IMPLICATIONS OF THE MEXICAN CRISIS FOR US TRADE AND INVESTMENT AND IN LATIN AME

Created: 1/19/1995

OCR scan of the original document, errors are possible

. 03 5 NO. i;- PAOB

Office of African and UttinS

Implications of (he Mexican Crisis for US Trade and^ Interests in Latin America

Intelligence Report

The reverberationi from Mexico's financial crisis probably will adversely affect US exports elsewhere in the region, slow Latin American efforts to integrate with Mexico and Join NAFTA, and Increase Brazil's chances of becoming the hubouth American free trade area.

-- Higher interest rates worldwide and decreased availability of financing would dampen investment growth and consumption, causing the demand for US goods to be lower than previously expected.

At the same lime, the steep fall of toe peso probably will cause Mexican goods to displace those of other countries In the USrend thai could increase trade friction with Central American and Caribbean governments upset by the temporary withdrawal of the proposed Interim Trade Program.

Brazil's proposal toouth American free trade area may become more attractive if other countries believe Mexican Imports would present stiff challenges to domestic producers and if they

' about the effect of NAFTA membership on their trade deficits.

On (he other hand, the tumult in Mexico could lead to greater US investment opportunities In Latin American countries not suffering from Mexico's ills.

Reduced lending and some governments' desire to improve foreign investors' perceptions of (heir policies are likely to spur (he privatization of state enterprises.

- Moreover, Latin governments' recognition of the need for increased direct foreign investment and for financial market reforms could help reduce barriers to US firms and provide arguments for enhancing protection for intellectual property rights. I-

The Financial Markets' Impact on Latin American Imports

Foreign investors' shift away from emerging markets in the wake of the Mexican debacle has reduced lhe cliances lhat Latin Anvyica-excluding Mexico--will post in increase in iu GDP growth rateercent4erceni during the next three years.inimum, even if Latin Ainerican govenunents can attract portfolio capital back, corporation, and public-sector entities probably will face delays in placing bonds for investrnem projects due to tormoil in micmational financial markets and even higher .Merestin pan to risk premiums. If investors remain uneasy about Latin American leaders' ability to keep their economic programs on crack-especially tn Argentina and Braril-and ruing US interest rates further diminish the attractiveness of Latin American financial initrurnems and stocks, financing could become more scarce.

Before Mexico's crisis, the increase in real economic growth elsewhere in the region seemed likely to widen the current account deficit of the eight largest South American countries8 billionillion. Financial analysts had projected thai direct and portfolio investments would have covered about threc-fouiths of this amount

Potential difficulties in raising foreign financing and concerns that larger trade deficits would heighten investors' worries could prompt some governments to retrench in order to curb import growth.

Lower-than-potential growth in Latin America would aggravate losses in USin^

percent drop in the real exchange rate against the dollarDP growth rale likely to range between ercent thisexico probably will importillion less from the United Stales than if it hadevaluation and grownercent

-- ercentage point reduction in the QDP growth rate in the rest of Latin America would cause US exports to be0 million lower than carliei projected.

Potential Problerns AfaMd sfttft

The peso's plunge and the sharp contraction implied for Mexican real wagesto cause-some displacerneot of Central American and Caribbean exports onmarket and create biiitcia!

likelypercent increase in production by Mexico's assembly plants, together with gains in competitiveness,ignificant threat to exports to the United States of assembled garments from countries in the Caribbean Basin. 'c

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- Already worried about the implicanons of NAFTA for their clothing sectors, Caribbean and Central American leaders probably will step up pressure on Washington to give them the same access as Mexico to the

US market. |

The weaJoiess-of the Mexican peso also will work against regional integration efforts.

Given Mexico's pressing domestic problems and its uncertain economic prospects, the Zedillo goverrtrnent may shift free trade negotiations with Nicaragua and Peru to the back

Although El Salvador, Honduras, and Guatemala'jrobably will continue free trade talks with Mexico, the president of Guatemala's Central Bank says that lie will recommend revising the strategy for negotiating tariff cols in order to guard against widening Guatemala's trade deficit with Mexico.

Costa Rica, Colombia, and Venezuela-which already have free trade agreements withlikely to resort to safeguards to protect domestic rnanufacturers if thereurge of Mexicanome products still under negotiation in Colombia and Venezuela's free trade agreement with Mexico are virtually certain to remain excluded from the accord.

Progress towardree trade area of the Americas (FTAA) probably will slow.

-- Chile's Finance Minister has indicated publicly that he expects the

timetable for free trade talks with Washington to slip because hemisfortunes will mtensity debate on fast track in the

Although the benefits of the FTAA wilttrong lure, Mexico's balance-of-payments crisis might cause some countries to reevaluate the timing for seeking NAFrA

The situation could work to Brazil's advantage in making itself the hub of afree, trade

-- The Zedillo idrninistration's likely continuing preoccupation IfVith its financial troubles may give room to President Cardoso to take the lead on regional trade issues, provided that BrazU does not experience any dramatic capital flight

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proposal to concentrate on integrating regional trade blocs and to link South America to NAFTA only after eight toears may gain more appeal if Mexico is perceiveduch tougher competitor and if

other countriesworrvabout the impact of NAFTA niembership on their .trade deficits. | |

Potential Benefits for US Investors

Although the crisis may slow liberalization efforts in the next few months as other countries wait to sec if the situation stabilizes, it could, on balance,ositive effect on US investment opportunities over the medium term.

cieased availability and higher cost of foreign financing probably will spur privatization and initiatives to attract foreign partners in upgrading infrastructure.

Latin American governments' heightened awareness of the need for increased direct foreign investment rather than volatile portolio investments could also help stimulate efforts to ease restrictions on investment and will provide an additional lever in gaining better rjTOtection for intellectual property

-- Bvcn though thetfompt tighter lirruts on, portfoU^

and probably will cause foreign exchange controls in some countries to remain in place, it may provide an impetus to open financial services to foreign banks and to draw up designs for private pension plans to promote domestic savings. I .

--Secr^t^

Tafciel -

Current Account Balanca

Billion us;

(ej

(Ol

6

Estimated

Proiected

table Is ContWenllal No.om.

-

Equity Investment Flows

US t

:

1.B

Total

equity Hows Include direct foreign brvastmenl and portfolio Investment.

(a)foiecied

Original document.

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