Bank Relief, Not Debt Relief

The sounds of triumph which greeted the preliminary announcement of the Mexican debt agreement last July had a hollow ring. Listening to the pronouncements of Mexico's President Carlos Salinas de Gortari and U.S. Treasury Secretary Nicholas Brady, one might have concluded not only that Mexico's economic crisis had been solved, but that the resolution of the Third World debt crisis required only the cloning of Mexico's agreement in each debtor country. But as Mexico and its creditor banks approach completion of negotiations for refinancing the country's foreign debt, the package has proved to be disappointing.

"The bank deal is no good even from the perspective of the Mexican negotiators," said Carlos Heredia, an economist formerly with the Mexican Finance Ministry. The country's $48 billion long-term foreign bank debt has barely been touched. If the economic growth which this country desperately needs after seven years of nearly unbroken recession is, as many Mexicans claim, dependent upon sharply reducing foreign debt payments, then this agreement will not provide the solution.

The restructuring of Mexico's foreign debt is occurring in the context of a government policy of financial and trade liberalization or apertura (opening up), that began in 1985. In four years, Mexico has moved from a managed trade system based on import licenses to a more liberal system based on tariffs. New laws have effectively lifted investment controls in most sectors of the Mexican economy. At the same time, world oil prices have been falling and Mexico has responded by scrapping plans to diversify its energy exports away from the U.S. market. Thus, a "silent integration" of the two economies is underway. Mexico's increased debt dependency on the United States is a key part of this economic integration, which could result in a bilateral free trade agreement after the conclusion of the current General Agreement on Tariff and Trade (GATT) multilateral trade negotiations.

Whatever minimal debt relief results from Mexico's bank agreement, one thing is certain: the average Mexican will not benefit from it. The standard of living of Mexican workers is still less than a quarter that of U.S. workers. This income gap was narrowing steadily until the 1980s, but now it is widening. The contrast between rich and poor in Mexico is among the worst in the world; the poorest 20 percent of Mexico's population receives 3 percent of total income, the richest 10 percent get 41 percent. Forty percent of the workforce is either unemployed or underemployed.

Mexico has been, in many respects, a model debtor. It has followed most of the conditions imposed by the International Monetary Fund (IMF) and the World Bank, and has paid its debt service and opened its economy. Despite the tremendous hardship these conditions brought, Mexico has little to show for its efforts. Production in 1988, for example, was 16 percent lower than before the debt crisis broke.

"Investment, the key to growth, has fallen from 22 percent of GDP in the 1970s to only 14 percent last year," said Heredia. To maintain political stability, Mexico needs growth of at least 4 percent a year to absorb its expanding labor force. But faster growth is impossible without more investment, which is, in turn, impossible as long as Mexico is forced to transfer 5 percent of its GDP abroad each year in interest payments instead of using it for investment.

As the first test of the Brady plan for Third World debt, the Mexico accord has dramatically failed in its effort to address these obstacles to economic growth. The point which is supposed to distinguish the Brady plan from the Baker plan and other abortive predecessors is that it does not rely on banks to provide new money, thus increasing debts rather than reducing them. Brady's new approach, announced in March of 1989, was intended to solve this problem by encouraging the banks to accept a 30 percent write-off of their outstanding loans.

The main elements of the Brady proposal are: (1) a U.S. Treasury estimate that Third World bank debt will be reduced by 20 percent over three years; (2) a de facto agreement by the banks that they would write down their loans in exchange for a guarantee of the remaining debt service payments by the IMF and the World Bank; and (3) an expectation that countries which benefit from debt reduction incentives will adopt free-market adjustment policies, including open trade and liberalized foreign investment rules.

When the Mexican agreement was announced on July 24, 1989, Mr. Brady and his Treasury colleagues must have felt great relief. The complex deal--negotiated with a country which has by far the most orthodox adjustment program in Latin America and which has a newly-elected government and a perfect record since 1982 of fulfilling its debt service obligations--was perhaps the most difficult agreement ever negotiated in the rancorous history of Latin America's relations with its commercial bankers. If the proposals made by the Treasury Secretary cannot work in the case of Mexico, by far the most important debtor in U.S. political terms, there will be little hope of applying them in more difficult cases like Venezuela, Argentina and Brazil.

In fact, Mexico, the United States and the world are now discovering that the Brady plan is unworkable even for Mexico. Behind the facade of success created by the Treasury lies the reality that the agreement provides only a tiny amount of debt relief for Mexico. Moreover, it abandons the principle of debt reduction upon which the whole Brady plan rests. The success of the package depends on a significant number of the banks being willing to make new loans, an unlikely event at present.

The preliminary agreement between Mexico and its 15 leading banks covers approximately $48 billion, about half of Mexico's $100 billion-plus foreign debt. Mexico's chief debt negotiator, Angel Gurria (sometimes known as "the Angel of Debt"), predicts the deal will be signed by the country's roughly 500 bank lenders in January. Under its terms, banks have three choices:

• They can swap their old loans for new 30-year Mexican Government bonds at a discount to face value of 35 percent; these "discount bonds" will pay interest at the same rate as the old loans- -13/16ths of a percentage point over international market rates.
• They can swap their old loans for new 30-year bonds with the same face value at lower interest rates; these "par bonds" will carry a below-market fixed interest rate of 6 1/4 percent.
• They can extend new loans (or recycle interest received from Mexico) over a four-year period equivalent to a total of 25 percent of their current medium- and long-term loans. The package aims at a maximum 35 percent debt reduction, a compromise between the 25 percent cut favored by Treasury and the 50 percent reduction proposed by the Mexican negotiators.

Some banks, of course, may decide to opt out of the deal entirely. Their loans, however, will be maintained under the existing rescheduling agreement, and will be the last to be serviced. A senior Mexican Finance Ministry official told Multinational Monitor that Mexico "will default on any loans under the old contract." If these banks sue Mexico, the official said, "We'll be happy to go to court, since our assets [in the United States] will be protected by the 95 percent of banks that participate in the exchange."

During the last week of negotiating the preliminary July agreement, two issues continued to divide the Mexicans and the bankers: the banks' insistence that they obtain increased interest rates, contingent in turn on higher oil prices, and the banks' eagerness for, and the Mexican negotiators' outright rejection of, debt-for-equity swaps.

The Mexican team yielded to the bank demands on both points. The banks are entitled to increased interest payments if oil prices top $14 a barrel, but the interest would not begin to accrue until 1996. And Mexico will resume debt-equity swaps on a scale of $1 billion annually over the next three years. Mexico suspended debt-equity swaps in April 1988, arguing that they unduly privileged foreign investors and fuelled inflation. "By opening the debt-equity window again, the Government is holding a garage sale of Mexican assets," claimed Heredia.

According to the debt agreement, the operations to reduce principal will be guaranteed by $3 billion worth of bonds bought from the U.S. Treasury. The "par bonds" option will be backed by about $3.5 billion in bonds that will guarantee interest payments for 18 months. Mexico will borrow $6 billion from the IMF, the World Bank and Japan and will put up $1 billion of its own money to purchase those bonds, which are referred to as "debt enhancements."

Even if, as the Mexicans have projected, 80 percent of creditor banks opt for reduction of principal and/or interest, Mexico's debt would drop by only $7.5 billion. "In this case, there would be almost no net gain for Mexico," said Jorge Castaneda, a professor of political science at Mexico's National Autonomous University, "Because the borrowing to back the debt reduction schemes totals $7 billion."

In terms of savings on debt service, Mexico will probably get less than half of what negotiators originally sought from the banks. Estimates as to the likely breakdown of bank participation in the three options suggest that the deal, combined with commitments already in place from multilateral and official lenders, would reduce Mexico's $10 billion in annual interest payments by no more than $800 million. In terms of reduction of the absolute debt, the bank deal could provide even less. Counting the approximately $1 billion in new commercial bank loans, instead of gaining a 35 percent debt reduction from the deal, Mexico may end up with a bank debt at least as large as it has today and certainly will continue to transfer annually the equivalent of between 4 and 5 percent of the nation's gross domestic product to foreign creditors.

The immediate reaction to the "debt reduction" pact has been mixed. The U.S. Treasury and the commercial banks are pleased, mainly because the agreed debt relief was only a maximum 35 percent. But one U.S. bank official admitted that the deal offers Mexico little real relief, as it would only stretch out debt repayments. "In reality it is the Baker plan again, but with more effective 'menu' items," the official said.

In Mexico, President Salinas proclaimed the result a victory. But economists of the nationalized bank, Banamex, believe that only a cut of at least 50 percent in the amount owed to foreign banks will make it possible to revive Mexico's economic growth.

"There is some concern that when the Social Pact ends in July 1990, the pressure may build up again, since the debt reduction package offers no rapid prospect of a return to economic growth," said Jorge Castaneda. The Social Pact between labor unions and business was launched in 1988 in an effort to stem mounting inflation. The previous Mexican president, Miguel de la Madrid, implemented the plan which devalued the peso, limited wages and froze prices.

There are other serious criticisms of the structure of the deal. Casteneda says "It is the banks who have been bailed out, not Mexico." The new center-left Party of the Democratic Revolution (PRD) is demanding that the bank deal be scrapped in favor of a payment moratorium and renewed negotiations with creditors. Ifigenia Martinez, a senator representing the PRD argues "It is our nation, not Mr. Brady or the banks, which should determine the real value of our foreign debt and how much we can afford to pay to creditors after satisfying our domestic development needs."

Organized labor, chafing under wage restraints and suffering from the 50 percent fall in real wages during the previous administration, views the bank deal as a signal that it should take a tougher bargaining line. Public sector unions and miners have struck to protest the agreement. Unions and left-wing parties, under the loose alliance of the National Patriotic Front which sprang up in September, have planned more protests.

The Mexican government is very concerned about the public impression of the deal because if the perception takes hold that this is a bad deal for Mexico, the prospective boost to investor confidence could be lost. Salinas hopes that the bank agreement will lead to an investment boom and a return of the estimated $55 billion in private flight capital which Mexicans have deposited in U.S. banks.

About $2 billion in flight capital has returned to Mexico since July, but this is probably less the result of the bank deal than of a Finance Ministry decree, issued on August 2, 1989, which declared a tax amnesty on repatriation of capital deemed to have left the country within the past three years. Since it would be difficult for the Ministry to differentiate capital by date of withdrawal, Mexicans suggest that the real intent may be to extend a blanket amnesty to all sacadolares (Mexican investors with dollar deposits abroad), by cloaking it in the more politically palatable guise of selective tax application.

The Mexican deal, far from being the triumph U.S. Treasury propaganda purports it to be, has merely underscored the obstacles which still remain in the path of meaningful debt relief for Third World borrowers and assurances of solvency for the greedy banks which poured so much good money after bad this past decade in Latin America.

Cameron Duncan is a Visiting Scholar at the Institute for Policy Studies in Washington, D.C. and co-author of From Debt to Development: Alternatives to the International Debt Crisis.