12:27 AM Feb 2, 1995


Geneva 1 Feb (Chakravarthi Raghavan) -- The financial rescue package for Mexico that the International Monetary Fund seems to be in the process of assembling, if published reports out of Washington are true, may be in violation of the spirit if not letter of the IMF's Articles.

The package may or may not rescue Mexico from the consequences of the folly of following the policy advices from the Washington institutions, but it may jeopardise the prospects for countries most in need, and for whom no other source is available -- the African countries.

It also raises questions as to the accountability of the Bretton Woods institutions and their economists and officials for their advices to countries and who would pay if the IMF funds are lost if the Mexican package fails to arrest outflow of funds and speculators opt out?

The Fund and the Bank (and the GATT/WTO in Geneva), and a whole group of neo-classical economists and institutions, have been encouraging developing countries to undertake all the classical liberalization and orthodox adjustment policies and to open up their capital markets, give up their balance-of-payments safeguards, and remove restrictions on capital account to get short-term capital flows for financing their current account deficits.

According to Washington reports, the Clinton aid package of $20 billion (to be provided without Congressional approval) will be buttressed by "additional" funds (which in reality may turn out to be as 'additional' as the Rio Earth Summit promises) -- an IMF standby loan of $7.76 billion and an additional $10 billion the IMF is trying to put together for Mexico from European treasuries and the Bank of International Settlements in Basle.

The report in Financial Times and other media said that if the IMF is unable to get this $10 billion money from other treasuries, "it will make up the money from its own capital".

But this may be a violation of the letter and spirit of the IMF's Articles on capital transfers.

Section 1 (a) of Article VI of the IMF, says "A member may not use the Fund's general resources to meet a large or sustained outflow of capital except as provided in Section 2 of this Article, and the Fund may request a member to exercise controls to prevent such use of the resources of the Fund. If, after receiving such a request, a member fails to exercise appropriate controls, the Fund may declare the member ineligible to use the general resources of the Fund..."

Section 2 (Special provisions for capital transfers) says: "A member shall be entitled to make reserve tranche purchases to meet capital transfer".

Section 3 then goes on to stipulate "Members may exercise such controls as are necessary to regulate international capital movements, but no member may exercise these controls in a manner which will restrict payments for current transactions..."

Instead of advising developing countries to follow these prudential policies, the Fund and the World Bank have been advising them to liberalise their financial sectors, remove restrictions on capital account, and create an environment to encourage foreign investors, including managers of funds and other portfolio investors, to make such investments.

It was because of the awareness that the IMF funds would not be available to countries having problems on capital account because of volatility of short-term flows, that the idea of a special facility has been flagged.

At the 1994 Cartagena conference organized by the G-24, a former IMF official, Aziz Ali Mohammad, now Special Advisor to the Governor of the State Bank of Pakistan, raised this issue and the need for a special facility available to developing countries to cope with the problem of volatility of short-term capital flows. He also focused then on possible potential problems that might arise from financial services liberalization under GATS and the trade liberalization process becoming hostage to unpredictable exchange rate fluctuations caused by massive movements of speculative capital.

But the G-7 countries, and particularly the US, are not willing to put the resources for this and authorize such a facility.

Nevertheless, the IMF Managing Director at the last Fund/Bank meeting spoke of need for developing countries moving towards capital account convertibility, while the World Bank has been encouraging countries to continue policies of openness for encouraging portfolio investments.

The Mexican experience, however, underlines the folly of following such advice.

Until 19 December, when the "Mexican crisis" broke, that country has been held out as the successful adjustor, having followed all orthodox adjustment policies and achieved success. It was hailed as such -- not only by the Fund, World Bank and the US administration as well as other official institutions.

Fund and Bank officials, and even US administration officials, now say that they had been aware of Mexican problems in 1994 itself, and had been privately drawing the attention of that country.

It is said also that even though Clinton at Miami Summit of Americas, praised Mexico, in private Washington had been concerned.

This raises though an interesting question: Did the Fund and the Bank and others "mislead" other investors and make them lose money and what responsibility do they have in terms of market regulations? And if they were aware of the serious risks in Mexico, how did they themselves act as prudent investors with their own funds. Did Fund, Bank officials and US treasury officials put their own monies or keep them in such emerging markets as Mexico's?

But it was not only officialdom that took this line about Mexican success. Private ones too did that.

The Swiss Bank Corporation in its December/January Economic and Financial Prospects called Mexico "Country for Investment Grade" and said a decade after the 1980s debt crisis, it was a changed country and " has already passed the threshold of economic stabilisation and is well advanced in its process of structural reform. As a result, the OECD circle of industrialized countries has warmly accepted Mexico into its fold." It spoke of the need for the consolidation of the reform process, particularly with regard to its political foundations, but was confident of this task being performed by President-elect Ernesto Zedillo.

The Financial times, in a supplement on 23 November, had an equally glowing view and talking of "The economy is remarkably resilient" and of "a decade of economic restructuring bearing fruit".

And well could they all paint such a rosy picture, pointing to the economic indicators:

According to data in the Santiago-based CEPAL's year-end review, from a 159.2 percent annual inflation rate in 1987, Mexico had brought down its inflation in 1994 to 6.9 percent.

From a 12.5 percent of GDP public sector deficit in 1984, Mexico achieved a 0.4 percent surplus in 1994 -- a 14.5% turn around, much higher than what the European Union countries are struggling to achieve in terms of their Maastricht targets.

And from an average negative 4.3 percent rate of GDP growth between 1981-1990, it registered during 1991-1994 a plus 2.7 percent rate.

All this it did after following every bit of orthodox economics and adjustment policy package: liberalising its foreign trade, opening up its financial sector and allowing capital flows and convertibility, and interest and exchange rate policies to encourage and attract foreign investors.

It also achieved what orthodox economics demands, namely, attacking labour market rigidities: the index of average real wage in 1994 stood at 99.4 (1980=100).

The only institution which has been consistently raising its voice and cautioning the developing world against such "economics", has been the UN Conference on Trade and Development. But thanks to the UN Secretary-General's action in not filling the post of its Secretary-General but merely keeping an office-in-charge, and that too on a short-leash, even UNCTAD's ability to speak out has been strained. And a blue-ribbon self-appointed group of Commissioners have now recommended should be wound up as part of improved Global Governance.

In 1991, in its Trade and Development Report, UNCTAD had warned against such financial liberalisation. It said (citing the Southern Cone country policies) that in a financially open economy with easy access to credit markets, the Southern Cone type of capital inflow problems can easily occur regardless of in what order the markets have been liberalised. It spoke of the situation of short-term inflows leading to real currency appreciation, encouraging domestic financial institutions to borrow abroad at much lower interest rates than they can raise at home.

"If the process is not checked," UNCTAD warned, "the real exchange rate can continue to rise until the deterioration of the trade balance leads to a loss of confidence, triggering capital outflow."

UNCTAD came back to the same topic in 1992 and warned of the unsustainability of the capital flows to Latin America. But the IMF scoffed at the UNCTAD warnings, adopting a "Fund-a-mentalist" approach.

In 1993, the TDR referred to the growth prospects and policy dilemmas, and the sustainability of capital flows and again said "...the particular configuration of exchange rates, interest rates and stock prices underlying the recent surge in capital flows cannot be expected to last. An important part of the arbitrage margins has been due to currency appreciations, particularly in Argentina and Mexico which, if continued, would eventually lead to an external payments crisis as exports fall and trade deficits mount... If, on the other hand, the currency appreciation is suddenly reversed, the arbitrage margin will disappear, possibly triggering a sharp drop in short-term capital flows...If trade balances in Latin America deteriorate further, expectations of devaluation can become widespread, thereby triggering profit-taking and capital outflows".

UNCTAD also raised warning signals of the "fragility" of growth in Argentina and Mexico and said: "Even though autonomous capital flows have so far been more than enough to finance external deficits, these countries need to undertake an external adjustment through higher investment and exports. If the opportunities for an expansionary adjustment are not exploited, deflationary adjustment may eventually become unavoidable"

And this is what is now happening or in store for Mexico.

The second Mexican crisis, and the improvised ways in which it is being sought to be tackled have clearly lessons for other developing countries, and the socalled emerging markets.

One political lesson that cannot be lost on these governments is that while the United States has some overriding political compulsions to put together a rescue package for Mexico (with US Congressional leaders supporting it so long as they need not vote for it!), and arm twist multilateral institutions and the Europeans to put up the funds, nothing on this scale will be attempted for others -- whether in the American backyards of Latin America or elsewhere. Nor would the Europeans do it in Europe or to its South nor Japan in Asia.

In terms of economic policy lessons from Mexico, a senior UNCTAD economist and one of the authors of its Trade and Development Report, said that other developing countries should heed the warnings atleast now and close their capital accounts and stop the access of their private sectors to short-term foreign capital flows. They should also prohibit "short-positions" on foreign exchange markets, he said. "If you borrow money in foreign markets when the 'assets' are in local currencies, you are in serious trouble," he explained.