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Arthur F. Burns Papers
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The original documents are located in Box B80, folder "Mexico 4/76 - 10/77 (3)" of the
Arthur F. Burns Papers at the Gerald R. Ford Presidential Library.
Copyright Notice
The copyright law of the United States (Title 17, United States Code) governs the making of
photocopies or other reproductions of copyrighted material. Gerald R. Ford donated to the United
States of America his copyrights in all of his unpublished writings in National Archives collections.
Works prepared by U.S. Government employees as part of their official duties are in the public
domain. The copyrights to materials written by other individuals or organizations are presumed to
remain with them. If you think any of the information displayed in the PDF is subject to a valid
copyright claim, please contact the Gerald R. Ford Presidential Library.
i
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date October 8, 1976
To
Board of Governors
Subject:
From John E. Reynolds Jul
RESTRICTED
Attached for your information are two notes on the Mexican
economic program prepared by Mr. Maroni.
LIBRARY GERALD FORD
RESTRICTED
Comments on the Mexican Program
in the Light of Recent Developments
The Mexican program negotiated with the IMF staff¹/ is a
very comprehensive one covering all facets of economic and financial
policy. It will require a considerable amount of austerity for the
three-year period over which it will be phased. This period begins
January 1, 1977, and there are no policy understandings between Mexico
and the IMF for the remainder of 1976. This hiatus for the next three
months reflects the fact that the present Mexican administration will
be leaving office on December 1 when President-elect Lopez Portillo is
scheduled to be inaugurated. Apparently, outgoing President Echeverria
was willing to take the blame for the devaluation, but not for the
austerity measures which the situation requires. The result may well
be an erosion of the advantages expected from the September 1 devalua-
tion before the austerity program begins to take effect. Recent de-
velopments in Mexico described below would seem to be in line with this
assessment. If this trend continues, the peso, which is currently held
within narrow margins by the Bank of Mexico, may well have to be
allowed to float to a lower value in coming months.
1/ A summary of the Mexican program will be found in a separate
paper also being circulated.
RESTRICTED
MR
KBH 4/12/96
GERALD FORD LIBRARY
2.
RESTRICTED
Recent Developments
The Mexican stabilization effort has gotten off to a shaky
start. On the basis of rumors (officially denied) that (a) bank
accounts would soon be frozen and (b) exchange controls were about
to be imposed, a run on banks developed around mid-September, and the
capital inflow of early September was reversed. While the panic has
abated, withdrawals from banks continue. Our Embassy in Mexico and
the banks themselves are receiving an enlarged volume of inquiries
about investment opportunities in the United States. The demand for
U.S. currency has also increased.
Late last month, the Mexican government announced that the
wage increase promised by President Echeverria on September 1 would
range from 16 to 23 per cent. Organized labor, which had threatened
a general strike unless the raise amounted to 65 per cent, agreed to
this outcome when the authorities made it clear that prices of many
consumer goods would not be allowed to rise by more than 10 per cent
and that a freeze would be placed on others. These price measures
were put into effect on September 27.
However, this wage increase is in addition to the wage
bargains currently being negotiated by individual employers and unions.
These range up to 10 or 15 per cent, so that the total wage increase
this year will turn out to be close to 35 per cent for most workers.
FORD
RESTRICTED
GERALD
LIBRARY
RESTRICTED
3.
On September 29, the Mexican government tightened controls
on public expenditures and placed new restraints on investment spending
and on hiring of workers by the public sector. But the public sector
must now pay the higher wages just announced, and the peso burden of
its external debt service payments has jumped with the devaluation.
It will also have to cover the increased losses which public enterprises
must incur as a result of the price freeze on essential goods and services
sold by them in the face of higher costs. In this situation, the
September 29 measures appear likely to provide only a partial offset to
the continuing fiscal deterioration.
The full extent of the program and the magnitude of the re-
quired adjustments have not yet been spelled out for the general public.
As a result, the public remains confused and skeptical of the Government's
ability to prevent a further deterioration of the economy. The Govern-
ment's credibility has been damaged by the fact that the currency was
devalued after repeated assurances that it would not be, and now its
confident statements about the future are widely disbelieved.
More significant measures than the newly announced restraints
on public spending will be needed before confidence begins to return.
For this, most observers believe that we will have to await the inaugura-
tion of President-elect Lopez Portillo on December 1.
The Long-Run Prospects
The magnitude of the Mexican disequilibrium is such that a
major shock would have to be administered to the economy if it were to
RESTRICTED
GERALD FORD LIBRARY
RESTRICTED
4.
be corrected quickly. The decision to phase the adjustment over a
three-year period will make the annual adjustments smaller and
therefore easier to accomplish. But there is a danger that the will
to practice austerity may gradually weaken before the objectives of
the program have been fully achieved. If this should happen, there
could well be some slippage in the country's economic and financial
performance under the program.
Indeed, the magnitude of the adjustment required, particularly
in the budgetary area, is so large that some slippage may be inevitable.
But even if the precise targets of the program are not fully achieved,
the result should still be beneficial--unless the slippage is so large
that the country ends up in effect with no program at all.
Mexico's prospective drawings on the IMF under the Extended Fund
Facility arrangement will be phased over the three years to which the
program is to apply, and Mexico's eligibility to draw will be subject
to suspension if specified targets under the program are not met.
This will give the Mexican authorities an added incentive to persevere
in their efforts. The Fund staff will closely monitor Mexico's per-
formance under the program and will conduct frequent reviews to deter-
mine its continued eligibility. Should slippage occur and should
eligibility be suspended, new targets must be negotiated with the Fund
to restore the country's right to draw. This will provide flexibility
in case of slippage and ensure that Mexico is not faced with an
RESTRICTED
FORD LIBRARY
RESTRICTED
5.
all-or-nothing situation. In other words, if the improvement expected
under the program does not fully materialize, the door will be open
to promote a more moderate measure of progress--one which, hopefully,
will be attainable.
This flexibility on the part of the IMF, though understandable
carries the risk that the authorities, encouraged by knowledge that a more
modest degree of progress may be forgiven by the Fund, will not exert
their best efforts to carry out the original program, or will tend
too easily to give in to domestic political pressures to relax their
austerity policies. But this risk is probably the price that must be
paid to avoid a complete break between the member country and the Fund
in case of unavoidable slippage.
The Mexican program is very specific in most areas of economic
and financial policy, but it does leave a few things unsaid. One of
these has to do with interest rate policy. In this area, there is
a need for a rise in interest rates to make them positive in real terms
and thereby enhance the attractiveness of peso assets to domestic and
foreign investors. No such commitment or target is explicitly mentioned in the
Mexican memorandum to the Fund. However, the Mexican authorities have ac-
cepted a commitment to pursue interest rate, credit, and reserve requirement
policies that will permit the currency issue to increase by no more than
the amount of any increase in the country's net international reserves,
and within that constraint they have made a vague commitment to pursue
RESTRICTED
GERALD FORD LIBRARY
RESTRICTED
6.
an interest rate policy aimed at retaining the largest possible portion
of domestic savings within the country and inducing compensatory capital
movements. Some more specific interest rate action might be particularly
helpful in cushioning the capital outflows that have resumed at a
steady rate over the past three weeks. In fact, Mexican interest rates,
which are administered by the Bank of Mexico and remain fixed for sub-
stantial periods of time, have not been increased since the devalua-
tion. The last increase occurred only about three weeks before September 1.
The most crucial task of the program must be to permit a shift
of resources into the external sector. The program requires that strong
steps be taken in this direction, especially on the fiscal side. But
even over a three-year period, the proposed reduction in the size of the
public sector deficit is huge and must be thought of as quite ambitious.
A large part of the public sector deficit may be found in the state
enterprises, the social security system, the state and local governments
and the Federal District. There may be great difficulties in bringing
about the needed reduction in these sectors.
If the reduction which is envisaged were achieved, it would
allow the tightening of monetary policy that would support the aggregate
demand objectives of the program and encourage a net inflow of capital.
However, the measures needed to achieve the 1977 target for the public
sector deficit may have to be so severe as to produce a recessionary shock.
RESTRICTED
LIBRARY GERALD R. FORD
RESTRICTED
7.
This will severely test the will of the authorities to persevere
on this course and may bring about social unrest.
On the external side, the restoration of confidence so as
to end capital flight is another problem area. This may require the
adoption of political and social policies which partially reverse the
course followed in recent years--a difficult move to carry out. It
may also require steps to overcome the credibility gap that seems to
have been created by the decision to devalue after repeated assurances
that there would be no devaluation. Should the flight of capital
continue, this would jeopardize the achievement of the targets for
external official financing and for the rebuilding of international
reserves.
The performance of real wages is likely to be the most critical
element in determining the success or failure of the program. Holding
down increases in real wages will help directly in reducing pressures
on the balance of trade by restraining real consumption. It will also
help improve the public sector finances since wages are such a large
fraction of total public expenditures. But organized labor in Mexico
is powerful and holding down wage increases will not be easy. Indeed,
the shift of resources into the external sector could create significant
difficulties with the incomes policy.
Prepared by Yves Maroni
Division of International Finance
FORD
October 8, 1976
LIBRARY
RESTRICTED
RESTRICTED
Summary of the Mexican program and IMF Staff Assessment
The Mexican program developed in agreement with the IMF staff
in support of the Mexican request for an Extended Fund Facility arrange-
ment involves a three-year effort to correct the economic and financial
disequilibrium affecting Mexico. The program calls for the following:
(1) a reduction in the fiscal deficit from over 8 per cent
of GDP in 1976 to about 2.5 per cent in 1979, with about 40 per cent
of the distance (to 6 per cent of GDP) to be covered in 1977.
(2) a rise in public sector revenues from 26.4 per cent
of GDP in 1976 to 30 per cent of GDP in 1979, and restraints on the
rise in public sector current expenditures so that they will decline
as a percentage of GDP, from 25.9 to 24.5 per cent. This would result
in a rise in public sector savings from 0.5 per cent of GDP in 1976
to 5.5 per cent in 1979.
(3) restraints on the rise in public sector capital formation
to lower moderately the proportion of GDP which it represents (from 8.7
to 8.0 per cent), but a rise in private fixed capital formation from
14.3 per cent of GDP in 1976 to 18 per cent in 1979. With these in-
vestment targets, the rate of growth of real GDP would rise from 4 per
cent in 1976 to 7 per cent in 1979.
(4) a drastic cut in external financing by the public
GERALD
LIBRARY
sector--the annual increase in net external public debt would fall
from an amount equal to 5.7 per cent of GDP in 1976 to an amount equal
to 1 per cent of GDP in 1979.
(5) a shift in the balance of payments on goods and services
account from a deficit equal to 2.3 per cent of GDP in 1976 to a surplus
RESTRICTED
MR 95-1,#4
KBH 4/12/96
RESTRICTED
- 2 -
equal to 0.6 per cent of GDP in 1979, with about two-thirds of the
improvement to occur in 1977.
(6) a rebuilding of the Bank of Mexico's net international
reserves in an amount equal to 1.5 per cent of GDP, two-thirds of this
(or close to $1 billion) to occur in 1977. In this connection, the
program specifies that gold holdings are not to be revalued during
1977.
(7) a flexible exchange rate policy consistent with balance
of payments equilibrium and permitting a lowering of import duties
and the progressive reduction of non-tariff restrictions on imports
imposed for balance of payments reasons and of artificial incentives
for exports.
(8) a monetary policy designed to hold the increase in the
currency issue at or below that of the net international reserves of
the Bank of Mexico, to observe the explicit limits which are being
placed on the increase in the Bank of Mexico's net domestic assets,
and in general to promote the achievement of the objectives of the
program. In this connection, there is a specific understanding that
interest rate policy will be aimed at retaining the largest possible
portion of domestic savings within the country and inducing compensatory
capital movements.
(9) a progressive convergence of the rate of nominal wage
increase in Mexico with those prevailing in its major trading partner
countries, adjusted for differences in productivity gains.
R.
FORD
GERALD
RESTRICTED
LIBRATA
RESTRICTED
- 3 -
(10) the setting of prices and rate structures of goods
and services sold by state enterprises at remunerative levels, coupled
with periodic adjustments in the face of cost increases.
(11) efforts to avoid subsidizing consumers save in ex-
ceptional cases of articles of popular consumption.
Specific targets for all of the relevant macroeconomic flows
have been set in agreement with the IMF staff not only for 1979 but
also for 1977 and 1978. Mexico's performance under the program will be
reviewed periodically and will be measured against these targets.
To promote adherence to the program, Mexico's eligibility to
draw against the Extended Fund Facility will be conditioned on several
key targets being observed. For 1977 specifically, suspension of
eligibility will be triggered by (i) failure to achieve the quarterly
international reserve target, (ii) non-observance of the quarterly
ceilings on net external borrowing of the public sector, (iii) failure
to stay under the quarterly ceilings on the overall deficit of the
public sector, and (iv) violation of the October and December ceilings
on the increase in the net domestic assets of the Bank of Mexico. In
addition, suspension will be triggered by the introduction or intensifica-
tion of any non-tariff import restriction for balance-of-payments reasons
or by the imposition of any restriction on international payments and
transfers for current international transactions. Suitable performance
clauses will be established before the beginning of the second and third
years of the arrangement.
RESTRICTED
DERALD FORD LIBRARY
RESTRICTED
- 4 -
II. IMF Staff Assessment of the Program.
The IMF staff believes that the program contains both
reassuring and worrisome elements. They find comfort in the areas
of balance of payments and external public debt management, as well
as in those for commercial and monetary policy. They are also en-
couraged by the guidelines for price and wage policies, but they express
concern over the political difficulties standing in the way of terminat-
ing the rather general subsidization of consumers of basic commodities
and of securing the broad support needed for a policy of readjusting
real wages.
They characterize fiscal policy as another critical problem
area. They point out that the needed budgetary adjustment is enormous,
even if it is phased over three years. They comment that the adjustment
will require both revenue and expenditure measures and that the needed
compression of public expenditures will not be attained without restraint
on wage increases, given the importance of wage costs in public spending.
It has to be assumed that appropriate tax measures will be announced with
the next budget.
The IMF staff also stresses that success of the program will
be contingent on an early restoration of confidence at home and abroad.
The program calls for a strengthening of the net international reserve
position of the Bank of Mexico and a strong pick-up of private investment
activity. The IMF staff point out that neither of these objectives are
attainable if massive capital flight from Mexico continues or if Mexico's
foreign creditors seek to reduce their exposure in the country. Implied
RESTRICTED
FORD is LIBRARY 938839
RESTRICTED.
- 5 -
in this statement is a concern that political and social policies as
well as economic policies may inhibit private investment or frighten
creditors into retrenching. In this connection, the political and
social trends of the last few years are not very encouraging. More-
over, the fact that President-elect Lopez Portillo is a technocrat with
a relatively limited political base is enabling outgoing President
Echeverria to place many of his own followers in key positions around
his successor, and this may make it difficult to remove some of the
irritants which worry the private sector.
Finally, the IMF staff pointedly states that "the success of
the program also hinges critically on developments in the remainder of
1976, a period for which there are no policy understandings with the
Mexican authorities." The IMF staff ends its analysis with the statement
that, "notwithstanding the formidable tasks ahead, /they have/ no
reservation in concluding that the program is deserving of Fund
support with an Extended Fund Facility arrangement."
Prepared by Yves Maroni
Division of International Finance
October 8, 1976
RESTRICTED
FORD & GERALD LIBRARY
CHAIRMAN BU' 'S
For Information Only
[10-8-76]
RESTRICTED
RESTRICTED
HANDLE THE ATTACHED DOCUMENT IN ACCORDANCE WITH INTERNAL
INFORMATION SECURITY PROCEDURES FOR RESTRICTED INFORMATION
LIBRARY GERALD ? FORD
RESTRICTED
Two pages missing from earlier distribution of this memo.
Please replace with the attached copy. .
GERALD R. FORD LIBRABY
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date October 8, 1976
To
Board of Governors
Subject:
From John E. Reynolds Jul
RESTRICTED
Attached for your information are two notes on the Mexican
economic program prepared by Mr. Maroni.
GERALD R. FORD LIBRANA
RESTRICTED
Comments on the Mexican Program
in the Light of Recent Developments
The Mexican program negotiated with the IMF staff¹/ is a
very comprehensive one covering all facets of economic and financial
policy. It will require a considerable amount of austerity for the
three-year period over which it will be phased. This period begins
January 1, 1977, and there are no policy understandings between Mexico
and the IMF for the remainder of 1976. This hiatus for the next three
months reflects the fact that the present Mexican administration will
be leaving office on December 1 when President-elect Lopez Portillo is
scheduled to be inaugurated. Apparently, outgoing President Echeverria
was willing to take the blame for the devaluation, but not for the
austerity measures which the situation requires. The result may well
be an erosion of the advantages expected from the September 1 devalua-
tion before the austerity program begins to take effect. Recent de-
velopments in Mexico described below would seem to be in line with this
assessment. If this trend continues, the peso, which is currently held
within narrow margins by the Bank of Mexico, may well have to be
allowed to float to a lower value in coming months.
1/ A summary of the Mexican program will be found in a separate
paper also being circulated.
RESTRICTED
OERALD FORD LIBRARY
2.
RESTRICTED
Recent Developments
The Mexican stabilization effort has gotten off to a shaky
start. On the basis of rumors (officially denied) that (a) bank
accounts would soon be frozen and (b) exchange controls were about
to be imposed, a run on banks developed around mid-September, and the
capital inflow of early September was reversed. While the panic has
abated, withdrawals from banks continue. Our Embassy in Mexico and
the banks themselves are receiving an enlarged volume of inquiries
about investment opportunities in the United States. The demand for
U.S. currency has also increased.
Late last month, the Mexican government announced that the
wage increase promised by President Echeverria on September 1 would
range from 16 to 23 per cent. Organized labor, which had threatened
a general strike unless the raise amounted to 65 per cent, agreed to
this outcome when the authorities made it clear that prices of many
consumer goods would not be allowed to rise by more than 10 per cent
and that a freeze would be placed on others. These price measures
were put into effect on September 27.
However, this wage increase is in addition to the wage
bargains currently being negotiated by individual employers and unions.
These range up to 10 or 15 per cent, so that the total wage increase
this year will turn out to be close to 35 per cent for most workers.
RESTRICTED
GERALD FORD LIBRARY
RESTRICTED
3.
On September 29, the Mexican government tightened controls
on public expenditures and placed new restraints on investment spending
and on hiring of workers by the public sector. But the public sector
must now pay the higher wages just announced, and the peso burden of
its external debt service payments has jumped with the devaluation.
It will also have to cover the increased losses which public enterprises
must incur as a result of the price freeze on essential goods and services
sold by them in the face of higher costs. In this situation, the
September 29 measures appear likely to provide only a partial offset to
the continuing fiscal deterioration.
The full extent of the program and the magnitude of the re-
quired adjustments have not yet been spelled out for the general public.
As a result, the public remains confused and skeptical of the Government's
ability to prevent a further deterioration of the economy. The Govern-
ment's credibility has been damaged by the fact that the currency was
devalued after repeated assurances that it would not be, and now its
confident statements about the future are widely disbelieved.
More significant measures than the newly announced restraints
on public spending will be needed before confidence begins to return.
For this, most observers believe that we will have to await the inaugura-
tion of President-elect Lopez Portillo on December 1.
The Long-Run Prospects
The magnitude of the Mexican disequilibrium is such that a
major shock would have to be administered to the economy if it were to
RESTRICTED
GERALD FORD LIBRARY
RESTRICTED
4.
be corrected quickly. The decision to phase the adjustment over a
three-year period will make the annual adjustments smaller and
therefore easier to accomplish. But there is a danger that the will
to practice austerity may gradually weaken before the objectives of
the program have been fully achieved. If this should happen, there
could well be some slippage in the country's economic and financial
performance under the program.
Indeed, the magnitude of the adjustment required, particularly
in the budgetary area, is so large that some slippage may be inevitable.
But even if the precise targets of the program are not fully achieved,
the result should still be beneficial--unless the slippage is so large
that the country ends up in effect with no program at all.
Mexico's prospective drawings on the IMF under the Extended Fund
Facility arrangement will be phased over the three years to which the
program is to apply, and Mexico's eligibility to draw will be subject
to suspension if specified targets under the program are not met.
This will give the Mexican authorities an added incentive to persevere
in their efforts. The Fund staff will closely monitor Mexico's per-
formance under the program and will conduct frequent reviews to deter-
mine its continued eligibility. Should slippage occur and should
eligibility be suspended, new targets must be negotiated with the Fund
to restore the country's right to draw. This will provide flexibility
in case of slippage and ensure that Mexico is not faced with an
RESTRICTED
FORD is LIBRARY GERALD
RESTRICTED
5.
all-or-nothing situation. In other words, if the improvement expected
under the program does not fully materialize, the door will be open
to promote a more moderate measure of progress--one which, hopefully,
will be attainable.
This flexibility on the part of the IMF, though understandable
carries the risk that the authorities, encouraged by knowledge that a more
modest degree of progress may be forgiven by the Fund, will not exert
their best efforts to carry out the original program, or will tend
too easily to give in to domestic political pressures to relax their
austerity policies. But this risk is probably the price that must be
paid to avoid a complete break between the member country and the Fund
in case of unavoidable slippage.
The Mexican program is very specific in most areas of economic
and financial policy, but it does leave a few things unsaid. One of
these has to do with interest rate policy. In this area, there is
a need for a rise in interest rates to make them positive in real terms
and thereby enhance the attractiveness of peso assets to domestic and
foreign investors. No such commitment or target is explicitly mentioned in the
Mexican memorandum to the Fund. However, the Mexican authorities have ac-
cepted a commitment to pursue interest rate, credit, and reserve requirement
policies that will permit the currency issue to increase by no more than
the amount of any increase in the country's net international reserves,
and within that constraint they have made a vague commitment to pursue
RESTRICTED
FORD is LIBRARY GERALD
RESTRICTED
6.
an interest rate policy aimed at retaining the largest possible portion
of domestic savings within the country and inducing compensatory capital
movements. Some more specific interest rate action might be particularly
helpful in cushioning the capital outflows that have resumed at a
steady rate over the past three weeks. In fact, Mexican interest rates,
which are administered by the Bank of Mexico and remain fixed for sub-
stantial periods of time, have not been increased since the devalua-
tion. The last increase occurred only about three weeks before September 1.
The most crucial task of the program must be to permit a shift
of resources into the external sector. The program requires that strong
steps be taken in this direction, especially on the fiscal side. But
even over a three-year period, the proposed reduction in the size of the
public sector deficit is huge and must be thought of as quite ambitious.
A large part of the public sector deficit may be found in the state
enterprises, the social security system, the state and local governments
and the Federal District. There may be great difficulties in bringing
about the needed reduction in these sectors.
If the reduction which is envisaged were achieved, it would
allow the tightening of monetary policy that would support the aggregate
demand objectives of the program and encourage a net inflow of capital.
However, the measures needed to achieve the 1977 target for the public
sector deficit may have to be so severe as to produce a recessionary shock.
RESTRICTED
GERALD R. FORD LIBRARY
RESTRICTED
7.
This will severely test the will of the authorities to persevere
on this course and may bring about social unrest.
On the external side, the restoration of confidence so as
to end capital flight is another problem area. This may require the
adoption of political and social policies which partially reverse the
course followed in recent years--a difficult move to carry out. It
may also require steps to overcome the credibility gap that seems to
have been created by the decision to devalue after repeated assurances
that there would be no devaluation. Should the flight of capital
continue, this would jeopardize the achievement of the targets for
external official financing and for the rebuilding of international
reserves.
The performance of real wages is likely to be the most critical
element in determining the success or failure of the program. Holding
down increases in real wages will help directly in reducing pressures
on the balance of trade by restraining real consumption. It will also
help improve the public sector finances since wages are such a large
fraction of total public expenditures. But organized labor in Mexico
is powerful and holding down wage increases will not be easy. Indeed,
the shift of resources into the external sector could create significant
difficulties with the incomes policy.
Prepared by Yves Maroni
Division of International Finance
October 8, 1976
is
FORD
RESTRICTED
GERALD
LIBRARY
RESTRICTED
Summary of the Mexican program and IMF Staff Assessment
The Mexican program developed in agreement with the IMF staff
in support of the Mexican request for an Extended Fund Facility arrange-
ment involves a three-year effort to correct the economic and financial
disequilibrium affecting Mexico. The program calls for the following:
(1) a reduction in the fiscal deficit from over 8 per cent
of GDP in 1976 to about 2.5 per cent in 1979, with about 40 per cent
of the distance (to 6 per cent of GDP) to be covered in 1977.
(2) a rise in public sector revenues from 26.4 per cent
of GDP in 1976 to 30 per cent of GDP in 1979, and restraints on the
rise in public sector current expenditures so that they will decline
as a percentage of GDP, from 25.9 to 24.5 per cent. This would result
in a rise in public sector savings from 0.5 per cent of GDP in 1976
to 5.5 per cent in 1979.
(3) restraints on the rise in public sector capital formation
to lower moderately the proportion of GDP which it represents (from 8.7
to 8.0 per cent), but a rise in private fixed capital formation from
14.3 per cent of GDP in 1976 to 18 per cent in 1979. With these in-
vestment targets, the rate of growth of real GDP would rise from 4 per
cent in 1976 to 7 per cent in 1979.
(4) a drastic cut in external financing by the public
GERALD FORD LIBRARY
sector--the annual increase in net external public debt would fall
from an amount equal to 5.7 per cent of GDP in 1976 to an amount equal
to 1 per cent of GDP in 1979.
(5) a shift in the balance of payments on goods and services
account from a deficit equal to 2.3 per cent of GDP in 1976 to a surplus
RESTRICTED
RESTRICTED
- 2 -
equal to 0.6 per cent of GDP in 1979, with about two-thirds of the
improvement to occur in 1977.
(6) a rebuilding of the Bank of Mexico's net international
reserves in an amount equal to 1.5 per cent of GDP, two-thirds of this
(or close to $1 billion) to occur in 1977. In this connection, the
program specifies that gold holdings are not to be revalued during
1977.
(7) a flexible exchange rate policy consistent with balance
of payments equilibrium and permitting a lowering of import duties
and the progressive reduction of non-tariff restrictions on imports
imposed for balance of payments reasons and of artificial incentives
for exports.
(8) a monetary policy designed to hold the increase in the
currency issue at or below that of the net international reserves of
the Bank of Mexico, to observe the explicit limits which are being
placed on the increase in the Bank of Mexico's net domestic assets,
and in general to promote the achievement of the objectives of the
program. In this connection, there is a specific understanding that
interest rate policy will be aimed at retaining the largest possible
portion of domestic savings within the country and inducing compensatory
capital movements.
(9) a progressive convergence of the rate of nominal wage
increase in Mexico with those prevailing in its major trading partner
countries, adjusted for differences in productivity gains.
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(10) the setting of prices and rate structures of goods
and services sold by state enterprises at remunerative levels, coupled
with periodic adjustments in the face of cost increases.
(11) efforts to avoid subsidizing consumers save in ex-
ceptional cases of articles of popular consumption.
Specific targets for all of the relevant macroeconomic flows
have been set in agreement with the IMF staff not only for 1979 but
also for 1977 and 1978. Mexico's performance under the program will be
reviewed periodically and will be measured against these targets.
To promote adherence to the program, Mexico's eligibility to
draw against the Extended Fund Facility will be conditioned on several
key targets being observed. For 1977 specifically, suspension of
eligibility will be triggered by (i) failure to achieve the quarterly
international reserve target, (ii) non-observance of the quarterly
ceilings on net external borrowing of the public sector, (iii) failure
to stay under the quarterly ceilings on the overall deficit of the
public sector, and (iv) violation of the October and December ceilings
on the increase in the net domestic assets of the Bank of Mexico. In
addition, suspension will be triggered by the introduction or intensifica-
tion of any non-tariff import restriction for balance-of-payments reasons
or by the imposition of any restriction on international payments and
transfers for current international transactions. Suitable performance
clauses will be established before the beginning of the second and third
years of the arrangement.
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II. IMF Staff Assessment of the Program.
The IMF staff believes that the program contains both
reassuring and worrisome elements. They find comfort in the areas
of balance of payments and external public debt management, as well
as in those for commercial and monetary policy. They are also en-
couraged by the guidelines for price and wage policies, but they express
concern over the political difficulties standing in the way of terminat-
ing the rather general subsidization of consumers of basic commodities
and of securing the broad support needed for a policy of readjusting
real wages.
They characterize fiscal policy as another critical problem
area. They point out that the needed budgetary adjustment is enormous,
even if it is phased over three years. They comment that the adjustment
will require both revenue and expenditure measures and that the needed
compression of public expenditures will not be attained without restraint
on wage increases, given the importance of wage costs in public spending.
It has to be assumed that appropriate tax measures will be announced with
the next budget.
The IMF staff also stresses that success of the program will
be contingent on an early restoration of confidence at home and abroad.
The program calls for a strengthening of the net international reserve
position of the Bank of Mexico and a strong pick-up of private investment
activity. The IMF staff point out that neither of these objectives are
attainable if massive capital flight from Mexico continues or if Mexico's
foreign creditors seek to reduce their exposure in the country. Implied
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in this statement is a concern that political and social policies as
well as economic policies may inhibit private investment or frighten
creditors into retrenching. In this connection, the political and
social trends of the last few years are not very encouraging. More-
over, the fact that President-elect Lopez Portillo is a technocrat with
a relatively limited political base is enabling outgoing President
Echeverria to place many of his own followers in key positions around
his successor, and this may make it difficult to remove some of the
irritants which worry the private sector.
Finally, the IMF staff pointedly states that "the success of
the program also hinges critically on developments in the remainder of
1976, a period for which there are no policy understandings with the
Mexican authorities." The IMF staff ends its analysis with the statement
that, "notwithstanding the formidable tasks ahead, /they have/ no
reservation in concluding that the program is deserving of Fund
support with an Extended Fund Facility arrangement."
Prepared by Yves Maroni
Division of International Finance
October 8, 1976
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CHAIRMAN BURNS
For Information Only
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[10-20-76]
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HANDLE THE ATTACHED DOCUMENT IN ACCORDANCE WITH INTERNAL
INFORMATION SECURITY PROCEDURES FOR RESTRICTED INFORMATION
FORD is 076839 LIBRARY
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BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date October 20, 1976
To
Board of Governors
Subject:
From John E. Reynolds
for
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The attached note by Mr. Mills reports his investigation
into the large syndicated bank loan for Mexico now in preparation.
FORD is GERALO LIBRARY
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
Office Correspondence
Date October 19, 1976
To
Mr. Gemmill
Subject: $800 million loan to
From
R. H. Mills, Jr.
Mexico
RAM
I spoke on October 15 with persons at Chemical Bank
(Robert Engelhardt), Chase Manhattan (Anthony Gerard), and Citibank
(Jerry Finneran) about certain aspects of the $800 million loan that
these three banks and 15 other banks are syndicating for the Mexican
Government. The 15 other banks acting as lead managers include five
U.S. banks, viz., Bankers Trust, Continental Illinois, Manufacturers
Hanover, First National of Chicago, and Bank of America. The
Principal comments I received were as follows:
1. The Mexicans did not have to do any "arm-twisting" to
get those 18 banks to act as lead managers.
2. Chase, Citibank, and Morgan Guaranty - -- which latter
subsequently dropped out of the negotiations -- pressed for the
imposition of some conditions regarding Mexico's economic performance,
but none of the other banks sided with them, and Chase and Citibank
eventually went along with the majority. Most of the banks still
think of Mexico as "the best game in town" because of its economic
growth potential and close relationship with the United States. The
Mexicans were adamant against any conditions they think of themselves
as being more like Venezuela than like Peru.
3. Chemical and Chase wanted more information about the
Mexican economic situation and the Mexican Government's stabilization
plan, and asked to see the IMF report, but were refused. They said R.
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Mr. Gemmill
- 2 -
that most other banks were satisfied with the information they had.
Both Chemical and Chase felt that, because of what they saw as an
inadequacy of information, the negotiations were not conducted in a
sufficiently professional way.
4. All three of the banks I talked with said their Mexican
exposure would rise as a result of the new loan, because no big re-
payments would be made soon on earlier loans to Mexico, and these
banks thought that all or most of the other banks involved would also
experience an increase in claims on Mexico. Big repayments by Mexico
will be coming up in 1978-79.
5. The probable interest rates of 1-1/2 per cent over LIBOR
for the 5-year tranche and 1-3/4 per cent over on the 7-year tranche
are the same as what Mexican public sector borrowers were paying
earlier this year. But the likely front-end fees -- 1 per cent on
the 5-year and 1-1/8 per cent on the 7-year -- are higher than Mexico
was paying before.
LIBRARY GERALD FORD
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C.9b
FINANCIAL INDICATORS MEXICO
(dollar amounts in millions)
1975
1976
OCT1-
Week ended
YEAR
QI
QII
QIII
JULY
AUG
SEPT
28
SEPT 22
SEPT 29
OCT 6
OCT 13
OCT 20
OCT 27
EXCHANGE RATE (CENTS PER PESO, END OF PERIOD)
8.00
8.00
8.00
8.00
8.00
8.00
5.03
4.96
5.04
5.03
5.03
5.04
5.03
3.77
SDR VALUE OF PESO
.06842
.06924
.06985
.04364
.06980
.06957
.04364
.04363
.04362
.04364
.04351
.04367
.04363
n.a.
SHORT TERM INTEREST RATE (E.O.P.)
12.94
13.11
13.11
13.11
13.11
14.36
14.36
14.36
14.36
14.36
14.36
14.36
n.a.
n.a.
LONG TERM INTEREST RATE (E.O.P.)
No appropriate long-term rate available
e
RESERVES (IFS, E.O.P.)
1,533
1,501
897P
1,159
897P
57
AVAILABLE IMF CREDIT TRANCHES (E.O.P.)
433
620
615
621P
615
618
621P
621P*
INTERVENTION, PURCHASES (+) OR SALES (-)**
OF DOLLARS
-262
-840
-228
-131
-189
-156
-241
-288
(OF OTHER CURRENCIES; EQUIVALENT)
SWAP ACTIVITY
'INGS (+), REPAYMENTS (-)
360
--
360
--
--
--
--
--
--
--
-360
-360
SWAP LINE 360
* With additional credits negotiated from the Compensatory and Extended Fund facilities,
Mexico's overall access to IMF credit could rise over time to $960 million.
FORD
The figures reported in this row are those for Mexican intervention that is reported
to us, we understand that these data are incomplete and the net intervention and
change in reserves since September 1 may be one half or one third as large.
GERALD
LIBRARY
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October 28, 1976
MEXICO: ECONOMIC INDICATORS
(NOT SEASONALLY ADJUSTED)
C.9a
October 28, 1976
1975
1975
1975
1975
1976
1976
1976
1976
1976
1976
1976
1976
1976
1973
1974
1975 Q1 Q2 Q3 Q4 Q1 Q2 FEB MAR APR MAY JUNE JULY AUG
REAL GDP(BIL.P)
354.1
375.0
390.9
N.A. N.A. N.A. N.A. N.A. N.A,
N.A. N.A. N.A. N.A. N.A. N.A. . N.A.
TP (1973=100)
100.0 107.3 112.3
106.9 115.7 112.8 113.8 116.3 116.6
112.8 123.3 113.6 118.8 117.4 N.A. N.A.
UNEMPLOYMENT
NOT AVAILABLE
WPI (73=100)
100.0 122.5 135.4
128.5 133.6 138.0 141.2 149.1 153.9
149.0 151.2 151.9 154.2 155.6 159.5 159.0
168.8
CPI (73=100)
100.0
123.8
142.3
136.3
140.3
144.9
147.8
154.2
158.2
154.6
156.2
157.2
158.4
159.0
160.4
161.9
167.4
M1* (Seas.adj.)
24.8
20.9
22.2
5.6
6.5
3.3
5.2
4.3
5.1
1.5
0.6
1.8
3.1
0.7
N.A.
N.A.
EXPORTS ($BIL)
2.1 2.8 2.9
0.7
0.8
0.7
0.8
0.8
0.9
0.2
0.3
0.3 0.3 0.3 N.A. N.A.
IMPORTS (SBIL)
3.8
6.1
6.6
1.4
1.7
1.6
1.9
1.4
1.7
0.4
0.5
0.5
0.5
0.6
N.A.
N.A.
TRADE BAL ($BIL)
-1.8
-3.2
-3.7
-0.8
-0.9
-0.9
-1.1
-0.7
-0.8
-0.2
-0.2
-0.2
-0.2
-0.3
N.A.
N.A.
BALANCE OF GOODS
& SERVICES (SBIL)
-1.3
-2.6
-3.6
-0.8 -0.9 -0.9 -1.1 -0.6 -0.9
N.A.
N.A.
N.A.
N.A.
N.A.
N.A.
N.A.
*Percentage change from previous period.
GERALD
LIBRARY
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
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October 29, 1976
To:
Chairman Burns
From: Ted Truman EMT
At Governor Wallich's request I prepared
the attached notes on the meeting on the Mexican
economic situation that was held at Treasury
yesterday. I have also enclosed a copy of
Mr. Maroni's notes on the Mexican economic
situation that were circulated to the Board
earlier in the month. Finally, you will find
copies of the latest summary economic and
financial data on Mexico that we have.
If you would like to discuss with me any
aspect of these materials this afternoon, I will
be available. I will also be available either at
home or in my office over the weekend.
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E.M. Truman
October 29, 1976
NOTES ON MEETING ON THE MEXICAN ECONOMIC SITUATION
(October 28, 1976)
Participants: Governor Wallich, Under Secretary Yeo, Messrs. Robichek
(IMF), Cross (Treasury), Widman (Treasury), and Truman
Note: These notes are not intended as a comprehensive treatment of the
Mexican economic situation. They are based on a meeting that was
held at the U.S. Treasury at which information on the major
features on Mexican economic performance was exchanged. (The
discussion covered wage policy, exchange-rate policy, fiscal policy
external debt, and short-term prospects.) However, along with
the notes prepared by Yves Maroni on October 8, (copy
attached) these notes serve to bring the evaluation of Mexican
economic situation up to date to the extent that available data
permit. A set of the most recent Mexican economic and financial
indicators is attached.
I. Wage Policy
Mr. Robichek led off the discussion by commenting that the Fund
staff has passed through several phases in its understanding of Mexican
wage policy following the initial floating of the peso on September 1.
First, there was fear that wage increases would eat away all of the
competitive advantage to be derived from the depreciation. Second, when
the Government announced agreement on a package of wage increases ranging
from 16 to 23 per cent, this was regarded as favorable. Third, it was
learned to everyone's disappointment that these adjustments were to be
on top of regular wage bargains. On Wednesday, the statement was made
in the IMF Executive Board that the government would encourage the re-
opening of wage bargains that appeared to be excessive; no matter how
desirable such a policy might it, it hardly sounds realistic.
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Mr. Robichek explained his understanding of the situation. The
roughly 16 million Mexican labor force consists of three, approximately
equal groups: (1) workers who earn the minimum wage, (2) workers
covered under normal collective bargaining arrangements, and (3) workers
who are "self employed" who are concentrated at both ends of the income
distribution.
In Robichek's opinion, the wage increase of 23 per cent granted
to the first group were not excessive given that the last adjustment
was on January 1, 1976 and assuming that a further substantial adjust-
ment would not occur in January 1977.
In his opinion, the major problem involves the second group of
roughly 5 million workers covered under collective bargaining agreements.
The one million government workers in this group had not received a wage
increase since August 1975; therefore, Mr. Robichek did not think that
the 21-23 per cent increase that they had now received was too worrisome.
The big question mark concerns the other four million workers covered
by collective bargaining agreements, who will receive a 16-23 per cent
increase automatically. Here, case-by-case negotiations are now under
way and no one can tell how they will come out.
Mr. Robichek offered the following general observations. (1)
His hope was now that the average wage in 1976 would be no more than 30-
35 per cent above the average wage in 1975. (2) Over the first eight months
of 1976 the increase in wages had been about 10 per cent. (3) Prior to the
depreciation, changes in the cost of living were running at about a 15
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per cent annual rate. (4) He had thought that the maximum tolerable 1976
wage adjustment given the depreciation was an overall increase of 20-25 per
cent which he felt would have been consistent with an "equilibrium"
exchange rate of 20 pesos per dollar -- a roughly 40 per cent depreciation
from the previous parity of 12.5 pesos per dollar. (5) While he did not
think that present wage situation was a disaster, he found it disturbing
and still very uncertain.
Mr. Yeo echoed Mr. Robichek's sentiments; he had gone from elation
to gloom and was now in the middle.
A question was raised about union reaction to the second deprecia-
tion of the peso. Mr. Widman reported that he had heard that the (or
some) unions had indicated that they would not seek to reopen the over-
all wage bargain.
II. Exchange-Rate Policy
Mr. Robichek remarked that Mexico's exchange-rate policy since
September 1 had been badly handled. First, they had managed the rate
too heavily. Second, they had adjusted it after the initial depreciation
in the wrong direction, i.e., forcing a small appreciation of the peso.
Third, they had held the peg at 19.80 pesos too long. All of the official
intervention that occurred was at pegged rates, which was contrary to
the advice the Fund had given to Mexico. (The Fund paper on the
Mexican drawings of their expanded first credit tranche and under the
Extended Fund Facility states as an assumption that "the Mexican peso
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will be allowed to float in the next few months with only limited net
intervention by the Bank of Mexico, the latter's net international
reserves should not change much over the remainder of this year.")
Mr. Robichek said that he was, therefore, relieved that the
Mexican authorities had apparently now decided to allow the peso to
float more freely. (The average quotation on Thursday was 25.90 pesos
per dollar or a depreciation of over 50 per cent since August 31.) The
question was what would be the market's reaction. It was a second and
risker gamble.
Mr. Robichek commented that the figures the Federal Reserve and
Treasury had been receiving on Mexican intervention were an inaccurate
indication of the change in Mexican reserves. These figures cover
only net sales to banks by the Bank of Mexico. On the one hand, they
do not include purchases of dollars from government enterprises in
connection with their financial and other operations. On the other
hand, they do not include payments to finance withdrawals from dollar-
denominated accounts with Mexican banks.
Mr. Cross offerred the estimate that the actual change in
Mexican reserves since September 1 was on the order of minus $350 million,
in contrast with the over $1 billion in reported "net intervention."
Mr. Robichek reminded the group that no one had been able to obtain
hard figures the Mexicans are very hard to pin down. It was agreed,
however, that hard figures were necessary in order to assess the damage
inflicted by Mexican intervention policy.
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Mr. Robichek commented that the analysis of the intervention and
reserve statisticswas complicated by the fact that the Mexican situation
was one of a large current account deficit, capital flight, and the need
for large amortization payments all of which led to extensive external
borrowing. (See Section IV below.) He also commented that withdrawals
from dollar-denominated accounts were associated with persistent worries
that these accounts would be blocked or taxed.
Mr. Yeo commented that Lopez Portillo wanted to hold the rate
so that he could take adjustment action later. (It was unclear to me
whether he was talking about exchange-rate adjustment or macro-economic
adjustment or both.) He said that Fernandez Hurtado had been caught in
a crossfire involving the present government, Lopez Portillo, and the
unions. He, too late, persuaded the authorities to let the rate move;
now he has not only lost a large amount of dollars but a psychological
advantage vis-a-vis the market. His problem now was that he had to
intervene to some extent to prove that he had not "run out of gas" or
"exhausted hisammunition, 11 but he could not afford to get trapped again
(in the near future?) into pegging the rate. Mr. Yeo said he expects
runs on the peso because observers realize that there is a high
probability that at some point the Bank of Mexico will be forced to block
the dollar liabilities of banks.
III. Fiscal Policy
As a prelude to the achievement of the objective under the
Mexican drawing from the IMF Extended Fund Facility of reducing the
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global public sector deficit from 9 per cent of GDP in 1975 and an
estimated 8.2 per cent of GDP in 1976 to 6.0 per cent of GDP in 1977
and 2.5 per cent of GDP in 1979, the Mexican Government on September 29
announced the tightening of controls on public expenditures, new restraints
on investment spending, and restrictions on hiring new workers by the
public sector.
At the meeting, it was generally agreed that everyone had
received glowing reports on what was happening on the fiscal policy
front, but no one had any specifics. It was agreed that such specifics
were urgently needed.
IV. External Debt
Governor Wallich asked what information we had about Mexican
debts that were coming due.
Mr. Robichek replied that in his analysis he viewed the problem
as having three components. The first component is borrowing necessary
to cover the current account deficit estimated, by the IMF, at $4.3 billion
for 1976 less long-term capital inflows estimated at $1.2 billion for
1976 -- a net figure of $3.1 billion. (Note part of the long-term
capital inflow is in kind, directly offsetting the current account
deficit.) The second component is the amount that is necessary to
cover amortization payments on external public debt. For 1976, he
estimated these needs at $1.7 billion, including the assumption that all
debt with an original maturity of under one year must be rolled over or
refinanced once during the year. Adding these two components together
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one gets a combined total of $4.8 billion ($3.1 billion in net current
account financing plus $1.7 in amortization) or an average $400 million
a month, which was the figure he worked with.
Governor Wallich commented that Fernandez Hurtado had toldhim that
they needed only $250 million per month. Mr. Robichek replied that this
was an example of the problem of pinning the Mexican's down; what
assumptions was Fernandez Hurtado making? He cited the example of
Mexican statements that short-term credit lines of about $3.2 billion
in mid-1976 were "renewable lines of credit." But this was certainly
not the way banks saw them. (In other words, if Fernandez Hurtado
were including only the borrowing needed to cover the current account
deficit net of long-term capital inflows, then the average monthly figure
would be just over $250 million per month, using the IMF's estimate of
the 1976 current account deficit, which is higher than the official
Mexican estimate.)
The third component in Mr. Robichek's analysis of the Mexican
debt situation is the potential gross outflows from the dollar liabilities
of banks. As of mid-1976, such demand liabilities were about $1 billion,
and they rose somewhat thereafter according to reports, but we do not
have up-to-date figures on these liabilities. Total dollar liabilities
of banks were about $3 billion in mid-1976. Mr. Robichek made no
attempt to include these amounts in his calculations of Mexican needs
for external financing. However, everyone agreed that they were a
critical element of the story on which current information would be
obtained.
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Mr. Yeo said that the situation was not entirely one of measuring
Mexico's needs. Mexico needed to establish the proper "adjustment atmosphere."
If they were faced with policy paralysis, or had a poor financial
environment, or did not take needed adjustment actions, then they were
headed for trouble no matter how comfortable the formal debt situation
was.
Governor Wallich asked Mr. Robichek what he knew about the $800
million syndicated loan for Mexico; what was its role in all of this?
Mr. Robichek said that this was designed to cover part of the residual
financing of the 1976 public sector deficit. No new expenditures would
be financed from it either in 1976 or in 1977. In principle, it would
cover the $400 million per month in external financing needed during
the last two months of 1976.
Mr. Yeo said that we would be obtaining specific information on
Mexican debts coming due. He also volunteered the observation that it
was a very confused situation, citing the experience he had the day
before when first he was told Mexico was receiving $150 million from
Deutsche Bank and later was told that the deal had been cancelled.
V. Effects of the Mexican Program
It was asked what evidence, if any, we had regarding the effects
to date of the Mexican depreciation of the peso and the associated
program on the balance of payments. It was agreed that we had none but
would try to obtain same.
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Mr. Robichek merely repeated the figures in the IMF paper which
indicate a gross external borrowing requirement of about $5 billion for
1977 composed of $2 billion for the current account net of long-term
capital inflows, $1 billion to add to reserves, plus about $2 billion
for "amortization." (In other words, the rate of Mexican external
borrowing in 1977 will on average be higher than in 1976. But the
purposes will be different.)
VI. Items not Mentioned
The following items were not discussed at the meeting.
A. There was no mention of the fact that Mexico has
removed its export taxes imposed after the first depreciation of the
peso and has reinstituted export subsidies. The second action would
appear to violate the spirit, if not the letter, of the Mexican
commitment to the IMF on commercial policy.
B. There was no discussion of monetary policy.
Attachment
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