Mexico - Current economic position and prospects

7 aj7g tt,2W.H. 29-a RESTRICTED This report is restricted to use within the Bank.I INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT CURRENT ECONOMIC POSITION AND PROSPECTS OF MEXICO July 29, 1954 Department of Operations Western Hemisphere  CURRENCY EQUIVALENTS Rate prior to Rate after April 19, 1954 April 19, 1954 U.S. $1 = 8.65 pesos 12.50 pesos 1 peso = U.S. $0.116 U.S. $0.08 1 million pesos = U.S. $116,000 U.S. $80,000 The par value of pesos 4.86 to the U.S. dollar that had been in effect from 1940 was abandoned July 22, 1948. Until, April 1949 the rate was then maintained between 6.50 and 7.00 pesos per U.S. dollar; in April-May it was allowed to fall to approximately 8.50 pesos per U.S. dollar, and on June 18, 1949, a par value of 8.65 pesos per U.S. dollar was adopted. Effective April 19, 1954 the par value was changed from 8.65 to 12.50 pesos per U.S. dollar.  T&BLE OF CO1TEIJ4TS Page No. BASIC DATA SUMTMARY AND COCLUSION'S i CURREN1T ECONOMIIC POSITION hAND PROSPECTS OF LEXICO I. ~ The Background 1 II. The New Administration 2 III. The Devaluation 5 IV. The Next Few Years 7 V. The Fiscal and Monetary Outlook 11 VI. The Outlook for Economic Growth 14 VII. Improving Investment 17 VIII. Financing Investment 18 ANNEX - EXTERNAL PUBLIC DEBT STATISTICAL APPEI3MDIX Table 1 - Indices of Real Produiet and Its Components Table 2 - Annual Average Increase of Real Product by Activities Table 3 - Gross Product, Consumption, Investment and Savings, 1947-1953 Table 4 - Investment and Savings as Ratios of Gross Domestic Product, 1947-1953 Table 5 - Balance of Payments, 1947-1953 Table 6 - Federal Government Revenue and Expenditures, 1950-1954 Table 7 - Prices and Wages  BASIC DATA Area 760,000 square miles Population - 1953 28.1 million Rate of population growth - 1953 2.9% National income - 1953 51,300 million pesos (At factor cost) U.S.Q 5s900 $210 per capita Balance of Payments - 1953 (millions of U.S.dollarss Exports (f.o.b.) 600 Foreign travel receipts 303 Receipts from other services (net) 31 Total receipts 934 Imports (c.i.f.) 811 Foreign travel payments 140 Direct investment service and official interest payments 71 Total payments 1,022 Net current account -88 Private long-term capital 53 Private short-term capital 5 Official loans and grants 2 Net capital account 60 Net errors and omissions -4 Deficit (-) -32 Principal Exports - 1953 Millions of U.S.$ , of total Cotton 152; 25 Coffee 81 13 Tomatoes 20 3 Shrimps 16 3 Copper 142 7 Lead 59 10 Zinc 22 4 Silver 32 5 Petroleum 27 4 Principal Imports - 1953 Millions of U.S4 % of total Staples 58 8 Petroleum 34 5 Raw materials 114 16 Consumers goods 149 20 Capital goods 379 52 Federal Government Finances - 1953 IMillions of pesos Revenue 4371 Expenditures 4,586 Deficit (-) -215 External Public Debt Millions of U.S. S Outstanding $ Undisbursed - May 1954 436 Annual service on above 1955: 56.0 1960: 40.6  SUMMARY AND CONCLUSIONS 1. Between 1939 and 1951 Mexico experienced a period of unprecedented economic growth during which national output more than doubled. Productive capacity, especially in industry, increased greatly during the period. This exceptionally rapid growth :as possible only be- cause and as long as existing railroads, ports, power plants and other community works could bear additional burdens, and existing ailfields, mines and forests could bear further exploitation. Little capital went to construction of houses, hospitals and schools. '.'oreover, high demand for raw materials abroad made possible a rapid expansion of exports and improved the terms of trade. 2. Economic development in 1939-1951 was largely financed fromL M1exican sources. However, the inadequacy of normal savings to finance the high level of investment led to inflationary fiscal deficits and bank credit expansion. The balance of payments had to be protected by increased tariffs, import restrictions and a major devaluation in 19)48-19b9. An extremely rapid increase in population, together with inflationary shift of income towards entrepreneurs meant that the growth of output vwas not reflected in a corresponding improvement of the general standard of living. 3. By 1952 a further increase of investment in transportation, power and petroleum was necessary to meet the demands of a growing economy, while at the same time more attention had to be paid to housing, hospitals and schools. World raw material prices fell sharply, and there was little prospect of another major expansion of exports. At the same time, population was growing faster than ever, and dissatisfaction with the slof improvement of the standard of living was increasing. In meeting these difficulties, Mexico had the advantages of being largely self-sufficient in food and raw materials, as well as producing a large variety of exports and possessing a well developed and expanding manufacturing industry. b. Late in 1952 the nezv administration of President Ruiz Cortines took office. Its first efforts were concentrated on eradicating graft, combating inflation and stimulating agricultural production. However, it soon found itself faced with an unexpected problemv, a recession which spread throughout the economy during the first half of 1953 and had its origin in a fall of export prices and tourism, bad crops due to droughts and a sharp reduction in public investment. The Sovernment preferred to meet this situation by stimulating private investment rather than by expanding goverment expenditures. It thereTore lom!ered the reserve requirements of the banks and avoided raising taxes. This policy, together vrith some monetary expansion resulting from the agricultural credit program and a sm.all deficit in government finances, checked the recession but failed to stimulate private investment sufficiently to reverse it. 5. Owing to a fall in prices, export values fell substantially in 1953 as did tourist earnings. Poor crops made high food imports necessary, and the reduction in public investment did not affect agencies like CFE, FAVEX and the National Railroads, which continued to import capital goods on the same scale as before. As a result, a significant disequilibrium  - ii - appeared in the balance of payments. wshen the Goverrnent decided to revive public investment without attempting to Lncrease its revenue, a big budget deficit appeared inevitable in 1954. A sharp increase in the trade deficit in the first months of 1954, together with disturbing symptoms of capital flight, brought the situation to a head and prompted the Government to devalue the peso 8.65 to 12.50 per dollar on April 19. 6. The devaluation came as a great shock to the public, and the imme- diate reaction of businessmen and investors, MAexican as well as foreign, ,-ras to change liquid funds into dollars and to halt investrient plans. Although confidence in Miexico's economic prospects wr;ill no doubt revive, the deva'ua- tion will probably discourage foreign investment in Mdexico for a tine and means a serious setback for the newly-developing capital market. 7. The devaluation should help to raise output wherever there is unused capacity, especially in those manufactures which can be substituted for imports. Higher prices should reduce consumption, especially of imported goods; so long as costs lag behind prices, a higher proportion of the national income will go to exporters and entrepreneurs, in whose hancs more of it should be saved. New export taxes will raise government revenue and reduce the budget deficit. The increase in output and savings will improve the balance of payments. All these effects, however, will gradually diminish as wages and salaries rise and private and public expenditures expand. 8. Government salaries and the wages of most unionized wvorkers have already been raised by 10% to 15% since the devaluation. Nevertheless, the devaluation, together with good crops and high coffee prices, is likely to create a surplus in the balance of payments large enough to restore foreign exchange reserves to their previous level by early 1955, even if flight capital does not return. How much longer this favorable balance of payments will continue will depend largely on whether excessive expansion of private and public expenditures can be prevented through control of bank credit and a balanced budget. 9. As exchange reserves are built up, there may be a dangerous expan- sion of credit unless commercial bank reserve requirements are raised. In spite of increased government revenue and reduced investment plans, there will probably be a small government deficit in 195b. Increased govermnent expenditures are likely to raise the deficit in subsequent years unless measures are taken to increase the revenue of the Government and its agencies. 10. Owing to greatly diversified exports and high earnings from tourisi4 Mexico enjoys a greater stability of exchange earnings than most other Tat n American countries. Its balance of payments position is further strengthened by near self-sufficiency in food and raw materials. i'evertheless, Mlexico is confronted with a problem comnnon in undeveloped countries: the pressure of a rapidly increasing population to enjoy an adequate standard of living calls for a rate of investment considerably in excess of normal savings. Miexico has hitherto tended to drift into the inflationary solution of this problem, with the consequent necessity of periodic devaluations. 11. Whether Mexico can solve this problemn on more rational lines depends upon the opportunities for increasing output through effective ink-i vestment, the adoption of methods to insure that investment is concentrated in the most productive directions, and the possibility of finding non- inflationary methods of financing the desired level of investment.  - 1ii - 12. Agricultural production can be increased by extending irrigation, by developing tropical areas, and by the use of improved seed and fertilizer. In manufacturing, Mexico has advant6ages over most other Latin American coun- tries in its industrial experience and large domestic market. Niew oil fields have recently been discovered and, if adequate steps are taken to exploit them, it should be possible to expand petroleum production at least sufficiently to keep up waith the rise in domestic demand. On the other hand, as long as the present mining tax systern is maintained, there is little prospect that the prolonged decline of hiexican mining will be reversed. 13. Despite these opportunities for increasing domestic output, the longer-range growth of lMlexico's exports is limited, on the one hand, by the difficulty, in the face of intense competition, of profitably selling more food and rawv materials abroad, and, on the other hand, by liexico's own mining and petroleum policy. Because of these limitations, lMlIexico's exports are, except for the next few years, not likely to rise much above their 1953 level. Although likely to be partly compensated by increasing tourist earnings, this stagnation of exports will be an obstacle to economic growth and add to balance of payments difficulties. Because Mexico is moving, and should continue to move, in the direction of greater self-sufficiency in food, raw materials, and manufactured goods, this shlould not become too serious a problem, as long as petroleum imports remain low; and the- could continue to remain low if petroleum investments were increased sufficiently. 1. In order to maintain progress, Mexico must now make substantial investments in transportation, povwer facilities, oil wells and refineries, irrigation, and industrial and agricultural machinery and equipment, as well as in housing, schools and hospitals. In order to ensure that these investments are channeled to the maxLmum advantage, the Government must exercise a more effective control over public investment. The selection and coordination of public investment has improved under the present administration. There are also indications that the President intends to take steps to make the Investment Coim!ittee which was established in 1953, operate more effectively. 15. If an adequate rate of investnent is to be maintained without inflation, it is essential that domestic savings should be increased. A permanently higher rate of private savings (as distinct from the tElporary spurt due to devaluation) is a long-run consequence of a higher level of income. On the other hand, immediate steps could be taken to increase public savings. Public revenue in Mexico is low in relation to national income, and there is substantial scope for increasing it, both by raising taxes and by increasing transportation and power rates and petroleum prices. 16. Even if public savings increased substantially, it would still be necessary to supplement them with external loans in order to meet the urgent needs for public investment. In rehabilitating the Pacific Railroad the Government is making a very necessary investment which should stimulate a substantial increase in output in a highly productive agricultural region. The Mexican Government is endeavoring to improve public investment and  - iv - combat inflation, and there is reason to believe that these efforts will meet with increasing success. Service of the proposed loan for this pro- ject should, therefore, be within lMexico's capacity. In fact, if public savings were increased, inflation prevented and investment wisely directed, Mexico could safely undertake additional external borrowing for productive purposes.  CURREMT ECONOMIC POSITION AND PROSPECTS OF IEXICO I. The Background 1. Between 1939 and 1951, Mexico experienced unprecedented economic growth. The country's productive capacity increased greatly and, except in mining, major gains in output were achieved in every sector of the economy. In spite of an increase in population greater than in most other countries, income per capita increased by more than 50%. 2. The growth of output and income was, however, not uniform, as some sectors of the economy, some geographical regions and some population groups lagged behind. While agriculture made great strides in the newly irrigated areas of the north, there was little progress in the overpopu- lated and exhausted lands on the central plateau. While new industries sprang up, productivity did not improve in the country's oldest manufac- turing industry, textiles, and mining stagnated. 'W,hile a network of new roads spread across the country, railroads fell into decay. Industrial development was largely concentrated in the Mexico City area and in the two next biggest cities, Guadalajara and Monterrey. While the average standard of living increased when workers moved from land to town, the real wages of industrial workers were probably not much higher in 1951 than in 1939. At the same time, commercial and industrial profits absorbed more of national income than ever before. 3. The rapid economic growth of the 1939-1951 period was made pos- sible by several exceptionally favorable circumstances. Over this period, and especially in its earlier part, Ilexico's investment was concentrated on projects which yielded quick and substantial returns, because it was possible to make existing railroads, ports, power plants and other co2mmu- nity works bear additional burdens, and to exploit existing oilfields, mines and forests. A backlog of investment piled up which would eventually have to be carried out, but which for the time being could be postponed without seriously interfering with current production. There was also a low rate of construction of houses, hospitals and schools. The newness of much of Mexico's capital equipment kept repair and maintenance costs low, although there were also cases of inadequate maintenance. The high demand for raw materials during and after the world war and again during the Korean war made a rapid expansion of exports possible and improved the terms of trade. 4. Economic development in 1939-1951 was largely financed from Mexican sources. Foreign private investment made a small but significant contribu- tion in manufacturing industry, and official external loans helped to finance railroad rehabilitation and power development. Mexico's normal savings were, however, inadequate to finance the large volume of investment, and inflation was brought about by fiscal deficits and bank credit expansion. The infla- tion made it necessary to protect the balance of payment by means of in- creased tariffs, import restrictions and a major devaluation in 1948-1949.  - 2 - Inflation and devaluation changed the distribution of income in favor of entrepreneurs and exporters, and against workers and most farmers. 5. By 1952, Mexico was entering a new phase in its economic develop- ment. Although investment in transportation, power and petroleum had al- ready increased in the preceding years, a further increase was required to meet the demands of a growing economy. Needs for housing, hospitals and schools could no longer be subordinated to directly productive investment to the same extent as in the past. Raw material prices fell sharply, and there was little prospect of another major expansion of exports. At the same time dissatisfaction had mounted within the country over the meagre results so far achieved in raising general living standards, and population was increasing faster than ever. 6. The indications were, therefore, that Mexico, for both internal and external reasons, was headed for a period of considerably greater diffi- culties than the one it just had passed through. At the same time, the country had as natural endowment and as heritage from its previous develop- ment several advantages in meeting these difficulties. It had large and varied natural resources, was largely self-sufficient in food and raw materi- als, and produced a great variety of agricultural and mineral goods for export. Its manufacturing industries were comparatively well advanced and furnished most of the consumerstgoods the country used and an ever expand- ing quantity of capital goods. Well developed tourism made a big contribu- tion to its foreign exchange earnings. II. The New Admninistration 7. When, late in 1952, the new administration of President Ruiz Cortines took over, it dedicated itself to give the country an honest govern- ment, to improve the lot of farmers and workers and to use public money more effectively than before. Its first efforts were concentrated on eradicating graft, combating inflation through reduced expenditures and control of prices, and on stimulating agricultural production through expansion of agricultural credits. At the very beginning of its term, however, the new administration found itself faced with a rather unexpected problem, a recession which spread throughout the economy during the first half of 1953. 8. The recession was a minor one, but it was all the more strongly felt because it followed a period of prolonged and rapid economic growth. It had started slowly in 1952 when export prices began to fall, tourism declined, and agriculture suffered severe droughts. To this was added a sharp reduction in public investment early in 1953. From these origins the recession spread throughout the economy and especially to industry and com- merce. Output increased by less than 2% in 1952, and declined by 2% in 1953, as compared with an annual average increase of more than 6% from 1939 to 1951. 9. The fall in export prices checked the growth of export industries, and from 1951 to 1953 there was no increase in export volume. In addition, income was reduced when the terms of trade fell in 1953 (by 8%) back to  - 3 - their 1948 level. Receipts from tourism in Mexico's interior (not including border visits) declined by more than 20% from 1951 to 1953, as competition increased from Europe, the Caribbean and Canada. Lack of publicity and inadequate amenities in many places gave Mexico a disadvantage which low prices were not sufficient to offset. Receipts from border visitors con- tinued to increase, but this was largely offset by increasing exipenditures of Mexicans on the U.S. side of the border. The drought, from which the country had been suffering for a number of years, became especially severe and widespread in 1952 and early 1953. It reduced the corn and bean crops and made necessary substantial imports of these mainstays of the i'iexican diet. Irrigation water reserves diminished drastically, and in the second half of 1953 early frosts and torrential rains added to the calamity. 10. There is little evidence that a reduction of private investment was an independent or important elerment in the recession. Private invest- ment had reached a very high level in 1951, and fell in real terms by about 4i% in 1952. This fall was, however, largely in agricultural machinery and equipment, and a direct result of the end of the cotton boom. Available information indicates that in 1952 and 1953 other private investment, mainly in industry and in construction, remained at the high level reached in 1951. 11. The fall in public investment early in 1953, on the other hand, contributed greatly to the recession. It did so particularly because of its suddenness (during the first quarter of 1953 the level of public invest- ment was probably not much more than one-half of what it had been late in 1952), and because the cuts were largely confined to public works in the Federal District, road construction and irrigation. M4exican labor and industry were hard hit because expenditures in these fields are chiefly local. On the other hand, the expenditures of the heavy spenders of foreign currency - Pemex, the National Railroads and the Federal Electricity Commis- sion - over which the Government has not much direct control, declined little, if at all. As a result, public imports of capital goods remained virtually unchanged and the reduction of public investment did not do much to improve the balance of payments. 12. The reduction in public investment was due to the desire of the new Government to take inventory and chart its course. It was also a reac- tion to previous excesses in public works and an expression of a belief that private enterprise should play a greater and government a smaller role in economic development than previously. Checking inflation and safeguard- ing the balance of payments were primary objectives of the Government, and reduction of public expenditures were necessary to attain those objectives, especially since it was decided not to increase taxes. Nobody realized at the end of 1952 that a reduction in public investment could only aggravate a tendency towards business contraction which was already present. 13. Although the recession was of no more than minor proportions, it dominated public thinking and influenced the Government's actions greatly. The Government originally wished to meet it by stimulating private invest- ment rather than by again expanding public expenditures. Its first measure was therefore to lower the reserve requirements of the banks in February 1954.  - 4 - It wras also because of this desire that the Government decided not to go through with a proposed supplementary tax on income which it feared might deter private investment. Instead the tax rate on distributable profits was increased from 10% to 15%, but at the same time the permissible deduc- tion for reinvested earnings in industry and agriculture was increased from 10% to 30%, or more if the vMinistry of Finance approved. This was intended to stimulate private investment rather than to raise revenue. 14. The Government also took measures to improve the collection of taxes, especially income taxes. These measures could not, however, offset the effects of the recession upon revenue. As exports fell, more goods were exempted from the export surtax, and incomes declined, Federal Govern- ment revenue fell from 4,860 million pesos in 1952 to 4,370 million pesos in 1953, and from 8.2% to 7.7% of national income. Federal Gcvernment expenditures also declined, owing to the reduction in public investment. They declined, however, less than revenue and there was a deficit of 215 million pesos (5% of revenue). Autonomous public agencies, states and municipalities (for which information is largely lacking) had substantial deficits which, however, were partly financed by foreign loans or credits. In addition, the agricultural banks expanded their credit very substantially, mostly with funds from the Bank of Mexico. 15. The relaxation of reserve requirements failed to bring about any substantial expansion of private bank credit. Similarly, the monetary expansion resulting from the public deficit and the agricultural credit program failed to produce an increase in business expenditures. Money supply during the whole of 1953 was significantly higher than in 1952 (from December 1952 to December 1S53 the increase was 9%). However, most of this increase was in deposits and not in currency, and at the same time as depo- sits increased, their use diminished as is shown by the fall in turnover of checking accounts by 6% during 1953. The increase in money supply implied therefore primarily an increase in the liquidity of private business Wkhich helped to keep up inventories and sustain orivate investment, but did not, for the time being, lead to an expansion. 16. This lack of response on the part of private enterprise was what might have been expected. Private investment was already at a high level (except agricultural investment), and as long as depressive influences con- tinued to spread from other sectors of the economy, an easier access to money was not much of an inducement to expansion. MIoreover, as a result of conflicting tendencies within the Cabinet, there was a certain ambiguity in the Government's attitude towards private enterprise which may also have discouraged private investment. On the one hand, private initiative was invited to increase investment. On the other hand, new efforts were being made to lower prices by controls. At the same time as private foreign capital was urged to join in the country's development, measures were announced to restrict the employment of foreign technical personnel. A proposal to increase real estate taxes in itexico City (wrhich at present are negligible) and its subsequent withdrawal without a clear decision may have helped to discourage construction.  17. When the recession continued throughout 1953, the Government turned more and more towards an expansion of public investment as the principal remedy. In the last quarter of 1953 public investment again reached the same level as in 1952. Further expansion was planned for 1954, while at the same time - owing primarily to the desire to stimulate private investment - little had been done to increase government revenue. A serious public deficit was therefore in prospect. 18. Planned public investment for 1954 amounted, before the devalua- tion, to about 3,700 million pesos compared with about 3,000 million in 1953. Moreover, a substantial increase in current government expenditures was likely. On the basis of authorized expenditures of the Federal Govern- ment as of the end of' iIarch 1954, total expenditures during the year could be estimated at 5,300 million pesos compared with 4,600 million pesos in 1953. Against this was a revenue which could not be expected to exceed 4,500 million pesos. The outlook was, therefore, for a Federal Government deficit of not less than 800 million pesos. This would have been 18% of government revenue, and the biggest deficit in Mexico since 1942. As foreign loans to be received by the Government were unlikely to exceed amortization of its foreign debt, all this deficit would have had to be financed domesti- cally. The deficit of states, municipalities and autonomous public agencies was estimated at 600 million pesos, two-thirds of which would, however, have been financed from foreign loans. The total public deficit of a potentially inflationary nature would, therefore, have been about one billion pesos, to which had to be added 500 or 600 million pesos of agricultural credits, mostly to be financed through the Bank of IIexico. The Government feared that a cut in public expenditure plans might throw the country back into reces- sion; it knew that the carrying out of these plans would result in inflation and loss of exchange reserves. III. The Devaluation 19. Up to 1953 there had been no signs of a serious disequilibrium in the Mexican balance of payments. The current account surpluses created by the devaluations in 1948-1949 and the rise in world prices in 1950 were followed by deficits in 1951 and 1952. These deficits were, however, largely covered by capital inflow. Owing to the fall in export prices, the value of exports fell in 1953 by $79 million (from $679 million to $600 million). It was expected in Mexico that this would be offset by a decline in imports brought about by the recession, and especially by the fall in public invest- ment. It came therefore somewhat as a surprise when it turned out that imports had declined only slightly and that there was a deficit on current account in 1953 of almost $90 million and an over-all deficit, not covered by capital inflow, of $32 million. 20. This unfavorable outcome was due exclusively to the unusually high imports of food and of capital goods for public investment. Because of abnormally bad crops, imports of wheat, corn and beans of $58 million in 1953 were