The Reorganisation of the International Financial System:

The Mexican Perspective

Luis Miguel Galindo

Summary

The objective of this investigation is to analyse the opinions on the reorganisation of the financial system and in particular those concerning the possibility of implementing controls or taxes on capital flows, from the Mexican perspective. The Mexican financial system has, since 1994, been suffering from a strong crisis which is characterised by a lack of liquidity and an elevated portfolio of bad loans which led to a greater bank concentration, a growing participation of foreign banks in Mexico and a massive bank rescue. The Free Trade Agreement with the United States and Canada has, implicitly, consolidated the idea that Mexico can dispose of extraordinary financial resources in case of a financial crisis. In this context the relevant discussion has centred upon the possibility of a Monetary Union. The Mexican government has maintained a strategy of free capital mobility and has even expressed itself against the use of temporary restraints as they have already been established in the framework of the free trade agreements. The private sector also has a favourable opinion on free capital flows since, from the nationalisation of the banks in 1982, capital restraints have become related to this process. It has also endeavoured to maintain a common front together with the government for the defence of the rescue of the banks. International organisations have also supported Mexico’s position and consider it an example to be followed by other emerging economies. In the interior of the country only a group of academics and trade unionists have defended the conviction that capital flows should be regulated or that the general economic strategy should be discussed. The opinions in favour of free capital mobility are, to a certain extent, founded on the idea that the Mexican financial strategy has been relatively successful in confronting the most recent international financial crises and their repercussions. It is hoped that "shielding" the economy will prevent the appearance of problems following the presidential succession in 2000. However, the crises related to the balance of payments have been a constant factor in the latest presidential successions for which this factor should by no means be ignored. If this happens, it may influence a change in the national perception of the international financial system. Under these circumstances the discussions concerning a reform of the international financial system have been moved to a second position and the general panorama indicates that Mexico will participate passively in the search for international agreements, at least till the year 2000.

Introduction

The discussion concerning the reorganisation of the international financial system has, in Mexico, been moved to a second position as a consequence of the economic crises of 1994 and 1995 and their effects on the national financial system, and because of new conditions that were established for the Mexican economy by the Free Trade Agreement (NAFTA) with the United States and Canada which came into effect on 1 January 1994. Because of the intensity of the Mexican financial crisis over the past five years, the discussion has centred upon the viability of the national financial system, the characteristics and conditions of the bank rescue, the growing participation of international banks and the instability that finds its origins in the propagation of frauds, or in its most recent case, the rescue of the third largest bank of the country (SERFIN) by the national banking institution.

The discussions concerning the reform of the international financial system have also been moved aside because of the context established by the NAFTA. There is, in fact, a strategic vision which has the tendency to assign the United States the position of "last instance moneylender" as in the crisis of 1994 with the granting of a credit of 50 thousand million dollars. Thus the reform of the international financial system does not seem to be a strategic priority for Mexico. On the other hand, there is also a point of view in which Mexico’s priority is to define the conditions for a possible monetary union within the NAFTA or a greater dollarisation of the economy.

The objective of this investigation is, therefore, to analyse the opinions on the reform of the international financial system and the use of restraints on capital flows in the context of the economic crisis and the NAFTA from the point of view of the various economic groups in Mexico.

Opinions of the economic agent: an interpretation

At the end of the eighties a structural process of transformation and modernisation of the Mexican financial system was initiated. The most striking elements in this process were the privatisation of the banking system, legal changes and modifications related to the functioning of institutions as for instance the elimination of quantitative restrictions like the coefficients of liquidity, and the orientation of the monetary policy towards the management of interest rates and the monetary base. Also, autonomy was granted to the Banco de Mexico, in accordance with the new Organic Law that came into effect in 1993, which establishes that the Central Bank can manage its own credit and that its main objective is the control of inflation. In addition, new laws were approved in order to modernise the Mexican banking system and make it more efficient. In this respect the 1990 Law on Credit Institutions and the Law for the Regulation of Financial Groups can be mentioned.

The private sector purchased the banks for values that were higher than their book value. This situation leads to an accelerated expansion of the banking credit and the rise of the margins between the passive and the active interest rates in order to guarantee a reasonable profit rate for the initial investment (Gutierrez-Perez, 1994). The credit explosion was moreover prompted by flexible and inexperienced regulations as well as the abandonment of quantitative restraints. Thus, the real growth rate of the credit consisted of 23.9% in 1994. The elevated rhythm of credit expansion, the overrating of the real exchange rate and the implementation of an inconsistent economic policy or one of weak foundations, finally led to the beginning of a strong economic crisis in 1994. The crisis manifested itself in the gross domestic product’s fall of 6.22%, an average exchange rate which went from 3.43 pesos to a dollar in 1994 to 6.81 pesos to a dollar in 1995, and an increase in interest rates of CETES at 28 days which jumped from an average of 15.13% in 1994 to 49.53% in 1995.

This resulted in a financial system with an important external debt, a rapid growth of the expired portfolio and a situation of bank illiquidity and insolvency which led to the need to implement a massive rescue operation of the banks by means of the Bank Fund for the Protection of Savings (FOBAPROA). In addition, a loan of 50 thousand million dollars was obtained from the United States in order to limit the negative effects of the economic crisis.

The years after 1994 have been characterised by fervent discussions concerning the regulations needed to avoid a similar situation as well as the appropriateness and indiscrimination of the rescue, considering the fact that, according to Standar and Poor’s, the amount might approximate up to 20 percent of the gross domestic product (Reforma, 2 July 1999) In this context the debate on the reform of the international financial system appears to be restricted by internal problems as well as the conditions imposed by the NAFTA.

The Mexican government has based its actual financial strategy on defending the free market and the unrestricted flow of merchandise and capitals, on an flexible exchange rate and on an attitude of acceptance by the current international organisations. Thus Ortiz, governor of the emissions’ institute declared that the Banco de Mexico does not have an objective related to the exchange rate or interest rates and confirmed that their level is determined by the market. Mexican president Zedillo similarly declared in Davos, Switzerland, that a greater worldwide liberalisation of commerce and inversion flows is required and he expressed his gratitude to W. Clinton as well as to the effectiveness of multilateral institutions.

At the same time, the Mexican government has not only defended the free capital flow but has also openly manifested itself against capital controls. Gurría, the Secretary of Finance, declared, for example, that it is difficult to maintain capital controls in the country due to its dependence on these resources and also said that capital flows are neither perverse nor unstabilising and it would be expensive and useless to implement restraints since it is not possible to escape from the judgement of the market.

Thus, the strategy of the government is based on reducing the negative effects of capital flows without restraining their mobility. For the government the macroeconomic policy has sought to maintain a manageable fiscal deficit and current account while at the same time it has tried to increase the international reserves in order to reduce the possibility of disturbances. President Zedillo and the Finance Secretary have manifested themselves to be in favour of fiscal and monetary wisdom or discipline in the face of external volatility, the use of budget cuts and an increase in the interest rates. This, in order to counterattack the effects of repercussions like the Asian crisis or the fall in the price of petrol but without mentioning the possibility of turning to capital flow control. The programme of free capital mobility was continued even when petrol prices fell and this led in 1998 to a number of adjustments in public expenditure in order to maintain the fiscal equilibrium. In this context President Zedillo declared that without the proper budget cuts serious disturbances would have occurred in the financial market. The Ministry of Finance asked for prudence in this type of situations and, at most, for the creation of a contingency fund (Sidaui, vice-governor of the Banco de Mexico).

In order to reduce the negative effects of the capital flows, the Banco de Mexico has, since 1991, sought to partially sterilise the monetary effect of capital entrance. It has tried to achieve this by means of selling its portfolio assets and, not too long ago, the monetary authorities also announced a combination of measures known as the "shielding" of the economy. These measures are based on the creation of credit lines in order to avoid a possible crisis in the balance of payments at the end of the six-year-presidential term. However, the problems of the Mexican financial system have led the monetary authorities to the understanding that serious mistakes were made in the monitoring of the banks (Ortiz) and that it is necessary to continue with the financial reform since it represents a "vaccine against new banking crises" (Zedillo). However, this reform is basically seen as something internal and does not include changes in the international financial system. As part of the reform, the government has encouraged and propitiated a greater participation of foreign banks in Mexico in order to inject liquidity into the financial system and modernise it.

The government strategy of free capital mobility has been supported by the continuous entry of capital into the country and its favourable composition over the last years. In effect, about 55 thousand million dollars entered the country by means of direct foreign investments compared to approximately 24 thousand million dollars by means of portfolio investments (Reforma, 5 July 1999). Because of this situation, the negative effects of the recent Asian crises have been minimal and it is even expected that a part of the capital flows that leave Southeast Asia can be acquired. The only important negative effect resulting from the Asian crisis seems to be the displacement of Mexican products by merchandise from Southeast Asia in either the internal or the United States’ market and therefore the negative consequences this could have for the job market.

Over the last months, the Mexican government has even actively promoted free trade and free capital mobility in international forums. In the APEC meeting, President Zedillo suggested to the Asian countries that in order to get out of the crisis, they were to implement a model of austerity of government finances and of trade liberalisation. President Zedillo confirmed this position once more when he said that he does not believe in investment controls and repeated that this point is not open for discussion.

The only relative complaint made by the Mexican government, by means of the Ministry of Finance, to the international financial institutions is that, despite the effort of the adjustment made, the international assessments continue to grant Mexico low qualifications in relation to its debt or its financial system. For example in 1998 Moody's Investor Service maintained the E qualification for the Mexican banking system with a similar result for the qualification of the debt.

The international organisations have shared and complemented the strategic vision of the government in relation to fund flows and use Mexico as a successful example of recovery after a strong economic crisis. Camdessus, managing director of the IMF declared that Mexico is an example to be followed by Thailand, Corea and Indonesia. Larry Summers from the United States' Treasury Department, said in Davos that Mexico taught the lesson to act promptly in a financial crisis.

The Mexican government’s optimistic vision concerning free capital mobility has implied that the international discussions on the modification of international organisations needed to control international instability, have not had an important internal answer even though these discussions have been reported by the press. Furthermore, the Mexican government has replied in a negative manner to the proposals by the IMF and Beck, director of Economic and Financial Affairs in the European Committee, concerning a possible implementation of restraints or temporary taxes on the portfolio investments, as in Chile, and that these should be included and used in the NAFTA framework and the Free Trade Agreement with the European Union (which is still to be discussed). Thus, President Zedillo has declared that the freedom of financial flows should remain unchanged. The Centre for Private Sector Studies joined this declaration, affirming that it is counterproductive to restrict investments since this will only generate uncertainty and financial panic. Only the president of the Business Coordination Council considered, on one occasion, that the taxes imposed on assets should only be analysed in the case of an international agreement.

The Inter American Development Bank (IDB) is the only international organisation that has directly informed Mexico of its need to establish regulations for the entrance and exit of capitals in order to avoid recurring crises due to the flight of speculative capitals. The IDB has, moreover, established that the level of liberalisation in Mexico is still insufficient and that the regulations contain important deficiencies.

The private sector has manifested itself in favour of the actual economic model. Eduardo Bourns, president of the Business Coordination Council, the president of the Confederation of the National Chambers of Commerce (CONCANACO) and the president of the Employers' Confederation of the Mexican Republic (COPARMEX) have, in various forums, expressed themselves in favour of the autonomy of the Central Bank, of maintaining macroeconomic policies with strong foundations and of the need to attract more capital by means of privatisation and a free economy. This vision is permeated by the private sector’s opposition to the measures that are related to the nationalisation of the banks in 1982 like the control of the exchange rate or the restraint of capital flows.

The necessity to have the bank rescue approved in the House of Representatives in 1998 and the uncertainty concerning external financial shocks, contributed to the conformity of the government and the private sector’s points of view. Thus, the various organisations of the private sector, as for example the Centre for Private Sector Studies, supported the approval of the FOBAPROA, while at the same time recognising that the economic policy was accurate. The Business Coordination Council, when facing the effects of the Asian crisis, asked for "fiscal and monetary discipline and certainty concerning macroeconomic bases". It also approved the toughening of the monetary policy in order to compensate for the external disturbances and the fall of the price of petrol.

The discordant voice within the private sector comes from H. Suarez, president of the fiscal commission of the Confederation of the National Chambers of Commerce (CONCANACO) who argues that the government should not reject the possibility to apply restrictions to the portfolio investment or the possibility to impose a tax on the exit of speculative capitals. Another disagreeing voice comes from the small and medium sized companies who critise the fact that there are scarce possibilities for credit, that it is elitist and only granted to triple A companies (Cemex or Telmex).

The trade unions have basically kept themselves absent from the debate about the reform of the international financial system. Their attention has centred upon the health of the financial system, on the preservation of labour rights in this context and on the new savings system for pension funds. Thus the CTM, the main trade union organisation of the country, considers that it is necessary to analyse the savings system for pension funds in order to prevent possible deviations or unfulfillment. The Federation of Banking Unions (FENASIB) has declared itself in favour of the preservation of the rights of its union members in the difficult present situation of the financial system. On a more general level, only isolated remarks have appeared like the one from Lujan, general manager of the Authentic Working Front, who considers liberalisation bad, and the one from Hernandez Juárez, leader of the telephone union, who considers that the economic policy lacks credibility and warns against a possible crisis.

The strongest criticism has centred upon the necessity to restructure the bank system and on improving the national banking regulations while mainly ignoring the discussion on the reorganisation of the international financial system. People as diverse as Ifigenia Martínez Navarrete, senator of the PRD, analysts of international banks, independent academics like A. Villagomez have coincided in this point and have argued that we will continue to see financial instability and the contamination of markets. Even subcommander Marcos catalogues the banking rescue a political-economic crime.

Various academics of international renown like Krugman and Kregel have, in international forums, also manifested themselves in favour of capital flow restraints. However, these arguments have not been taken up in the internal discussion, with the exception of the debate concerning the Monetary Council and the possibility of a Monetary Union in the framework of the NAFTA. Professors Barro and Dornbusch have expressed themselves in favour of such a Monetary Council for Mexico and they have been supported by the Centre for Private Sector Studies who considers that this mechanism could contribute to the stabilisation of the exchange rate and prices. The government has expressed itself against this idea. Thus, President Zedillo rejected a Monetary Council. Ortiz, governor of the Banco de Mexico, considered a Monetary Council to be inadequate because of the conditions of the country and Gurria, Minister of Finance, supposed that both the restraint of the exchange rate and the Monetary Council are very rigid measures which take the power to intervene away from the State, thus resulting to be too recessive. Kutscher, director of the corporation of Swiss banks, expressed himself in a similar manner when he considered that it will be difficult to create a single currency in the NAFTA because of the differences between its economies.

The visions and perspectives of the reform of the international financial system are to a great extent influenced by political tendencies, given the presidential succession in 2000. In fact, the new president will have to establish the economic conditions needed for a long term economic development in which the international financial system plays an important part. The discussion may be framed by a new crisis in the balance of payments similar to what occurred in the previous four presidential six-year-term. The discussion could even be intensified this time because of the presence of a president from a party which at the moment resides in the opposition. In this context, important changes could take place in Mexico's attitude with respect to the free flow of capitals.

Conclusions

The discussion on the reform of the international financial system has in Mexico been put aside as a consequence of the national financial crisis and the convergence of a combination of public and private interests in favour of free capital flow and with international organisations supporting this position. In effect, the magnitude of the financial crisis of 1994-1995 led to the need to implement a massive bank rescue and to a situation of insolvency of various private agents. The magnitude, characteristics and velocity with which the bank rescue was executed, with little experience and an insufficient framework of regulations, led to the acceptance of a multitude of irregularities. Most striking is that banks accepted loans without a proper guarantee, that they granted loans to ghost companies and that the money was even channelled to political parties. Likewise, in these surroundings a great number of frauds took place whose amount and consequences are still unknown.

Under these conditions, the fundamental concern of the government was to offer a guarantee for free capital mobility as part of its strategy to promote a free market and heal and legally formalise the bank rescue. These are still under discussion in Congress. The government has shown itself to be against the use of possible capital restraints, both temporarily or those that are contemplated in the NAFTA and the Free Trade Agreement with the European Union. This is also due to the fact that measures that are associated with exchange restraints or the control of capital mobility generate additional uncertainty in Mexico since these are being linked to the nationalisation of the banks in 1982.

The government strategy expressly supports the liberalisation of financial markets which it has even promoted in various international forums. This position has been supported by various international monetary organisations and the government of the United States who have considered Mexico an example to be followed in its handling of financial crises and its "successful" model of free capital mobility. In this context there exists the implied idea that given the existence of the NAFTA and the strategic condition of Mexico for the United States additional loans can be expected to be granted in case of serious financial problems, similar to what occurred in 1994. Mexico's only complaint to the international organisations is that the effort it has made, has not been recognised in the qualifications of the debt or its bank system.

The private sector has also taken up a strong position in favour of the free market and, as a consequence, in favour of free capital mobility. Its support to the government has been linked, to a certain degree, with the creation of a common front in facing the bank rescue and by preventing any measure to be taken which presupposes a greater government control over the bank system as a consequence of the bank crisis. Some small and medium sized companies and businessmen show a number of discordant opinions when they consider a reorganisation of the national financial system a necessity.

The unions have centred their concern in the preservation of their labour rights during the reorganisation of the national financial system and in the situation of the security of the pension funds. However, their positions are even more general and do not include specific propositions.

The main opinions concerning the reorganisation of the international financial system have been defined in the academic environment and in centre-left opposition groups or parties like the PRD.

At the moment the active participation of Mexico in international agreements on financial regulations is remote and it is to be expected that these agreements will be accepted passively. This is due to the fact that the present strategy is based on the promotion of the free mobility of merchandise and capital, that in the government’s view Mexico has not greatly suffered from the most recent financial crises and that the international market is, therefore, not seen as an immediate obstacle to the economic development, and to the implicit idea that it is possible for Mexico to obtain preferential treatment in case of an international financial crisis given its strategic position in the NAFTA. In any case, the economic conditions during which the presidential transition will take place in the year 2000, may define a change in the position of the Mexican government and the redefinition of alliances and positions concerning the rest of the economic agents.

In this context the reforms to the international financial system that seem to have most presence in Mexico are those that are related to the possibility of a monetary council, despite the fact that the Mexican government has expressed itself against this measure.

References

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