is mounting. Zedillo took heat on Mar. 7 as Mexico's Congress angrily debated the tough terms Washington imposed in exchange for the bailout loans. Despite opposition, Congress was expected to approve the aid package. And the government was likely to release its long-awaited economic plan soon after the vote mn the bailout.

But few investors expect the new economic targets to greatly improve the business climate. "Unless we have something absolutely dramatic, unexpected, creative, and tangible, it will have no impact, because it's months late," says Philippe Mellier, the newly named president of Ford Motor de Mexico. Indeed, the consensus economic forecast is for a drastic slowdown of 3% to 5% this year.

With little to offer on the economy, Zedillo seems to be trying to buy time with such spectacular moves as jailing the brother of his predecessor, Carlos Salinas de Gortari, and offering unprecedented power to opposition parties. Still, as Denise Dresser, a political scientist at the Autonomous Technological Institute of Mexico, points out: "Democracy doesn't fill the belly." It also may not be enough to pull Mexico out of its economic nosedive.

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