Frightening Specter of Bankruptcy

By Thomas A. Sancton

An ailing neighbor looks to Tio Sam for a helping hand

Finance Secretary Jesus Silva Herzog exuded a somewhat forced air of confidence as he addressed his countrymen last week. Like a terminal-ward doctor polishing his bedside man ner, he likened Mexico's economy to a "sick patient" who required different treatments as his condition fluctuated.

With an unemployment rate of more than 50% and inflation that threatens to reach 100% by year's end, Mexico's economy is certainly ailing. In fact, the economic cri sis was widely viewed as Mexico's worst since the 19 10 revolution.

But to many Mexicans, the govern ment's drastic prescriptions seemed near ly as bad as the disease: the imposition of strict currency controls, an effective freeze on most dollar accounts, sharp price hikes and the second peso devalua tion in six months. Most was Silva Herzog's admission that Mexico was unable to meet current payments on its huge $80 billion foreign debt, among the highest in the Third World. The statement raised the specter of a possible default that would have a domino effect on the international banking system. No one was more concerned than U.S. bankers, who hold about 60% of Mexico's debt.

Indeed, rumors ripped through Wall Street late last week that two major New York banks, Manufacturers Hanover Trust Co. and Chase Manhattan, had extended so many loans to Mexico that a default would leave them insolvent. Both banks denied the reports, but rates for three-month maturity U.S. Treasury bills plunged to a 26-month low of 6.99%. Three of the world's largest banks--Bank of America, Citibank and Lloyds Bank of

Britain--were reported to have the greatest "exposure," in banking terminology, to Mexican borrowers.

To forestall a default, Silva Herzog had spent a weekend in New York City just before his televised speech. He returned home with the promise of a $1 billion advance against future oil sales from the U.S. Treasury's Exchange Stabilization Fund and another $1 billion loan from the Commodity Credit Corporation for grain purchases from the U.S. Meanwhile, an additional loan of $1.5 billion was being negotiated with the central banks of seven other Western countries and Japan.

After his speech, Silva Herzog returned to New York to meet with representatives of about 115 international banks that hold Mexico's foreign debt. He requested a 90-day postponement of loan repayments totaling some $10 billion. Silva Herzog added that Mexico would require between $500 million and $1 billion in additional credits over the next year. The proposals were accepted in principle.

The key to the salvage effort is Mexico's application to the International Monetary Fund for about $4 billion in loans over the next three years. Banking sources said that the request might be approved within six weeks, which would in turn give the commercial banks enough confidence to reschedule Mexico's debts. But the IMF is likely to demand some painful belt-tightening measures, including wage freezes, import restrictions and reduced government subsidies, which could dangerously aggravate social tensions in Mexico.

Ironically, the latest crisis had its roots in what was supposed to be the country's economic salvation: the discovery in the late 1970s of oil reserves estimated to total as high as 200 billion bbl., second only to Saudi Arabia's supply. As the pace of oil development increased, public expectations rose, and the government of President Jose Lopez Portillo launched a bold expansionist program. To pay for imports, private and public corporations increased their borrowing abroad. The crunch came when the current worldwide recession, along with the oil glut, sent prices tumbling for Mexican crude. Meanwhile, high U.S. interest rates increased the carrying cost of the Mexican debt.

As public confidence waned, Mexicans began converting their national currency into dollars at a rate of up to 25 billion pesos a day. Increased capital flight prompted last February's 40% devaluation. But the government immediately undermined the measure with sharp wage hikes that fueled inflation and led to a new run on the peso. Lopez Portillo, who had earlier vowed "to fight like a dog to defend the peso," was thus obliged to decree a second devaluation on Aug. 6. To complicate matters further, the government froze all foreign-currency bank accounts in Mexico, then announced last week that they would be paid off only in pesos at a fixed rate of approximately 69.50 to the dollar--far below the market rate, which was hovering around 100 at week's end.

The result has been a combination of panic, confusion and anger as Mexicans awaited the government's next move. "This is like Russia," said a 54-year-old Mexico City librarian who saves her money in dollars to go on a yearly trip. "We are trapped. It is against the working people who save their money for some simple pleasures." The anger has been aimed largely at President Lopez Portillo, who on Dec. 1 will turn power over to his hand-picked successor, Miguel de la Madrid Hurtado, who won 74% of the vote in last month's presidential election.

As bad as things seemed, most analysts felt that Mexico would eventually find a way out of its crisis. "When the dust clears," said one U.S. Federal Reserve Bank official, "I am confident this will turn out to have been a much shorter-term problem than the one in Poland." Working in Mexico's favor is the oil pool, which, despite declining prices, guarantees a substantial future export income. Another, paradoxically, is the sheer magnitude of the country's debt; rather than spark widespread financial chaos by declaring a default, international bankers have little real choice but to reschedule Mexico's payments. Finally, Mexico's strategic and economic importance to the U.S. means that the oft vilified Tio Sam can be counted on, once again, to lend a helping hand.

--By Thomas A. Sancton.

Reported by Laura Lopez/ Mexico City and Frederick Ungeheuer/ New York

With reporting by Laura Lopez, Frederick Ungeheuer

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