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Mexico: Long-awaited recovery on the way

FRIDAY SEPTEMBER 19 1997

By Daniel Dombey

Ever since Mexico's disastrous 1994 devaluation, the country has seemed to run two economies at the same time, one spurred on by a surging export industry, the other held back by weak domestic demand. Now that has changed.

The country's domestic sector, cruelly hit by the post-devaluation slump, is staging a long-awaited recovery, while exporters are beginning to complain that they are hurt by the strong peso. Although it is still much too early to talk of any consumer surge, imports of consumer goods are increasing at a remarkable rate: in July they were up 44 per cent on the same month the year before.
For the second quarter of the year gross domestic product grew by 8.8 per cent compared with the same period in 1996. While the manufacturing and construction industries grew by 9.1 per cent and 10.2 per cent respectively, continuing well-established trends, the service sector also improved markedly, growing by 7.7 per cent.
Such a recovery might seem exceptional in other countries. But Mexico is a cyclical country par excellence. Most presidents inherit an economic disaster at the beginning of their six-year term, work hard to improve it, only to see things fall apart in their final years of office.
President Ernesto Zedillo is half way through his term. The hope is that the reforms he introduced to get the country out of its 1995 crisis, when the economy shrank by 6.2 per cent, will be deep enough to prevent the country from falling into the same old cyclical trap again.
Mr Zedillo threw open the banking sector to foreign banks, which now control more than 20 per cent of the troubled sector's assets. He opened up the distribution and transportation of natural gas to private companies. He waved ahead the liberalisation of the country's long-distance telecommunications market. And, in what is seen as his central reform, he moved the country's pension system from a state-funded pay-as-you-go scheme to a scheme where private fund administrators compete for workers' social security contributions.
The changes are likely to add to the efficiency of Mexico's economy. Mr Zedillo hopes that the pension reform will increase the country's domestic savings and reduce its dependence on volatile foreign funds. But whether such developments will be enough to transform Mexico's long-term prospects remains to be seen.
Mexico has avoided some of the chief sins of the past. The country's monetary policy is transparent and non-expansionary, while under Mr Zedillo's predecessor money supply at times grew by more than 20 per cent more than inflation. By contrast, during 1995 and 1996, the first years of the Zedillo administration, monetary policy was among the tightest in the world.
Inflation is still a problem, however. After having jumped by 52 per cent in 1995 in the wake of the devaluation, and by 27.7 per cent in 1996, inflation is expected to reach 17 per cent this year. But the figure is now far from the levels that made the government cripple industry with interest rates of 100 per cent and above.
The country's banking sector is also a concern, despite the entry of the foreign banks. Although there have been innumerable government bail-out schemes, the banks are still saddled with a heavy burden of bad debt and are often unwilling to make fresh loans, so stifling economic activity. The banks' mortgage portfolios are a special worry.
An increasing area of debate has been exchange rate policy, which is heavily influenced by the formally independent central bank. Against almost all expectations, the peso has strengthened for the year so far, in both nominal and real terms, despite accumulated inflation of more than 10 per cent. The finance ministry is understood to be upset with the central bank's steps to encourage higher interest rates. Exporting companies have cried 'murder'.
The strong peso has undoubtedly helped domestic consumers - but has hurt the trade balance, which according to preliminary figures for July has moved into deficit for the first time since the devaluation.
The government argues that trade deficits are not unusual for developing countries with constant needs to import to upgrade their infrastructure - and it adds that the key is how the deficit is financed.
And despite the formidable inflow of portfolio investors so far this year - by late August, the stock market was up 50 per cent in dollar terms - Mexico's entire current account deficit could easily be financed by foreign direct investment, which can only be withdrawn with difficulty. So far this year, foreign companies have agreed to acquire Mexico's biggest brewer, its biggest retailer, and its biggest cigarette manufacturer, as well as other companies. Such investments come on top of acquisition of new facilities.
Mexico's economy looks in better shape than it has since the peso devaluation. Short-term problems remain. But the real test will be whether the country can avoid a consumer boom - and, eventually, another of the periodic crashes that have dogged its recent history.