Created: 2/1/1986

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Implications of Mexican Financial Problems

special national inihllgcncr kmimato




The tohowing intelligence orgcmzations partkipated in the preparation oi the Estimate:

Th* Control Inft&gence Agency, Th* Dttenva intdgvnce Agency, the Notional SwiXtly Agency, and th* iMel&gence oraanra'iort of th* Daportrnant of Slate.

Aho Participating,

ot ant Chief of Staff for In'ofligenra, Daparlman' of the Army lha Oirartc* of Navol loteligenca. Deportment ofNovy Tha Aitiitant Oiaf of Sttrff, Intelligence-.ol tha Air Fexco Tha OirMio*elligrote. Marina Corp*

[orning Notice Intelligenceii^Mamodi Involved (YVNlNTf

Unauthorized Disclosure



implications of mexican financial problems

im-llon> diiik.hjvt-lucmxl b. irx-



Mexico's economic outlook lias become grim indeed:

1 "lie country's financial position, already shaky. Is now made significantly more difficult liy tin- sharp fall in oil prim.

Mexico Qtv has aniHiincwl it turdsillion in fnuticial reliefe believe Ihe needs are on the order9 billion, depending on the level al adjustment undertaken

President de la Madrid!-

lis con-imit

Ironted on all sides by political constraints that sharply limit liis ability to take tough adjustment measures.

hanks areard line, ami we expect many European hanks will not wantprovide substantial amounts of new money,arger share ot the debt to US interests

Thr key variables ut present are the price of oil and the nature of the supporting financial package that Mexico receives: from outside:

Should Mexico agreeinancial package in sonicof new money and concessiom, we believe the government will promise to undertake economic reforms but. because of domestic political constraints, fall far short of measures needed to prevent future financialignificantly improve lhe |marlormance of tbe Mexican economy.

Should the price of oil fall further or substantial liuancial assistance not be given, we believe Mexico will shortly begin to withhold interest payments selectively and may subsequently take additional unilateral actions.

In our view. Mexico will implement significant economic reforms only if deteriorating economic conditions convitier the ruling Institutional Revolutionary Party ;PRI) that its grip on power is threatened. We giveow probability over the next year, and in any case it will become more difficult lo make as the PRI gets closer to8 presidential elections.

If Mexico succeeds in negotiating significant new money and interest rale concessions, other debtors will put strong pressure on kinks lo match the terms. In the event Mexico takes unilateral action to limit its debl burden, we do not believe other debtors will act immediately in

concert to follow the Mexican load. Kvcn so, because of similar economic pressures affecting other debtors and the precedents for unilateral action, others could decide to follow suit. Tlie prospects for radical action by other debtors would increase if they perceived that Mexico was not sufferingesult of its actions.

Overall, the most likely outcome lor Ihe near term will he one of semibailout. minimal Mexican reforms.!

or not such an outcome evolves in coming weeks, the longer term financial outlook for Mexico

years, aim PRI will rise

certainly will dissatisfaction significantly.

This information i$

troubling. Feonomic conditions within Mexico almost the next two to three

deteriorate over the next two to with the stewardship of the ruling


Current Setting

exico is facing serious financial problem* ibis yearesult of expansionary economic policies, lower oil prices, anduch lesser degree the financial burden of the September earthquake. High government spending before elections In July and an accommodative monetary policy caused Ihe public deficit to swell to almostercent ol CM' last year, nearly double tlie rate targeted by the IMF. At the same time, inflation rose toercent, revrrsina two years in which the rate of price increases had fallen. Moreover. Mexico's trade surplus declined by almost

gainst this backdrop, the leeent sharp fall in oil prices is actingatalyst both to increase the financial burden of Mexico's lureign debt and to stimulate demands for relief on foreign debt servicing charges, winch will be> billion in lWtf.5 billion in interest. At Mexico's current average oil export price of about SI5 pci barrel, oil revenues will he roughly STi billion less than initially estimated for IHofi. Each additionalorine in thenu.t. 1it it5 million loss' in annual reieiplsa! an export level

est in

- I. '


Mexico: Real Interest Rale on External Debt'

nltll> I :



m.aiibinglt CTodurUon antKH'KC'ideciraon lo aVfend raarket dare unieaJ ofod prteeaeiudeidrapprd to



uring buyer

rt barrel,re honel andi-ihr hnrinnlnc of lamur* Uroran inair ave followedmice* downwaldaatr ronv hai retroactively ledueed price" several inn December Mexican crude, which soldrhariel discount from average wuild puces IWtt. hai lost ground. (bmnrtihvr prruuresaiid

diaulkf action wiih thr rrirvacllvr

hair leaned the Ueurant lo luwcier barrel, abwt Sb pit bairrlto pits* rtgicett rs>Ketport level* aiaylienow aaper day conpared

million baerrk per day



in oilherernce volatility and ahead How fail anil in large part. On ihc irlicnlarly Saudi Ara-creased marketoi responded to the cooperation and me

or incirami

ikely to voluntarily cut output significantly. I'nih-

Ir-ms in telling oillinted market or in pricing oil oimpotitively. however, could lead to productionin all pioduciog countries.

Wc cnviilon two imsslhle price scenario*

I'm* Emium Under this most llli-ly sienatlo. stolid od prim DsrragF per barrel lor ihrwith Mexican rmdr rmtmiiioitIeep dm-inl of at leaster bamrl below this avrraoe OPtC produaen limit their market dure largot lo aboutruJboo barnd* per day (V'cJlnorerhaalhr taailHand winter oil renui re merits cause prwei tn turn in

theI halfexico's llnanclal prob-

leinsI buyers additional let rrage, anilU fuiivdontinue nlferina discounted oil to bring ripoils up lo the targe levelnilllnii Iwirrh per day

rnor GoflaaMess likely butaiai bkr munn wodd oil price* cualinue In simalaadrt baled lor Ihr year Mrs scan crude price* (laobla lo HO lori barrel of below In tho ca*r. Saudiand <rthrf ttVYt'. eounines agarruively stair out an inririued inarket shire and at'rmpl tn nnluce ID null.miay lor ihc year [

illion barrels perexports in

ccounted lor aboutol Mexico's

export earningsovernment:e.

n the political front, the pressures limn lulling oil price* coming on lop of lhe already difficult financial and economic situation liavc causeddebate within lhe ruhng Imtilutioua!Pailv (PRO and Ibe government over riohcies required to restore Mexico's economic health De la Madrid, n. our roimtion appears to rrmainover what measures lo take In satisfy competing economii' ami polilical dernands wiih shrinkingAlthough the0 budget called for reducing the public-sector deficit,bservers believe the government had no intention of luoWlng through llie iioveinmrnt seems lo agier tor now onolicy of polilical statements designed lo dxiw ihe rest of the worldrisisinuniuent Indeed. SiJva. Herri*ossible presadeirtial candidalca. hoi leaned tn the political rhetoric. annouiBvingamdua in laic January thai 'lhe limit of the lespoiisihiliiy to ourhe respoiisibililv lo our people.'


|President de hi Madrid Is coming under increasing pressure from interests inside the ruling PRI and,esser extent, ciulsidc of it.P



unions, which

-i .iv!

supported lhe administration faithfully, now aredemanding more govenimenl alleniion and| .eftin political organizations and Indcpen-denl labor groups recently sponsored several peaceful

Pirn,exican Trade








callingebt moratorium; the lamest has attracted an0 marchers. De ta Madrid certainly docs not see die recents threatening and could limit them if he chose. Although the government has tolerated the demonstrations so lar, wc believe therehance theyand significantly, inflamed in part by the government's increasingly harsh rhetoric on the debt Should the demonstrations increase significantly, take on antone, or turn violent, they wouldactor in government policy.

$adrid's stance on llie debt is alsoby the fact that tbe PRI must contestncluding diflieult laces in the states of Chihuahua, Durango. and Sinaloa. To the extent that tlie government and ruling party can avoid economic austerity measures and escape burdensome debt service payments. Ihey will retain greater popular support and have greater resources at their disposal fur public works, patronage, andirluaily no prospect thai the I'HI wouldovernorship to an opposition party citherbout svhich the government is most concerned,arge number ol siatehouses will once again be at stake.

he private sector's influence on debt policy In diluted both by its weakened Institutional clout under this administration and divergent views Firms dealing heavily in foreign trade generallyadical Mesican position that could jevei trade lines and cripple operations. Other businessmen are morewith dwindling domestic consumption,il Mexico City resorted to lurlher economic contraction to make debt payments The problems austerity lias Caused for the private sectorey element in the strength of the opposition National Action Partyarticularly in the north.wc believe this is of secondary concern to de la Madrid al present, it docs make it increasinglyfor the PB1 to retain control of key governorships

Tabic I

6 Balance of Payments



.. iii -.


i. I'iHani"

FrlicjjrvrVbruarv *

CiDirnl Account

lido Balance

i uric











Mi. t


. : .





aiui plunrnvTiIi


Lo Madrid's Vlewi

S Dc la Madrid, for hb part, lias tjter.e drbl issue in the

pirscould sJntt withiling pnriireai currents He has noted en numerous occasions that Meiko <Jty will honor its international fiitancul obligation* Reeeitllv. however, he has stressed (hjt debt imvolentieavy drain on the economy and that circumstances may which hb government, despite its best intentions, may not be able to vcrviee il* debt Indica live of de la Madiid's stance has been his position on the IS debt inilialive announced bv SecTetarv Bakes in Seoul Ire la Madrid lias praised WaOurrctoa for recoemsna tbat Cat in debtor states mint have the wherewithal to grow At the same lime, he has maintained lhat the funds to be made available to debtors under the plan are insuffioeiil and that the conditions associated wilh it could piove politically




private wilor

Until .cRrtl linndrml.'iim md kmc In "i

Slniri Irrra



(lunar in

l.nun andjpiul lliftht






hVU'iiii :-


.Mf lU'.ll oil ennui

pricer> ImiitI.ullUm lutrr'i irr HW

' Hi'i piOCailtur, mlII1UUbaud illii*

'wit hnriaiii

' SbiIi kivmI (eJam* Urate iAnn> ad0 perMb il Imi'jam Ivrrru pre tin:iriMitai-ritf MMmitilr*jfcitico

! 'U"UIi pen-nil and

It-ihoiprrrrm. cli>rr**lcci t"a lir> priiml. mi bniMiii> In cuinui inriiri ami jiUil'iimlir-wuimmlil irdlicrCUP 33


M I .1 V If

Do la Madrid's political position willey bearing on Mexico* debt policy.!

expect lie la Madrid lo displ iv iluiacteristle caul ion in lot'imlallnR Mexico's debt policy and lo eschew any radical course, suchnilateralof Meitcao debi. exceptul reanrt Mon-like. in our view, woulderies of Mciicafrom posturing througharrearagesapping debtthe President leaving latitude for ictieat mid re-concilia-linn with creilllors ut each step along ihe way.)

Ill Despite de la Madrid's moderate policy prediand pfasmalic berJ. he nuglili government to lake strong unilateral action to reantW tlie debt issue, espeiiallt if he perceived Washington and creditors weretoplight. We believe he would makeW'uion only after carefully weigliing ihc political amihcne'lti ofove Alto, swaying de la Madrid to embark onadical course could he his perception lhat Mexico's lutiire economicwhich are vubstanl tally tied to oil prices, were wamne. and lh it domestic polllical imperative* madeove attractive In our view, ibe variable' ciuiently entering into de la MadihTi dedtkm (till weigh Muirxl the radical option. Noortbrk-av. eveoti lhat occur in the weeks aad month' ahead,the path of od prices and progreu in the debtould alter ihehinking ami thai of key

Fit>rr 3

US Dollar/PesoKales

of Ihe Bonks

II.ebruary announeemuni lhal ibisinancing needs would be i9 billionesult ol fulling oil prices surprised creditors, who believed ihit figure overstated tineawk, niven oil prlcat lhal prevailed al lhal (line. I'lcvioudy. the Mi-1leans had5el new fi-nancmg6 of whidi roughlylltow would

loin.evalualton. an increase inercent, and additional unspecifiedresultingn 5drop In realbelieve that

(lie sharply higher request was designed to iwetsure them into granting 'oncesUoits on interest payments Mexico's actual financingdepend on theof eionoinic measures implemented byharp devaluation of theWe beheve lhal politically difficult rconomit adjustrrreiit measures. Mexico's actual net financing seeds areillion, assuming an average Mexican od priceer barrel f

anker* argue lhal Mexicoduce Its ii nanelng needs4 billion il II implement* sigrilli-cant eeonoinic reforms,harp devaluation of Ihe peso and an increase in domestic utter est tales designed primarily to improve the trade Iwlance and arrest capital flight. These measuresS-

Given their vk-wi of the Mexican situation, most banks areard line:

Malor US banks have stated that interns! capital izalioii or Interest forgiveness is unacceptable and lhat, with some new money and economic udiust-incnl. Mexico willn interest paymentcliff scheme

Bankers base maintainedequest lo* new money as high6 it uriaccept-



US/Mwieon Tan

he United Slates' principal loreiant petmlrura aad ibud brgrri trade if paltam

US banks holdVi percrat of Mexico* tunr mcKlol debt, and invnatmeiit in the countryS firms accounts fur over in percent of total foreign incm mm t

The rvnouiiLies ol dnreia of dues un both isdei nf thr bolder are ifiraiarauh tr^ioVpetafrat ami Ihr arH-brtng of their people aKeitwined

The border assembly pmaiain. dominated hy US (iron, ii Mexico') (ast-aiowing economicand .Inarts is the aooaid-laigeg foreign itxclsairgc

Thousand* of US eiiiiens visit Mexico annually, helping make louri'ui the ihird-UrtjCSt foreign exchange corner.


aide. Private creditors have said that realistically Ihev can raise onlyillion.

In any case, bankers will demand that thr Men-can budget6 be accepted by Ihe IMF before agreeing In raise new medium-term cred-IU.I

csplle their currnnl position. wre believecould ratie as muchI!.if Mexico were willing lo undertake subatantial structural adiuslrnenl. bul interest payment concessions of any kind would pose nuuor problems for US Ixanks under current regulations. Specifically, deferred intcresl payments oi interest forgiveness would substantially reduce bank profitability and could result in the hanks having to writef the value of thru loaos Furthermore, interest concessions giantrd lo Mexico wouldtrong precedent for similar relief to other Latin delgors (sco table

uropean and Japanese creditors willMexican negotiations and wouldaction. Despite lhe exposure of theirgovernments iu these countries believe lhedealing svllh the problems falls onthey view Mexico primarilySofare noi willing to put up substantial no* funds for Mexico given Our polilical climate and the decline in oil pi Ires European Iwnks. however, would br more willing lo entertain an interest capitahzalioii scheme Although tbey could suffer financial kraut, tbey are in much better shape Ihan most major US banks because of greater reserves against their troubled loansegulatory environment that treats interest paymenu diffrimlly.

Mexican Negotiating Tactics

n our slew. Mexico Caly behevrs it ran yield lillle uiitli iU nedatcas We believe Vlencan officials will nwt eommitinenl lo serious longer term structural changes lhat run counter to traditional Mexican political and economicand wouldegative Impact on important interest groups Goseiiimeiit invohement ineep seated, with many Mexicanstrong gosenunent tnlevrnrrsjone ia the PRI Private-sector autonomy has been sacrificedpl groups such as labor and lhe left In return, affected influential businessmen have beenby protected market* and appointment lo top positions in stale-owned rnlrrpeises Al the same lime, strung Mexican rulionalumong-held policy of import substitution hinder Mexican policymaker* from significantly opening the economy.


Economic Reform

Imm Icrm structural changes needed to encourage donicstic savings and intcUmenl and reverse capital flight induce

Maintaining the peso and donieslic interestppropriate levels

Reducing 'heole in tlx! economy, especially bv reducingederiil budget deficit. Ifcliiidalins ineflicienl public enterprises, andMexico's hanks to nil vale-sector control

l.iberalixini: trade to pre mole competition through elimination of irniiort licenseseaucrntK red tape

export promotion in the privateto diversity munisnf foreign exchjr.iic mid reduce vultit-rahlhty to volntiV oil prices

C.'hanginsreiiui investment policies and laws lo

jcOuire capital, create jobs, and modernize Indus-

hould creditors be unwilling to provide coutin ucd significant financial assistance to Mexico, then wc believe the government will increasingly be forced into the position of having to decide tooratorium or to begin to undertake more significant economic reforms. At this point, we believe lhat political conditions in Mexico argueebt morato riurn, in part because the approach of the 1US$ presidential election will make it more difficult for the government to undertake serious lefnrm as lime noes on. However, should the I'M conclude that il* long-term hold on puwci is threatened by Mexico'sproblems, we do not rule out the possibility that the government will gradually decide to seii-ous slruotural reforms!


believe his

decision* are inllucnced by his concerns over foreign reaction to any strong Mexican moves on debt Even now. foreign banks arc taking actions in an attempt to isolate Mexico and try topillover from the clfects of any radical Mexican actions on otherIndeed, somearticularly smaller foreign and US regionalreduce or cease irade credits and interbank lines to Mexico. Some smaller banks may also decide to take other actions, including attempting to attach Mexican monetary and assels. Although such actions would cause serious short-termis dependent on strategic imports and access to the international financialdoubt thev would have disas-Irous economiche short term. Over the longer term, however, loss of access to lorcigfiartiCulailv trade finance, would make it impossible for Mexico to make any serious headway in improving domestic economic conditions.)

e believe the Mexican Government willto debate (he options over the next lew weeks.same time, ihey will step up pressure publiclyfor new money and concessions onAlthough Ihe government is currentlysome bankersartial debt moralorium,it more likely that, should live ncgotationsthe government will begin In .selectivelypayments, possibly within the next fewihnusdi Mexico would tie able to lemaininterest through April, given current net reserve.'billion. Mexico City could, for example, failinterest paymentsORCA debt due onpayment made by the government toobligations. The government. .H- in 'In-

IJS Treasury as welleans ofeadline lorcurrent regulations loans not receiving interest would be nlaicd on "iionaceiiiar statusays alter the interest payments stopped.

hould the negotiations drag on, thereeries of moves ihe Mexican Governould lake beyond selectively withholding interest payments but short oloratorium on all debt. These stew iticludc-

lo make payments lo commercial banks on medium- and long-term credits but honoring otherarticularly short-term ciedits.

cheme that links debt payment to export performance or some other criteria.

a moratorium until oil prices stabilize.

Reactions of Others to Mexico's Action

he outcome ol Mexico's dcalimcs with creditors will have an important effect on negotiations with other dctgois Mexico will draw moral support Irom many Latin American countries in negotiations tor interest rate concessions and new funds. Most Latin dehtois, including IBnuil. Argentina, and Vcnerocla, recognize that Mexico has little choice butduce or susiieiid its debt service burden. The (Cartagena Group


olatin dctoor nations prolraWv "ill endoise any action taken by Mexico. Should Mexico succeed in negotiating significant concessions, othci Latin debtors will put stronn pressure on banks to match the terms Al the veiy least, other debtors will uselo Mexicoenchmark for future iiecotialions with their individual

ring Sell

i- Mine ome countriesvaluate their positions onthe debt, particularly if they perceived thativiis not suffering serious consequences from itsions I

Should Mexico unilaterally limit its debtwe do nol believe that otherincluding the Cartagenaimmediately act into follow the Mexican lead Instead. Ihey would watch closely how tbe banting system and Western governments responded to any Mexican moves and how live Mexican economy as well as live puhlie reacted to whatever countermejsures were imposed. Moreover. Bra/.il, Venezuela, and Colombia are iu relatively strong financial positions at present,Caracas also lias In lie coneni lied with oil prices prospects.

Political Outlook

c la Madrid ami some other Mexican leaders almost certainly arc aware lhat economic conditions within Mexico will dcterioiate over tlie next two to three years, and dissatisfaction with the stewardship of tin- ruling PHI will rise significantly, in our judgment They also probably realize that it is in Mexico's long-term interests to undertake fundamental economic reforms Most I'M officials and other key interest groups, however, feai that this would result In an OrOSiou ol their long-term political hegemony I

ebtors outside of Latin America arc also likely In .seek special treatment or reevaluale llieii posit ions in servicing the debt, either in the case Mexico obtains major concessions or unilaterally reduces its debt service payments Many of these countries are lust as hard pressed as is Mexico by declining prices for llieii exports and economically and politically onerous debt service burdens. (See annex.}!

hould Mexico City and its credllorsegotiated settlement of the current debt question, we believe the de la Madrid administration will publiclyelf lo additional austerity and economic reform. Although Mexico City will promise far more than it will deliver, labor and other key groups will oppose even modes! reforms as they are implemented Moreover, real incomes would decline again in 1WH) on top of real wage declines in each ol the last thiee years We do not i'xpeel lltcse conditions to cause serious unrest in ihe near term. Disgruntlemenl with gnvernmeni policies and with the President'showever, will grow over time and make It more dillieult for the PRI lo retain offices in key areas

Should Mexico obtain special treatment, others are likely Iu try to make tlie case that they too are beset by world market forces, see no prospects' for an improvement in exportnd cannot for do mcstic political reasons make further substantial cuts ir. Imports. Indeed, should Mexico he unable In come to terms and take unilateral action to limit lis debt

hould the negotiations fail and Mexico take some unilateral action on its deht. (hereonic short-term political gain. Over the longer term, how-ever, domestic conditions would suffer because ol Ihc loss of foreign loans and trade credits and would add In dlssalisfanion with tin- PR)


mnsl rescut attentionsed on LDC oil exporters, most LDCs thai rely heavily onexport earning? die in serious financial ciindJlion

The pricr i4 tin. tin example lui fallen b(0 percent sincegh nearly all of the decline coming since theapse ol lhe tin market lale hut year.

Zinc, lead, and phosphate price* have declined sharply over the Usl year

Price* ol important LDC agratsdlural exports, inehjdinrr rice, palm oil. and coeonot oil abo have dropped over lhe las!orula.

Indeed, of someey LDC primary commodity exports, only five havc no< exiierii'iicrd lulling priies over lhe past year]

Collectively, these adverse price trendsibe export perforrnance and debtof debtors us Africa and Asia Egypt,haa been hit not only by falling oil priors,by lower prices for cotlnn, second only lo ml asexport. Morocco also experiencedearnings due largely to the drop in the pricewhich accounts for one-iuurth ol luWhile lower ml prion will benelil oilMorocco, tbe effect of lhe declines in pricesex port products have, in many cases,

Tin* picture is similar in Asia, wiih thr adverse el fitjlhiu- oil prices lining accentuated by price trends for olher primary commodities lhal account lor llse bulk of their nonoilor Malaysia the collapsr of tbe tin market not only means lower prices fear III tin exports, but abo perhaps basing In pot op fundi to cover tbe International Tin Council's share of the cost of ihe collapse


Price Changes in Key LDC Commodity Lx ports









f t

Tabic 4

Selected Debtors: Debt Seivicino; Capabilities


CommoditiM u

n Valued

d Tutil


n! Imiut*.

for 1*





Hjm'J miut4*

'in rs- material*rcieivB lumis cohl.


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