More Was at Stake in Crisis Than Saving Wall St. Investors Pumping up the Peso

THE BALTIMORE SUN

New York -- A lot more than the fortunes of a few Wall Street high-rollers was at stake in the festering Mexican currency crisis -- it threatened to destroy investor confidence in Mexico and to destabilize the U.S. financial system.

What began six weeks ago with the collapse of the Mexican peso and the massive exodus of foreign investment capital from Mexico City and other emerging financial centers reached a turning point this week as President Clinton authorized direct U.S. Treasury action in the face of bipartisan objections to a $40 billion loan-guarantee package.

The Treasury Exchange Stabilization Fund, normally drawn on to defend the U.S. dollar, will be used to throw Mexico a financial lifeline. This will take the form of a $20 billion line of currency swaps -- in effect direct country-to-country loans for periods of up to five years, combined with securities guarantees that should let Mexico roll its crippling short-term debt into longer-term bonds due to be repaid in up to 10 years' time.

The International Monetary Fund will extend a $17.8 billion credit line and other central banks will kick in $10 billion through the Bank for International Settlements, based in Basel, Switzerland, bringing the total close to $50 billion.

In bypassing Congress, the administration cited dangers to the U.S. economy, currency and markets and the global financial system as well, if the crisis was allowed to fester any longer and Mexico defaulted on its obligations to investors holding its bonds.

Even the legendary global markets speculator George Soros expressed alarm last week, telling fellow financiers in the Swiss resort town of Davos that Mexico's fiasco could have "global repercussions."

Mr. Soros, who is based in New York, runs a multibillion-dollar investment fund and made about $1 billion in profits when Britain's pound collapsed in 1992.

"The whole notion of integration or world capital markets means you cannot unhook," said Shafiqul Islam, chief emerging markets strategist at the New York subsidiary of Credit Suisse, a Swiss-based bank. "When you are part of a family, others get affected as well."

It remains to be seen whether President Ernesto Zedillo and his financial team can stabilize the currency, which has lost about 40 percent of its value against the U.S. dollar since the crisis flared Dec. 20.

Mexico will use more than half the emergency credit line to repay the holders of $28 billion in tesobonos, short-term, dollar-linked bonds coming due this year, which were the focus of investor panic.

Mexican authorities hope this will alleviate uncertainty, allowing the country to bring down short-term interest rates, which soared to an annualized rate of 48 percent at the height of the crisis as the central bank desperately sought to pull in new money by offering high returns. This would ease the pressure on Mexican banks and businesses, reducing the risk that the country might fall into a recession later this year.

1982 all over again

At times, this crisis seemed a rerun of the Third World debt crisis of the early 1980s. Mexico assumed a starring role then, too, when it announced in August 1982 that it could no longer make payments on its $85 billion in loans from foreign banks, governments and agencies. But the steps taken over the years to resolve that crisis have profoundly changed the relationship between developed and developing nations.

Probably the most important mechanism was the Brady Plan, named for Reagan-era Treasury Secretary Nicholas F. Brady, its architect. The U.S. government prevailed upon commercial bank lenders to forgive about a third of the debt owed by Mexico, Argentina and other countries, and repackage the rest into tradable instruments known as Brady Bonds.

This promoted Latin economic development and the resurgence stock markets that attracted billions in indirect investment. Unfortunately, Mexico started depending too much on the influx of foreign investment cash to offset what it sent abroad for debt payments and imported goods, while foreign investors found high Mexican interest rates irresistible.

By late last year, Mexican authorities were finding it increasingly difficult to refinance the short-term debt, which by September 1994 amounted to nearly $58 billion. This amounted to 35 percent of Mexico's total debt -- and was due in less than one year. Mexico had to keep foreign money coming in or a cash crunch would develop.

Mexico's financial house of cards came crashing down in December as the government, whose resources were also being drained by the need to defend the value of the peso, tried to carry out a devaluation. Panicked foreign investors bolted out of the Mexican markets to create a liquidity crisis, a vicious circle in which shattered investor confidence drove foreign money out of Mexico just when it was most needed.

There is little doubt, though, that Mexico's crisis stood to undo a decade of struggle by Latin American and other Third World nations to lighten their debt burdens and gain entry as participants rather than relief-seekers in the global financial system. Moreover, with U.S. and Mexican fortunes bound by the North American Free Trade Agreement, the U.S. government ultimately had little choice but to stage a rescue. A Mexican economic collapse could spill across the border as demand for U.S. products shrinks and Mexican companies cut back operations here, resulting in layoffs for U.S. workers.

Mr. Zedillo must now impose rigorous economic policy on a population which had hoped to see living standards rise after years of shrinking real wages. If the peso devaluation is to have any lasting positive effect, inflation, already on the rise as import prices surge, must be restrained. Mr. Zedillo has to resist demands for wage increases, undermining popular support even he faces resistance in his own ruling party to reform measures.

Beyond the volatile issue of loosening Institutional Revolutionary Party control of the electoral process, Mr. Zedillo must keep pledges made to the International Monetary Fund to obtain its $17.8 billion portion of the aid package, including stepped-up privatizations of state-owned companies.

Growth at standstill

Meanwhile, the country's economic growth is set to slow to a virtual standstill rather than the 2 percent growth Mr. Zedillo had hoped for. Mexico's crisis was felt not only in Argentina and other Latin markets but as far off as Malaysia and Poland. International investors who took heavy losses in 1994 in nearly every developed and developing market alike have been bailing out of emerging markets.

Only last year, Mexico was considered so stable it was expected to win an investment-grade credit rating from Moody's Investors Services and other such agencies, stamping it as safe enough for pension funds and other conservative investors. If its "economic miracle" was just a mirage, could any emerging market be trusted? It could be years before some investors will be ready to venture back into such markets.

"People have now learned the lesson of risk and will remember that for quite a while," said William Nemerever, an international bond fund manager with the Boston investment firm Grantham, Mayo, Van Otterloo & Co. who nonetheless sees ample opportunity in emerging markets. But he agrees many investors overlooked the risk in Mexico-type markets.

In fact, Mexico is still very much on the development path, however promising and sophisticated its financial markets may have seemed, and the peso crisis was just a milestone on a frequently rocky road.

Brendan Murphy, a former UPI foreign correspondent, follows global capital markets for the International Reports newsletter and Market News Service.

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