Mexico - First and Second Export Development Projects

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 8875 PROGRAM PERFORMANCE AUDIT REPORT MEXICO FIRST AND SECOND EXPORT DEVELOPMENT PROJECTS (LOANS 2331-MB AND 2777-ME) JUNE 29, 1990 Operations Evaluation Department Is docment has a restricted Astibuda and may be used on bin dhepfor ce of their ofcial duties. Its co ftals my not otherwise be disclesed Wedd okn n CUnaENCY EQUIVALENT Currency Unit - Peso (Mex$) At the present time, the exchange rate policy of the Mexican Government is to permit a marginal daily devaluation of the peso. In December 1988, the following (selling) rate prevailed in the *free" markets US$1.00 - Mex$ 2,330 Mex$1,000 - US$0.43 In May 1989, the following (selling) rate prevailed in the *free' market: US$1.00 - Mex$2,481 Hex$1,000 - US$0.40 ABBREVIATIONS AND ACRONYMS BANCOMEXT - National Foreign Trade Bank (Banco Nacional de Corvrcio Exterior - also referred to as BNCE) CVD - Commitment to Sell Foreign Exchange (Compromiso de Vender Divisas) FIFE - Program for Financing Fixed Investments for Exports (Programa de Financiamiento de Inversiones Fijas para Exportaciones) FOMEX - Trust Fund for Promotion of Exports of Manufactured Products (Fondo de Famento a las Exportaciones de Productos Manufacturados) FONATUR - Trust Fund for Tourism Development (Fondo Nacional de Fomento al Turismo) ONZ! - Trust Fund for Industrial Equipment (Rondo de Equipamiento Industrial) InCE - Mexican Foreign Trade Institute (Instituto Mexicano de Camercio Exterior) GATT - General Agreement on Tariffs and Trade GIRA - General Interest Rate Agreement IMF - International Monetary Fund PITEX - Temporary Import Porgram for Exports (Programa de Importaciones Temporal para Exportaciones) PROFIL. - Export Financing Program (Programa de Financiamiento de Exportaciones) PROFIEX - Integrated Export Promotion Program (Programa de Fomento Integral de Exportaciones) SECOFI - Secretariat for Trade and Industrial Development (Secretaria de Comercio y Fomento Industrial - also known as SECOFIN) won omCIAL USE ONLY THE WORLD BANK Washwnton. DC 20433 U.S.A. Oace Of 0.ctor-Celeral Opatmas Evalawan June 29, 1990 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND TE PRESIDENT SUBJECT: Program Performance Audit Report on Mexico First and Second Export Development Projects (Loans 2331-ME and 2777-HE) Attached, for information, is a copy of a report entitled *Program Performance Audit Report on Mexico First and Second Export Development Projects (Loans 2331-M and 2777-Mg)* prepared by the Operations Evaluation Department. A Attachment This document has a restricted distribution and may be used by recipients 601y in the performance of their ofRcial duties. Its contents may not otherwise be disclosed without World Bank authoriation. FOR OFFICIAL USE ONLY PROGRAM PERFORMANCE AUDIT REPORT MEXICO FIRST AND SECOND EXPORT DEVELOPMENT PROJECTS (LOANS 2331-ME AND 2777-ME) TABLE OF CONTENTS Page No. PROr-RAM PERFORMANCE AUDIT REPORT Preface ....... .. . * ....... * .... ............. ** .......... Data Sheets................................. . ...................... iii Evaluation Summary. .................... . ........ # .......... * .......... vii I. ECONOMIC BACKGROUND ..... .............. ............ 1 II. GENERATION OF THE FIRST LOAN............................. 8 III. imPLEMENTATION OF THE FIRST LOAN, GENESIS AND IMPLEMENTATION OF THE SECOND ............................. 11 TV. SPECIAL ISSUES ........................**..........o........ 22 A. Did PROFIDE Stimulate Manufactured Export Growth? .... 22 B. Why Did Exports Grow? ................................ 24 C. Was the Export Growth Economically Efficient? ........ 26 V. CONCLUSIONS AND LESSONS FOR THE FUTURE .................. 31 TABLES 1 - Nominal and Effective Protection of Selected Industries, 1979 37 2 - Export Development Loans 2331-ME and 2777-ME Disbur ments by quarters ............................................... 38 3 - Commitments and Disbursements of PROFIDE I-III at Selected Dates ........ . . . . . ......... #....... .. . . . .... 39 4 - Sectoral Distribution of PROFIDE II and III Commitments and of the Growth of Manufactured Exports, 1983-1989 .......... 40 5 - MEXICO: Domestic Resource Cost (DRC) Levels, 1982 and Annual Rate of Change (Z), 1970-1982 ...................... 41 6 - Interest Rates Charged on 90 Day PROFIDE Dollar Loans, 1983-1988 ........................ ,......................... 42 ATTACHMENT Comments Received from the Borrower ......................... 43 This document has a restricted distribution and may be used by recipients only in the performance of their oficial duties. Its contents may not otherwise be disclosed without World Bank authorization. TABLE OF CONTENTS (Cont'd.) Page No. PROGRAM COMPLETION REPORT I. BACKGROUND, SCOPE AND OBJECTIVES OF THE EXPORT DEVELOPMENT LOANS# ..... ......**** ............. 47 t. EDP I ........... ...........*.. ....*....... 47 B. EDP II .*. ........ . .. ..... **........... . . ........ 49 11. THE EXPORT SECTOR ....... ..... ......... .* .. o .. 51 III. IMPLEMENTATION OF THE PROJECTS ......................... 55 A. EDP II .......... .................... 57 B. FIFE ....................... *.......... ... .. . ..... 59 C. EDP I ....... ................... ............. 60 ZV. BANK PERFORMANCE ................*...................... 61 V. GENERAL CONCLUSIONS .................................... 63 ANNEXES I - Exports 1975-1988 ........................................ 69 II - Index of the Real Exchange Rate .......................... 70 III - Estimated and Actual Disbursement Schedule (Loan 2331-ME) 71 IV - Estimated and Actual Disbursement Schedule (Loan 2777-ME) 72 V - Cumulative Commitments (Loan 2331-ME) .................... 73 VI - Cumulative Commitments (Loan 2777-ME) .................... 74 VII - PROFIDE - Financing by Principal Industrial Subsectors, 1984-1988 ....................... ...................... 75 VIII - PROFIDE - Average Size of Loan Operations ................ 76 PROGRAM PERFORMANCE AUDIT REPORT MEXICO FIRST AND SECOND EXPORT DEVELOPMENT PROJECTS (LOANS 2331-ME AND 2777-ME) PREFACE This is a Project Performance Audit Report (PPAR) on two Export Development Projects in Mexico, involving two IBRD loans of US$350.0 and US$250.0 million to Banco Nacional do Comercio Exterior, with the objective of supporting the growth of non-traditional exports through the creation of an export development fund. The first loan was approved on June 23, 1983, and became effective on December 27, 1983. The second loan was approved on January 20, 1987 and became effective on March 26, 1987. The original closing date of the first project was extended by 33 months to June 30, 1989, whereas the small outstanding balance of the second is expected to be disbursed on schedule. The PPAR was prepared by the Operations Evaluation Department (OED) and the Program Completion Report (PCI) was prepared by the Latin America Regional Office of the Bank. The PPAR is based on the attached PCR, the Staff Appraisal and the President's Reports, the loan documents, study of the project files, and discussions with Bank staff. An OED mission visited Mexico in January 1990, and discussed the effectiveness of Bank's assistance with Banco Nacional de Comercio Exterior (BANCOMEXT), Banco de Mexico, financial intermediaries and other agencies and sub- borrowers. Their kind cooperation and valuable assistance in the preparation of this report is gratefully acknowledged. The PCR provides an account and assessment of the project's experience and discusses the performance of the Bank and the prcjectls executing agencies. The PPAR analyses particular aspects of the two operations further, such as the evolution and achievement of the various objectives, their implementation, the pattern of disbursements, the role of interest and exchange rates, and the volume, efficiency and sustainability of the export performance, as well as the relation between the loans and general trade policies. The draft PPAR was sent to the Borrower for comments. The comments received from BANCOMEXT are reproduced as an Attachment to the PPAR. PROGRAM PERFORQANCE AUDIT REPORT HERIODt FIRST EXPORT DEVELOPMENT PROJECT (LDAN 2331-ME) BASIC DATA SHEET LQAN POSITION (Amounts in US$ million) As of Mar. 31. 1990 Original Diab=ed Cancelled Bai Oustanding Loan 2331-ME 350.0 349.3 0 102.1 247.2 CUMUATIVE ESTIMATED AND ACTUAL DISBURSEMENTS ME IML EMI EM 1188 EMa Appraisal Estimate (US$ million) 180.0 320.0 350.0 350.0 350.0 350.0 Actual (US$ MitLLon) 0.9 84.1 174.6 285.1 347.2 348.5 La Actual as I of Appraisal (Z) 1 26 so 81 99 99.6 Date of Final Disbursement Deoember 29, 1989 PROJECT. DATS Original P1an Agal Board Approval 06/83 06/23/83 Signing (Loan Agreement Date) 9/28/83 09/25/83 Effectiveness 12/83 12/27/83 Closing Date 09/86 06/30/89 STAFF INPUTS (staff weeks) PY81 EM2 831 MS M8 EM. WZ M& Iotal Identification/ Preparation Preappraisal .2 1.5 10.8 - - - - - 12.5 Appraisal - - 70.5 - - - - 70.5 Negotiations - - 14.5 - - * - 14.5 Supervision - - .4 36.0 33.7 34.4 21.8 7.7 134.0 Other . -. - - - Subtotal .7 1.5 96.2 42.4 \ 34.4 34.4 21.8 7.7 239.0 JA Includes 6.25 for exchange adjustment. - iv - ISSIQ DATA Date No. of No. of man Date of (ma.(. ,J. D Persons 2M Relport Appraisal 6/83 15 7 105 3/08/83 Supervision I 2/84 12 2 24 2/24/84 Supervision II 4/84 12 6 72 6/19/84 Supervision III 9/84 15 6 90 10/15/84 Supervision IV 4/85 4 1 4 4/30/85 Supervision V 2/86 5 3 15 3/05/86 Supervision VI 3/87 10 2 20 4/22/87 Supervision VII 3/87 5 3 15 12/16/87 OTHER PROJECT DATA Borrower: BANCOMEXT (Banco Nacional de Comercio Exterior) Executing Agencies: BANCOMEXT Follow-On Project: Second Export Development Project Loan 2777-ME Amount (US$ million) Approval Date PROGRAM PERFORMANCE AUDIT REPORT SECON EZORZ EVLPHM PROJECT (LOAN 2777-ME) BASIC DATA SHEET LOAN POSITION (Amounts in US$ million) As of Mar. 31. 1990 Original Disburse Can-elled ftgal Outasandin Loan 2777-ME 250.0 237.5 0 0 237.5 II E TIMATED AND ACTUAL DISBURSEENTS Appraesl stLmate (US$ million) 15.0 131.5 218.0 246.5 250.0 Actual (US$ million) 0 127.3 211.8 237.5 g Actual as Z of Appraisal (2) 0 97 97 96.3 99.6 -PROJECT DATES Original Plan Acal Board Approval 01/87 01/20/87 Signing (Loan Agreement Date) 93/87 03/18/87 Effectiveness 06/87 03/26/87 Closing Date 09/30/90 09/30/90 STAFF INPUT (staff weeks) H81 ~M4 g=2 X81 IM L SA 1. S Total Identification/ Preparation Preappraisal - - - .8 7.2 22.8 - - 30.8 Appraisal - - * - - 21.2 4.1 25.3 Negotiations - - * * - 1.3 11.9 - 13.2 Supervision - - - - * - 6.9 28.3 35.3 0Othe r - .* .Al ..... .3 .. .....4 Subtotal 0 0 0 .8 7.4 45.3 23.2 28.3 105.0 La As of March 31, 1990. - vi - MISSIN DATA Date No. of No. of Man Date of (mo./vn Das&. Persons py Reqort Appraisal 11/10/85 10 4 40 12/27/85 Supervision I 03/23/87 10 2 20 4/22/87 Supervision II 11/19/87 5 3 15 12/16/87 Supervision III 04/25/88 10 4 40 6/06/88 OTHER PRWECT DATA Borrower: Banco de Comercio Exterior (BANCOMEXT) Executing Agencies: BANCOMEXT - vii - PROGRAM PERFORMANCE AUDIT REPORT MEXICO FIRST AND SECOND EXPORT DEVELOPMENT PROJECTS (LOANS 2331-ME AND 2777-ME) EVALUATION SUMMARY Introduction 1. Under the influence of rapidly rising oil export revenues and of large scale external borrowing, production, consumption, imports and in- vestments in Mexico grew fast in the late 1970s. This process, to the extent that it depended on foreign loans, would only have been sustainable if oil prices had continued to rise indefinitely; when they levelled off in 1982 the vulnerability of the economy--a balance of payments on current account deficit of 11% of GDP, negative public sector savings, a stagnant non-oil export sector and en overvalued currency--became apparent. Private lenders refused to renew credits, Mexican capital left the country and a serious crisis, affecting investments, output and employment, spread from the balance of payments to the rest of the economy (PPAR, paras. 1.04, 1.05, 1.07 and 1.09). 2. Once the Government , at was elected in 1982 had taken stock of the situation, it concluded tLat a multi-pronged strategy was required. On the one hand, external assistance was urgently needed to relieve immediate balance of payments pressure; for this, agreements had to be sought with creditors to reschedule debts and money had to be found to meet current obligations. New money as well as accelerated disbursements of existing loans (and some shifting of designated end-uses of such loans) might accomplish the latter objective. But at the same time, major corrective actions would have to be taken to enable the economy to resume a more sustainable growth path after the current crisis was weathered (PPAR, para. 1.10). 3. Such measures would have to address the imbalance between aggre- gate demand and supply of resources, the fiscal deficit and inadequate savings levels (or excessive investment levels). They would also have to address the deeper causes holding back growths the distortions caused by uneconomic administered prices, including interest and exchange rates, by subsidies to inefficient industries, and by penalties on efficient ones (PPAR, paras. 1.11, 1.13-1.15). 4. Creditors, by and large, were eager to help, provided Mexico took the initiative in preparing and implementing such a program. The IMF signed an EFF Agreement in December 1982 and the commercial banks commenced rescheduling discussions. The Bank endeavored to participate and be helpful in several of the spheres mentioned. On the one hand, it hoped to add to the flow of urgently needed freely disposable foreign exchange through its Special Action Progtam (SAP)* adopted in 1982 (for countries affected by the oil price increases). It also modified loans to let money originally destined to finance fixed investments be used for current im- ports. And it tried to design a quick-disbursing project, the first of the two considered in this Report, for the same purpose (PPAR, para. 1.15). 5. However, neither the Bank nor the Government were ready, at that time, to enter into the sort of relationship that would have been involved in direct and simple balance of payments support in exchange for policy understandings, namely a Structural Adjustment Loan (SAL). Instead, it was decided to try to design a quick-4isbursing project loan, with two special featuress (a) the *project* would establish a revolving fund to allow exporters access to importtd current inputs, and (b) the framework of policies affecting ex-ports would be the subject of a continuing dialogue between the Government and the Bank. A certain ambiguity regarding the situation that would ensue in case of major disagreement in the course of this dialogue was allowed to exist from the beginning (PPAR, paras. 1.16-1.17). 6, Nevertheless, the operation as designed represented a considerable advance over the past in regard to tha scope and nature of economic manage- ment that was to become the subject for continued exchanges of views--if not negotiations--between the two parties. A Letter on Export Strategy was incorporated into the legal documents and was supplemented by a more de- tailed draft document--submitted to the Board with the Loan, though it never became part of the legal agreements--spelling out actions to be taken and objectives to be achieved (PPAR, para. 2.05). 7. While the intentions stated in the Letter were not as precise or, indeed, as far reaching as seemed--and later proved to be--necessary or as might have been required under a SAL, there is no doubt that they dealt with important issues. As a framework, these included, in particular, adherence to, '...a realistic exchange rate as a priority to facilitate the expansion of non-oil exports and the efficient substitution of imports...* as well as I...a policy on interest rates that is consistent with the for- eign exchange policy. It promised I...gradual programmed and selective, (but not quantified or time-specific) change in protection with a shift toward greater reliance on tariffs and less on licensing (imposed, for all products, when the crisis broke). Other items dealt with--not so much as programs but as actions taken--referred to debt management administration, tax incentives, export promotion, and other administrative details (PPAR, para. 2.10). ObJectives 8. The objectives of the first operation thus were several, and an evaluation of the loan depends, to some extent on the relative ranking one assigns to them. - ix - (a) Resource Transfet. A quick-disbursing loan, to provide balance of payments support at a critical mc-aent, was one of the avowed objectives (PPAR, para. 2.07, 3.01). (b) Bottleneck Breaking. Related to the above, but not identical vwith it, was the hope to remove a bottleneck to export exi -sion by giving exporters assured access to imported .aputs by permitting them to borrow scarce foreign ex-hange from the revolving fund. (c) Policy Improvement. To "...support Mexico's strategy to expand non-petroleum exports' (President's Report of Loan 2331-ME) and to become an active partner in shaping this strategy was a further objective. The means to achieve the latter was to be the dialogue structured around a regular joint review mechanism dealing with the execution of the Export Development Strategy outlined in the Letter on it. It should be noted that it was taken for granted that the overall macroeconomic management was satisfactory and was being monitored by the IMF. Implementation 9. The first loan did not succeed as a device to respond quickly to Mexico's foreign exchange crisis. It took two and a half year- after effectiveness before substantial disbursements were achieved, and effectiveness itself came six months after Board approval. Moreover, part of the loan (US$52 million) was disbursed only after a new emergency--the 1985 earthquake--had made it necessary to re-allocate some loan proceeds to reconstruction needs, i.e. to purposes not foreseen when the loan was made (PPAR, para. 2.07, 3.01). 10. The reasons for the slow disbursement derived both from analytical flaws in the design of the operation as well as unforeseen events. It had been assumed at appraisal that because there was a foreign exchange shortage, exporters would be eager to borrow loan funds to pay for their imported inputs. The balance of payments analysis was not complemented by a credit market analysis. In the event, demand for the facility was virtually nil becauses (a) Exporters did not trust the Government's assurance that foreign exchange for future debt service for loans that might be contracted by them would be readily available in the official market (where they had to deliver their foreign exchange receipts) (PPAR, para. 3.03); and (b) were not willing to risk having to buy the exchange in the free market at an unpredictable but possibly large (in 1984, it was 50%) premium (PPAR, para. 3.03); (c) there were large subsidised peso credit lines available which, even if exchange was bought in the free market, had the advantage of being not only cheaper but exchange risk free (PPAR, para. 3.03, 3.08-3.09); (d) The recession of 1984, which could not have been antici- pated at appraisal, caused the demand for general imports to collapse to such an extent that the supply of foreign exchange was much less tight than had been originally estimated (PPAR, para. 3.05). 11. There were also other, more ephemeral reasons for the early lack of borrowers. The formalities to be complied with initially seemed forbid- ding to banks and exporters and the facility was not widely known; moreover not all participating banks promoted it actively because the profit margins were modest compared to what they were used to. But the above-mentioned four economic causes were fundamental. After they disappeared, demand picked up. 12. The second objective--export expansion by bottleneck breaking, by definition could not be achieved until the loan began to disburse. While precise calculations are problematic, it is estimated in this Report that a significant portion--between 40Z and 80%--of the sizeable growth of Mexico's manufactured exports between 1983 and 1989 (US$8.9 billion) were associated with the operations of the revolving fund (PROFIDE) (PPAR, para. 3.10). 13. This conclusion is predicated on the assumption that during this period, because of debt negotiations, corresponding amounts of commercial bank trade credits would not have been available as an alternative source of funds. This seems a reasonable assumption for the period, but future lending for working capital to exporters would have to be justified by evidence that commercial banks 2re not willing to supply such credits. Given the recent (early 1990) signing of a formal rescheduling agreement with the banks, this may no longer be the case. And it would be a contravention of the Articles of Agreement of the Bank--which make it a lender of last resort--to displace private funds available on reasonable terms. The fact remains, nevertheless, that while PROFIDE played an important part in the sizeable expansion of manufactured exports and its sustainability is no longer in doubt, the export drive was reinforced by appropriate foreign exchange rate management; the existence of special incentives and subsidies; and attempts by manufacturers (though not always the most efficient ones) to make up for the slack domestic demand by exporting at marginal costs (for details see paras. 4.01-4.20). Policy Dialogue, Policy Support, Policy Lending 14. As noted, a stated objective of the project was "...to support the Government's efforts to expand exports rapidly by: (i) assisting the Gov- ernment in the formulation and implementation of a comprehensive export - xi - development strategy..." (President's Report, para. 90). The formal ve- hicle for this was the Letter on Export Policy Strategy, the implementation of which was to be reviewed jointly twice a year. During these review, Government and Bank would '...agree on adequate additional measures to be taken regardingi (i) actions being taken by the (Government) to put into effect the policies and administrative actions set forth in the Export Strategy Paper...I (Guarantee Agreement, Sect. 3.02). 15. This process did not take place as envisaged. A certain amount of exchange of views did occur at the technical level, during the frequent Supervision Missions and this seems to have been very useful in developing a common understanding regarding the nature of the policy issues, methods for analyzing them and directions of possible solutions. This process of developing a common language and analytical framework was helpful, subse- quently, in developing the first Trade Policy Loan. But there is no evi- dence that the Missions on these matters were even perceived as trans- mitting the views of the Management of the Bank, as indeed, often they were not. (Many Supervision Mission recommendations to the Bank were not acted upon.) The first formal review, which under the Guarantee Agreement was to take place a...no later than March 1, 1984' was finally scheduled for November of that year. The record of what transpired is skimpy, but by that time work had just been initiated on a trade policy loan and it appears that the policy discussions from that time on were dominated by the exigencies of that operation rather than by the Letter on Export Strategy. Given the rather limited nature of the objectives set in that Letter- -especially with regard tn tariffs and import licenses--this was probably a positive development. The Second Loan 16. By comparison with Loan No. 2331-ME, the processing and execution of Loan 2777-ME was anticlimatic. By 1987, when it was signed, the ob- stacles to disbursements had been largely overcome, most of the competing subsidized lines had disappeared and the process functioned smoothly as exporters, intermediaries and, especially, the by now very efficient Banco de Comercio Exterior, had gotten accustomed to it. At the same time, the trade policy issues had been clearly transferred into the discussions sur- rounding the first Trade Policy Loan (TPL) and, in any event, these had been notable advances in the Government's policy formulation and execution. Helped also by a decision to allow some large individual loan commitments, the funds moved faster than forecast by the Appraisal Mission and by early 1990 the issue was no longer whether PROFIDE could place additional sums- -BANCOMEXT clearly could--but whether further Bank lending of this kind was needed or whether more conventional sources of funds would soon be available again. Lessons 17. Export credit financing is not an efficient device for achieving quick resource transfers in emergency situations. - xii - 18. They require, in any event, not merely proof--a rather easy one- -that a balance of payments gap exists but--much more difficult, and rarely accomplished--a credit market analysis in which demand for foreign exchange denominated loans is assessed, with particular attention to such issues as: (i) the existence of local currency credit lines, their cost to borrowers and the latter's access to foreign exchange if they have borrowed domestic currency (PPAR, para. 5.04(c); (Ci.) the perceived and actual risks of exporters when they borrow foreign exchange, e.g. multiple exchange rates, trust in continuity of Government policies, etc. (PPAR, para. 5.04(b). 19. Such an analysis, which has to integrate issues of interest rates and exchange rates with those of institutional capabilities and con- straints, requires financial-economic staff well-acquainted with the sector in the particular country in question. It cannot be improvised on short notice. This is another reason why such operations are normally unsuitable if quick action is especially important (PPAR, para. 5.06). 20. The provision of working capital to exporters by the Bank requires explicit proof that the conventional sources of such funds--commercial banks--cannot be expected to be available for reasons other than the inherent commercial unprofitability of the operation. 'While such situa- tions exist--as they did in Mexico in the 1980s--they are usually temporary and it is therefore important for the Bank not to help to create structures that are predicated on a long-term borrowing relations with the Bank or to create expectations that such a relation is intended. It must be made clear to borrowers that the Bank, as lender of last resort, normally cannot undertake such operations. 21. A related, albeit unwieldy, problem is ensuring that Bank loans are not channelled to sub-borrowers who could normally be expected to have access to foreign sources of funds on reasonable terms. At present, there is no Bank policy on this issue neither for term nor for short term capital. It may therefore be worth considering the possibility of reviewing this matt..* to the end of devising workable guidelines--at least for operations invol%Lng credit for working capital (PPAR, paras. 5.04(c), 5.07, 5.10). 22. On a more general level: usually it is neither efficient nor prudent to link major general policy objectives to operations of this kind. If the conditions are relatively undemanding--as was adherence to the Letter on Export Strategy--the harm done with the Review Process in this case--only makes it more obvious that little importance is attached to them. If loan conditions are stringent and not enforced, the process discredits the value of loan covenants besides not doing any good. And if they are stringent and enforced, they may lead to suspension of disbursements and thereby create serious difficulties for intermediaries and/or ultimate borrowers (exporters in this case) who have no control over or responsibility for the non-compliance. By and large, project, quasi- project, or sector leading should normally await the establishment of the macroeconomic settings that are needed to make the project succeed. 23. There may, nevertheless, occur situations in which there is value in finding devices that help the Supervision Missions to focus on the general policy framework in which the project operates, and to engage the borrower in dialogue about it. This may be the case particularly in a situation like that prevailing in Mexico in which trade policy had not been part of the Bank-Government discourse in the past. As a transitional de- vice, to create a common understanding of issues, problems and possibili- ties, this may be an excellent tool, provided that it is not misinterpreted and taken to be more than that. PROGRAM PERPORMANCE AUDIT REPORT MEXICO FIRST AND SECOND EXPORT DEVELOPMENT PROJECTS (LOANS 2331-MI AND 2777-ME) 1. ECONOMIC BACKGROUND 1.01 Mexico's economy in the 1970s and early 1980s was overwhelmingly influenced by events related, directly or indirectly, to the petroleum sector. Four elements may be distinguished: (a) the world market developments, with major price rises in 1973-74 and in 1979-80; (b) the announcement of major new reserve discoveries in Mexico in the mid seventies; (c) the reaction to these events of successive Mexican Governments in the management of the economy; (d) the concurrent reaction of the Mexican and foreign private sectors, including especially foreign commercial banks. 1.02 Some of the main ingredients of this story are well known, having been dealt with exhaustively in Bank and other reports. On (a), suffice it to recount that the international price of oil by 1974 was 650Z above its 1970 level, then moved within a relatively narrow range until 1978 and in 1979 began to rise sharply again, averaging in 1981 25 times the 1970 level, (nine and a half times in real terms) (See Table 1.1.). 1.03 This price explosion might have had a positive but only relatively minor effect on the Mexican economy, had it not been for the multiplication of reserves that became public knowledge in 1976-77. The Mexican oil industry is relatively old and production had been declining for a number of years, as the major traditional fields were being depleted. The new discoveries were not a marginal increment but a quantum jump; they con- verted Mexico from oil-insignificance to one of the world's major inter- national petroleum producers and exporters. -2- Table 1.1: NOMINAL AND REAL PETROLEUM PRICES, 1970-83 Saudi Arabian US$ Wholesale "Real" Price (Ras Tanura) Price Index of Petroleum US$ per Index (1970-100) (Index (2)t(3)) barrel (1) (2) (3) (4) 1970 1.30 100 100 100 1971 1.65 127 103 123 1972 1.90 146 108 135 1973 2.70 208 122 170 1974 9.76 751 145 518 1975 10.72 825 158 521 1976 11.51 885 166 533 1977 12.40 954 176 542 1978 12.70 976 189 514 1979 17.26 1327 213 622 1980 28.67 2205 244 906 1981 32.50 2500 265 941 1982 33.47 2575 271 949 1983 33.47 2575 274 940 Source: IMF International Financial Statistics various issues. 1.04 The Government that took office in 1976 responded in a manner that would only have been sustainable if it could have been assumed that the new wealth would not only last indefinitely but that oil prices were destined to continue to rise without major interruptions.1 Instead of using the windfall to retire debt or to add it to domestic savings for productive investments, they did the latter while simultaneously greatly increasing public consumption and following policies (e.g., on wages and subsidies) 11 Such an illusion was not unique to Mexico. See, for examples 'Overall, a real increase in the price of oil of some 22 annually from 1982 to 1995 seems most likely.* IBRD World Development Report 1982, p. 34. This would have yielded a price of about US$43 per barrel by 1988 (nominal). In the event, of course, prices fell, not only in real but even in nominal terms (to around $18 p.b.). See also the publications of the Club of Rome and Energy Future, Report of the Energy Project at the Harvard Business School (Robert Stobaugh and Daniel Yergin Editors, Ballantine 1980) which forecast oil prices for around 1990 at a minimum of US$65 per barrel. (It is not absolutely clear what the inflation assumption for this projection were, but of course if it was made at a constant general price level, than it implied on even higher nomial oil price once inflation was factored in). -3- that stimulated private consumption as well. The aim was to accelerate growth and improve living standards quickly; the means were to borrow (See Table 1.2). And, given the euphoria in the world's 7inancial community about the future of oil, borrowing abroad proved easy as long as oil prices were rising. Table 1. 2: MEXICO: CONSOLIDATED PUBLIC SECTOR FINANCES AS I OF GDP 1974 1975 1976 1977 1978 1979 1980 1982 1983 Current Revenues 14.5 16.4 17.8 18.3 19.5 20.6 22.4 20.4 23.8 Current Expenditures 15.4 17.1 18.6 18.0 17.9 18.4 20.2 21.4 29.8 Savings -0.9 -0.7 -0.8 0.3 1.6 2.2 2.2 -1.0 -6.0 Capital Expenditures 6.3 9.3 9.1 7.0 8.3 9.6 10.1 13.7 11.7 Deficit(-) or Surplus -7.2 -10.0 -9.9 -6.7 -6.7 -7.4 -7.9 -14.7 -17.7 Sources Mexico After the Oil Boom Refashioning a Development Strategy. IBRD. Report No. 6659-ME (June 23, 1987). Notes Given the well known statistical difficulties with Mexico's public sector accounts, these figures cannot be totally reconciled with others, including those of the national accounts. But it is be- lieved that they correctly reflect the prevailing major tendencies. 1.05 Initially, the strategy seemed relatively successful. Output, consumption and investment grew at 7, 6.5 and 9.5Z per annum, respectively and although in each category it was the public sector that grew fastest, private investment, too, grew faster than output. Even domestic savings seemed to rise at a very satisfactory rate (over 8% per year). But it was in this area that the actual weakness of the strategy lay: the increase in the external debt and foreign investment was such that interest and earn- ings on foreign capital rose by 236Z and national savings--i.e., the sav- ings left to finance investments after interest and other foreign capital charges have been paid--actually rose more slowly than GDP (See Table 1.3). -4- Table 1.3: SHARES AND REAL GROWTH OF SELECTED GROSS DOMESTIC PRODUCT AND EXPNDITURE CATEGORIES, 1975-81 Share in GDP (%) Growth 1975 1981 1975-81 (2) Gross Domestic Product 100 100 49.0 Exports 7.1 9.0 92.7 Imports 10.4 15.9 73.1 Gross Domestic Expenditure 103.3 107.0 54.1 Consumption 78.6 77.0 45.8 Private 69.7 67.9 45.0 Public 8.9 9.1 52.8 Fixed Investment 21.7 24.9 71.1 Private 12.7 14.1 64.7 Public 9.0 10.8 79.7 Change in Stocks 3.0 5.1 150.2 Memorandum Items Gross Domestic Savings 21.4 23.1 60.5 Gross National Savings 19.6 19.1 44.7 Net Factor Income -1.8 -4.0 236.1 B.0.P. -on Current Account -5.1 -10.9 Source: See Table 1.2. Note: The calculation are based on constant peso data. It would have been preferable to use current price data for the share figures, but this would have introduced some inconsistencies with the real growth data because of some oddities in the deflators. 1.06 Another way of looking at the same phenomenon is that already by the mid-seventies--as a result of the previous Government's fiscal policies --the current account deficit of the balance of payments was almost twice as high as it had been historically--including the period of the fifties and sixties when the economy had grown steadily at about 62 per annum. At over 52 of GDP it was uncomfortably high, but in the rest of the decade this proportion rose to almost 11Z, and thus Mexico became increasingly dependent on the continued confidence of its creditors. But these could only look to continuing increases in Mexico's oil revenues as a basis for any expectation that they would be paid on time and in full. -5- 1.07 The processes by which this excessive borrowing was brought about were varied and complex. One important one was relative neglect of the maintenance of export-competitiveness in Mexico's non-oil economy, which went counter to a long tradition of careful monetary and exchange manage- ment. After 1976--i.e., as soon as oil became Important--the real exchange rate was permitted to appreciate (30% between 1976 and 1981) and non-petro- leum exports virtually stagnated in real terms during the following four years (See Table 1.4). Had it not been for the expansion in petroleum exports--which by 1981 accounted for 69X of all merchandise exports. against virtually zero in 1970--the balance of payments crisis would have come to a head much sooner. Table 1.4: NON-PETROLEUM EXPORTS AND THE REAL EXCHANGE RATES, 1970-81 Non-Petroleum Non-Petroleum Exports Real Exports (US$ million in Exchange (US$ nillior) 1970 Prices) Rate Index 1970 1290 1290 100.0 1971 1366 1322 99.6 1972 1666 1544 101.1 1973 2072 1698 98.9 1974 2816 1942 95.9 1975 2627 1655 94.8 1976 3112 1877 129.8 1977 3662 2081 111.1 1978 4290 2261 103.4 1979 5033 2357 98.3 1980 5702 2341 92.1 . 1981 6115 2302 91.1 Source: Mexicot Recent Economic Developments and Prospects, IBRD Report No. 4996-ME, May 7, 1984. A subsequent Bank Report describes the resultst "The country's financial situation on the eve of 1982 was precarious indeed. The exchange markets were unstable and the official exchange reserves were negligible. International interest rates had reached an all time high and the oil mar- ket faced a glut. Commercial bankers as well as asset hold- ers could see clearly the vulnerability of the Mexican finan- cial system. Thus the short term loans stopped being rolled over2 and capital flight reached dizzying dimensions in the ./ When oil prices levelled off. [Notes Not in original.) - 6 - first few weeks of 1982, when the authorities no longer could support the peso... Throughout the year the economic and financial situation remained virtually out of control, withb the government appearing to be responding to, rather than guiding, the events. Various attempts were made to rectify the situation, and different measures (trade restrictions, public expenditure cuts, devaluation, exchange controls and eventually nationalisation of the domestic banks were tried but they either proved to be insufficient or came too late.3 Hexico: Recent Economic Developments and Prospects, IBRD Report No. 4996-ME, March 7, 19849. 1.08 The above adjectives, while dramatic, are not exaggerated. Some of the dimensions of the crisis were, inde-d, dizaying. In particular the reversal of a net short term capital inflows of over US$10 billion in 1981 to an outflows of US$1.7 billion in 1982 and US$5.1 billion in the follow- ing year is majors the US$15.3 billion turnaround represented over 13% of 1981 GDP (See Table 1.5). Table 1.5: MEXICO SELECTED BALANCE OF PAYMENTS ITEMS, 1979-83 (US$ billions) 1979 1980 1981 1982 1983 balance or Current Account -4.9 -7.2 -12.5 -4.9 5.5 Direct Foreign Investments 0.8 1.3 1.2 0.7 0.4 Long Term Capital (Net) 3.8 5.6 10.5 9.7 3.8 Public (Net) 3.1 4.1 8.7 8.9 3.5 Private (Net) 0.7 1.5 1.9 0.8 0.3 Short Term Capital (Net) -0.1 5.1 10.2 -1.7 -5.1 Sources See Table 1.4. 1.09 Imports collapsedt from US$34.4 billion in 1981, they fell to US$21.8 billion and US$12.7 billion respectively in the next two years. Fixed investment, both public and private, fell by about one-third between 1981 and 1983 and unemployment rose substantially (See Table 1.6). 1.10 The dimensions of the crisis were such that it was clear that any remedial policies had to contain, inter alia, major macro-economic reorien- tation. The excess of investment over national savings had to be brought down from its unsustainable 112 of GDP; consumption had to be reduced, arrangements with creditors for refinancing and/or rescheduling had to be sought, the public finances had to be brought into better balance and the dependence of the economy on oil had to be reduced. The latter required recovering the eroded competitiveness of the non-oil sectors, manufactur- ing, mining and agriculture, as well as such service sectors as tourism. 31 It is not explained in what sense the bank nationalization was insufficient or came too late. -7- Table 1.6s SELECTED UNEMPLOY)NT STATISTICS, 1981-83 (Z of labor force) Year Quarter Mexico City Guadalajara Monterrey 1981 II 5.8 8.1 5.6 IV 4.9 9.5 4.2 1982 11 5.4 8.3 5.5 IV 5.8 7.7 6.0 1983 II 7.7 13.2 13.6 IV 9.8 12.8 12.3 Sources Mexico After the Oil Boom, etc. (op. cit. p. 121). 1.11 While it was recognized that the exchange rate was a vital element in this, there was an increasing body of opinion, both in Mexico and in the Bank, that held that in Mexico a favorable exchange rate was a necessary but not a sufficient condition for a resumption of sustainable economic expansion and, more particularly, of industrial development. 1.12 This thesis was based on the particular modality of Mexico's in- dustrial growth of the preceding four decades. A sizable industrial plant had been built up, including some very efficient units, but it was felt that renewed expansion and especially moving into increasingly technologi- cally sophisticated processes and products, would require a substantially different strategy. 1.13 Although much--not all--of Mexico's industrial growth in the post World War II period had been left to the private sector, it had neverthe- less been the result of very active government interventions. In part, these had been financial; through its development bank Nacional Financiera and through other devices the government supplied equity capital and often subsidized credit to many firms which would have had difficulty in obtain- ing financing from market sources. But more important still were the vari- ous import restricting policies: tariffs, quotas and absolute import pro- hibitions which, as time went on, had built an increasingly formidable pro- tecting wall around Mexico's industry. 1.14 It was felt that the pattern of this protection had become in- creasingly dysfunctional and counterproductive, that the great dispersion of nominal tariffs made for a highly irrational pattern of effective pro- tection, (See Table 1) that increasingly potential export industries were hurt by the high costs of protected inputs, that the quantitative restric- tions were conducive to the toleration of inefficiency and high costs and that the time had long past where many industries could justifiably demand protection on *infant industry" grounds. - 8 - 1.15 A certain amount of sophisticated technical work was done on these issues in the early 1980s by Bank staff in collaboration with Mexican officials and investigators.4 It had documented many of the above theses and had laid the intellectual foundation for the view that structural adjustments of the Mexican economy, to enable it to overcome the crisis, in addition to macro-economic, demand-oriented measures, should involve a drastic realignment and rationalization of the protective systems with a view to letting comparative advantages have a more determining role in resource allocation. It was thought that this would add efficiency, flexi- bility and dynamism to the industrial sector, lower the costs of efficient industries and permit their expansion--be it for exports or for import sub- stitution--and would shrink or close down (or improve the performance of) the least efficient industries. 1.16 While by itself this view did not yet involve a decision to livk such measures to Bank loans, it laid the foundation for at least discussing them, in particular, in connection with lending in the industrial sector. 1.17 It should be noted, especially, that in the early and mid-1980s these trade policy issues engaged Mexican officials and economists very deeply. An active controversy took place over several years within the Government, in which the level of the debate was high on both sides and which only around 1985 wa definitely decided--at the political level --against those advocating continuation of the traditional policies. (See below, Chapter III.) II. GENERATION OF THE FIRST LOAN 2.01 In January/February 1983 a combined programs/projects mission visited Mexico to develop a fast disbursing project loan operation under the Bank's SAP.5 It was by no means the only Bank action for Mexico at that time--a proposal to modify an existing Capital Goods Industries Development project (Loan 2142-ME) so as to use US$100 million of it for an Export 4/ The genesis of this was an earlier "pure* research project, comparing protective policies in a number of countries. See Bela Balassa (Ed.) The Structure of Protection in Developing Countries (IBRD/Johns Hopkins University Press, 1971). 5/ Adopted in 1982 by the Bank to increase disbursements quickly in all countries that were affected by the second oil shock--although obviously Mexico's case, as an oil exporter, was rather atypical--provided this was achievable under sound project and/or program criteria. -9- Development Fund was also being processed, for example--nor was the Bank alone in considering emergency assistance to Mexico since the IMF was also doing so.6 The mission proposed a project that would provide resources for the above-mentioned Export Development Fund. 2.02 The mission did its work one month after the assumption of office by President de la Madrid, and its discussion of policy matters had, neces- sarily, to be based on the statements of intent of the new Administration. Obviously, in the initial months, these had to be rather programmatic and general, although some indications of their underlying thrust seemed to be discernible. 2.03 Actually the mission came back with a gloomy short-term outlooks licensing of all imports was to remain in place, as was the dual exchange rate system (although an early convergence of the official and free-rates was hoped for); the Government would allow exporters access to the pre- ferred official rate for their imports but had yet to issue details imple- menting regulations. Non-oil exports, which has fallen by 22% in 1982 were expected to stagnate, not curprisingly given the 502 gap between the offi- cial rate at which exporters had to deliver their foreign exchange earnings, and the free market rate. 2.04 The mission proposed to address some of the policy issues rather delicately: the Government would issue an Export Development Strategy document. "...incorporating as far as possible, timetables for major ac- tions (which) should be reviewed and agreed with the Bank during negotia- tion of the proposed loan. The statement should be formally transmitted to the Bank prior to presenting the loan to the Executive Directors.07 Joint periodic reviews of the execution of these policies would take place during the disbursement period. 2.05 The question of formal loan conditionality of these policy matters was thus left somewhat ambiguous. Given the lack of precedence in formal understandings between the Government of Mexico and the Bank on broad macroeconomic management issues such an approach seemed prudent, albeit not devoid of some risk of possible future disagreements. It left a certain amount of leeway to both parties for subsequent interpretations of what was a formal commitment and what was a mere statement of intent or expectation. 2.06 The loan proposal was for a Bank loan of US$350 million, of which US$275 million would be allocated to EDF, a revolving fund to provide short-term loans in foreign exchange to exporters to finance the cost of their imported inputs; US$72 million would be allocated to provide medium and long-term investment subloans to provide fixed investments to export 61 An Extended Fund Facility for SDR 3.6 billion had been approved in December 1982. 7/ See Mexico--Export Development Loan Issues Paper, March 8, 1983. - 10 - industries8 and US$3 million would be devoted to technical assistance and export promotion activities. 2.07 It was expected that the bulk of the loan, i.e. the EDP component, would be disbursed in 12 months after loan effectiveness and the remainder in a further 18 months. It was stated clearly that the size of the loan was less than the estimated absorptive capacity of the sector and was de- termined by lending program resource constraints. It appears, however, that the demand analysis on which this conclusion was based had focused essentially on Mexico's foreign exchange requirements and had not included a study of the special issues related to the demand for foreign exchange denominated credit at (more or less) competitive interest rates (see below, Chapter III). 2.08 The loan was processed considerably faster than usual; already on May 11 draft documents were submitted to the Loan Committee. The Loan Committee was concerned about a number of issues; an analysis of later events suggest that in some cases it may have accepted the staff's reas- surances too readily. 2.09 One concern was whether Bank funds might displace funds from com- mercial banks. The staff believed that Mexico's debt situation would in- hibit banks from lending for some time.9 Another question concerned demand. As noted below, the response, in terms of foreign exchange needs seemed persuasive but ignored the credit aspects. The Loan Committee was con- cerned, rather, with the unmet demand, and objected to the proposed first- come first-served approach...although it was, as one member noted, the only one consistent with a true market orientation. Instead, it demared that after six months the allocation (i.e. rationingl) criteria for EDF should be developed and be made part of the periodic review process.10 8/ Although on its face it would seem odd to transfer funds from the fixed investments financing Capital Goods Industries Loan to the current input financing EDF (see above, para. 2.01), while simultaneously making a new US$72 million loan for fixed investments, apparently it was felt that, because the Capital Goods Industries were essentially import competing, the adopted solution was institutionally more appropriate (Direct communication from a Team Member). 9/ It will be seen below that not only was this too pessimistic a view but the question may have been too narrowly framed by focusing only on banks and not on the displacement of any private funds. 10/ This decision does not seem to have been followed up on, if--as must be presumed--sectoral or subsectoral allocation criteria were meant. Only pre-allocations among the intermediaries were later imposed (to make many banks participate) and credit ceilings on ultimate borrowers were set (to prevent excessive concentration of funds on a few beneficiaries). * 11 - 2.10 The Loan Committee, on the other hand, did not question the pro- posed interest rate arrangements which turned out to be the source of con- siderable complications later (see below, Chapter III). In general, in spite of the above concerns, the Committee expressed itself in quite posi- tive terms, influenced apparently by the fact that a project financing approach would be combined with at least some dialogue and understandings on policy matters. 2.11 The loan negotiations took place a week later (May 18-20) and did not yield major changes. The transfer of FOMEX (the Trust Fund handling the EDP) from the Banco de Mexico to the BNCE was made a condition of ef- fectiveness and the Bank recorded its willingness to consider making "indirect exporters'll eligible for EDF funds once a study of the administrative requirements had been completed.12 The loan was thus processed with admirable speed up to that point; some four months after the return of the first mission it had been negotiated and a month later it was approved by the Executive Directors. The record is not clear on why it then took as long again until it was signed (September 25) and why it only became effective December 27, 1983. The point is not a trivial one: the operation was conceived to provide emergency assistance to Mexico and clearly the management and staff initially made a major effort to act expeditiously.13 III. IMPLEMENTATION OF THE FIRST LOAN, GENESIS AND IMPLEMENTATION OF THE SECOND 3.01 In the first two and a halZ years of loan implementation, dis- bursements were highly disappointing, casting serious doubts on the ade- quacy of the loan structure for the achievement of the resource transfer 11/ Domestic suppliers of inputs to exporters. 121 For unexplained reasons this did not happen during the first loan. There are, of course, conceptual difficulties on how to let producers who are not themselves direct earners of foreign exchange, borrow from a revolving fund whose characteristic is that it lends and must recover foreign exchange. 13/ It may be argued, however, that in the second semester of 1983 it was already clear that there was less cause for special speed than had been assumed: the US$100 million passed to EDF from the Capital Goods Industries Loan had been effective since June 23, 1983 and were not disbursing. - 12 - objective of the operation (See Tables 2 and 3.) Since, as noted above,14 by the time the loan became effective the staff had already had six months to observe the behavior of the first US$100 million PROFIDE 115 from the very beginning some of the causes of the disbursements lag were well under- stood, while others became clearer gradually. 3.02 It is not possible, at this late date, to be very precise about the relative strength of the various operative causes and besides these clearly fluctuated over time. Thus, the early complaint by exporters that the required documentation was onerous and unreasonable lost force later; less because the Bank agreed to simplified documentation than because ex- porters became more expert in, and willing to submit themselves to some necessary formalities as the financial advantages of the program to them became greater or clearer.16 3.03 Similarly, the quite unexpected initial unwillingness of Mexican entrepreneurs to indebt themselves in foreign exchange was a composite of several concerns. In part it was the instinctive reaction of firms that had suffered large exchange losses when the devaluations of 1981-82 had caught them with sizeable foreign exchange debts. And since most exporters also sell in the domestic market--indeed most sell mostly in the domestic market--no real distinction between 'safel and Ounsafe" external debts was made. But there was more to it than that. It could be argued that as long as they only borrowed to finance re-exported inputs, there was no rational reason to fear a foreign exchange risk. Actually, however, there were two very good reasons. One was that they could not retain their foreign ex- change earnings for needed debt service. They had to sell all exchange inflows and buy back what they needed for debt service. To borrow PROFIDE funds thus required confidence in the Government's willingness--and abil- ity--to always make available the exchange for debt service. In the early to mid-1980s this confidence was very weak; the continuing debt crisis, the lack of decisiveness in the Government's stabilization program, and perception of discontinuity in other policies all contributed to making such borrowing appear very risky. 14/ See Chapter II. 151 Following the PCR and previous Bank reports, the EDF will henceforth be referred to by its Spanish initials PROFIDE (Programa de Financiamiento de Exportaciones). PROFIDE I refers to the US$100 million from Loan 2142-HE and PROFIDE II refers to the current inputs financing under Loan 2331-ME. 161 FOMEX also became more adept at selling itself. Its original PROFIDE Operational Manual, which exporters and bankers had to understand and to follow, was a rather formidable 50 single-spaced pages documents; without much change in substance the 1990 version has shrunk to 18 double-spaced pages. - 13 - 3.04 The other, complementary reason was the dual exchange rate. If the exporter who sold his exchange at the official rate could not buy his debt service requirements on the official market he would have to go to the free market and incur--perhaps--an unpredictable loss. This, too, made PROFIDE borrowing look much riskier than the Staff Appraisal Report had suggested. In both respects, the present high demand for PROFIDE/type funds can, inter alia, be interpreted as a sign of a major revival of private sector confidence both in the continuity of Government policies and in the continuation of the virtual disappearance of the gap between the official and the free market exchange rates.17 3.05 But there were other reasons for the absence of demand for PROFIDE funds between mid-1983 and mid-1985. The contraction of the economy was cited by the staff, and although there is no direct way in which this can have caused a decline in the demand for imported inputs for exports, it is possible--direct evidence is lacking--that the depressed domestic indus- tries increased their offer of domestically produced inputs to the export industries. In other words, there may have been import substitution on the input side in the export industries. The other mechanism by which the recession reduced the demand for PROFIDE funds was that more foreign exchange was available to finance imported inputs, as domestic absorption of imports fell. 3.06 Quantitatively the most important factor seems to have been the maintenance by the Government of credit lines to exporters at preferential interest rates. There were several of these lines. One was-the FOMEX peso fund fed by 2Z of all import duties since 1962 (1% in the eighties) and relent to exporters at a mere 8% per annum. It was estimated that in 1983 over US$1.2 billion of such credits were disbursed. Another was the--also very large--flow deriving from the Central Bank Rule that commercial banks had to lend 1.21 of their assets to exporters. These funds were lent at the OTotal Cost of Funds* rate which was about 10 percentage points below . the *Average Cost of Funds" (which was more of a true market rate). This line continued in existence for four years (i.e. until the second loan). Obviously, both these credits were far more attractive--being without foreign exchange risk--than PROFIDE or even than the about US$1 billion Export-Import lines made available by Mexico's 12 major trading partners (Japan excluded) at a cost--to the ultimate borrower--about one percentage point below that of PROFIDE. These export-import lines also hardly moved in 1983. 3.07 Finally, contrary to staff assumptions at the time the loan was made (see above, Chapter II) some foreign commercial banks seem to have reappeared, somewhat surreptitiously--given the delicacy of this during the 17/ One interviewed exporter complained to the Evaluation Team that he was still penalized by the difference between the buying and the selling rate (i.e. he would prefer to retain his foreign exchange) but in comparison to the official-free market differential of the mid-1980s this is trivial. - 14 - debt negotiations--so that figures were hard to come by, but supervision missions repeatedly cited reports of reopened trade credits. By February 1983 a supervision mission was already so concerned about the lack of dis- bursements of PROFIDE I and II that it suggested that the Bank should pro- pose to the Government a package of measures modifying the operation of PROPIDE, exportlimport procedures, credit policies and institutional ar- rangements. If no agreement was reached, the remaining US$80 million of PROFIDE I should revert to the Capital Goods Industries Loan and up to US$200 million of PROFIDE II should be cancelled. 3.08 The mission, despite the previous emphasis on policy improvement, did not suggest the obvious remedy, namely to abolish the highly subsidized 8Z credit lines (the rate of inflation in 1983 had been 1082 and in 1984 was 70Z wholesale). Instead it opted for protecting PROFIDE, asking that "... SECOFI18 rationalize the selection of payment for im- port licenses--encouraging exporters to pay for their imported inputs with foreign exchange, preferably foreign credit lines... ...introduce a new pre-shipment credit policy in FOMEX to limit preferential peso financing for (to 7) domestic imports and to require foreign exchange finance for imported inputs--as a key feature it is recom- mended that peso financing for domestic inputs be coupled with PROPIDE financing for the imported inputs along pro- portions (Omezcla") to be justified by the cost structure of the specific export project.... Supervision Report, February 24, 1984. Other parts of the proposed package included a reduction in PROFIDE interest rates to ultimate borrowers, simplification of documentation re- quirements, elaboration within three months of a proposal to finance indirect exporters, and some promotional and administrative measures. The proposal to reduce interest rates to ultimate borrowers to 1.5 percentage points above Bankers Acceptance Rate (BAR) from the original BAR + 3 percentage points was not rationalized, except as a counterproposal to a Mexican request to go down to BAR +0.5 points. 3.09 In April 1984 the Government informed the Bank--apparently motu proprio as no record of a Bank request could be found--that the 82 peso denominated FOMEX line of credit had been eliminated but that FOMEX would continue to give preferential terms (352-50% of ACF) to exporters for locally produced inputs. The staff took the position that some of these funds would leak to exporters for their imported inputs and would continue to undercut PROFIDE.19 18/ The Ministry of Trade and Industry. 191 Memo, IDF Division Chief to Regional Vice President, April 17, 1984. - 15 - 3.10 It appears that by mid-year the Bank's thinking about the project had become increasingly dualistic. On the one hand, during the Spring 1984 PIR Meeting of June 4, 1984, when the SVPOP questioned whether the project had not best be converted from a credit project to an export fund (i.e. selling foreign exchange to exporters rather than lending it) the regional management responded that: I...working level agreements had been reached on changes in procedures and reduction in interest rates to increase the speed of commitment. While there was some problem of availability of competing lines of credit, demand for funds provided by the loan was building up...Finally, it was expected that the current relative abundance of for- eign exchange would be reduced in 1985, increasing the demand for subloans still further. If there is insuffi- cient progress by the time of the loan review scheduled for November, the corresponding portion of the operation would be cancelled.* (Memo to files: Spring 1984 PIR, June 18, 1984. Emphasis added.) On the same day the Supervision Mission which had returned a month earlier, issued its final report20 which included the following overall assessment: "...The mission was able to reach agreement with the Mexicans on a limited package of procedural and operation- al adjustments to the existing loans,21 except for the interest rate issue22 which is still under consideration by the Government. The mission made some limited progress in developing a Government consensus on the status and prospects of the two loans...In essence, the mission argues that even the full package of agreed revisions of loan regulations would not ensure a major acceleration in the disbursement of these loans"i over the near term because there are more fundamental issues relating to the depressed economic environment and the implementation of the Government's institutional and policy reform objectives, as discussed below. The structure of policy and institutional authority is so divided and diffused that it was difficult for the mission to achieve a broad 20/ The Division Chief distributed it three days later. 211 Loan 2142-ME was being supervised at the same time. 22/ Emphasis added. 23/ Emphasis added. - 16 - consensus with the Government. While a number of key officials effectively acknowledged the correctness of the mission's findings, in many cases they were constrained in doing so by considerations relating to the still unsettled distribution of authority and definition of hierarchy, and by the fact that there are appreciable differences of views on policy.' (Supervision Report of June 18, 1984, Annex I.) It is not clear how the report to the top management came to differ so drastically from that of the Supervision Mission;24 although the conclusion--that a decision on cancellation should be postponed until the November consultations--was the same (the mission reported that this was the Government's wish), the assumptions underlying it clearly differed greatly. Nor is it totally clear what the alleged differences of views on policies were and how they affected disbursements. Regarding the first question, it seems that nhat was meant was the well known debate within the Government regarding trade liberalization, to which there was substantial intellectual and bureaucratic opposition...in addition to that emanating from the productive sectors that felt themselves threatened. But the link with the slow disbursements was not spelled out. 3.11 It seems to have been around this time that the idea of making loans to Mexico tied to policy packages rather than to fixed investments or--as in the case of PROFIDE--to specific activities, acquired new impetus. Not only did the mission note that I...any future project and/or program/sector operation will have to take into consideration the record of experi- ence with Capital Goods Industries Development and Export Development Projects...it will be necessary not only to develop an appropriate high-level framework for clear definition of policy but also to ensure project design that reflect our understanding of current institutional arrangements and jurisdictions... "3 24/ One team member who was consulted has speculated--his direct knowledge and memory are limited--that negotiations between the US and Mexican Governments on interest rates had reached a satisfactory conclusion between the return of the Supervision Mission and the PIR Meeting and that the Regional Management was therefore reporting more up-to-date information than the Supervision Mission. This is possible--the US and Mexico were discussing the issue because U.S. interests had complained about the Mexican interest subsidies and the U.S. had threatened commercial policy retaliation. But no corroboration of this hypothetical connection between the two matters could be found in the written record. 25/ Emphasis added. - 17 - 3.12 The staff vent even further in pushing the idea of policy-based lending, arguing that the time for such initiatives was rapidly running outs "The mission's report also strikes a note of concern, regarding its conclusion that much of the initial impetus for the restructuring of Mexican industry and trade, as envisioned in the managerial plans of President de la Madrid, has already been substantially dissipated. Given that the 'window' for important policy initiatives is likely to close toward the end of 1985 (the start of the second half of the current presidential term), the mission would recommend that the Bank move forward as quickly as possible in the area of industry and trade. There is a particular need for intense preparation for the end-of- the-year review...8 3.13 What is of special interest here is; (a) that there was considerable skepticism about the fut4re of the "apertural policies; (b) that this was viewed as a challenge for more Bank policy involvement rather than a reason for caution; (c) that for the first time the supervision of the loan was linked to the joint review of trade policy measures that had been considered one of the most interesting aspects of the loan (see above, para. 2.04) but that had received virtually no attention so far.26 3.14 The written record does not yield evidence of such an exchange of views having taken place by June 1984; previous supervision reports have only description references to the Missions' observations on events in this field. Nor did many formal reviews, as prescribed in the Loan Documents, take place later. Rather, as the work in preparation of the First Trade 26/ Section 3.02 of the Guarantee Agreement specifies that: "The Guarantor shall, every six months, starting not later than March 1, 1984, until the completion of the project, exchange views with the Bank and the Borrower, and agree on adequate additional measures to be taken, regardings (i) actions taken by the Guarantor to put into -effect the policies and administrative actions set forth in the Export Strategy Paper...' The Guarantor, of course, was the Government. - 18 - Policy Loan became more intensive, it preempted center stage of trade policy discussions between Mexico and the Bank. This, of course, removed whatever formal commitment character the Export Strategy Paper might have had and thus obviated the possible difficulties that might have arisen from insisting on particular measures. It is an open question whether this advantage outweighs the possible longer term costs to the Bank in terms of its credibility and of the inviolability of its legal agreements, to ignore or tacitly disregard important covenants. 3.15 Four months later the staff's thinking had advanced even further in the direction of policy related lending. But instead of seeking new quid pro quo commitments relating disbursements to new policy measures, the October Supervision Mission reported that 'Based on the impressive progress achieved by the Govern- ment in the policy and administrative areas and the accel- erating level of imports into Mexico under the temporary import scheme for exporters, we believe there would be justification for the Bank to consider a fast disbursement mechanism (e.g. a one-shot disbursement against documented general imports for exporters) of the order of US$100 to US$125 million under the loan (the estimated amount of funds expected to be otherwise uncommitted under the proj- ect by year-end 1985).' This recommendation--rather similar to the proposal of the SiPOP during the Spring 1984 PIR meeting--was made before the proposed November 1984 policy review. It did, however, follow closely acceptance by the Government of the Bank's proposal on how to revise PROFIDE interest rates for foreign exchange loans (BAR + 1.65 p.c. points). 3.16 This idea was refined further when the staff sought guidance from the Regional Management regarding the position to take in the forthcoming review meetings.27 Two alternatives were proposed either (a) reassign US$125--US$150 million (*the amount likely to be uncommitted by the end of the year") to a fast disbursing mechanism'...cum conditionality... (i.e. these funds could be disbursed from the ongoing EDP upon compliance with a set of policy conditions discussed below)*, or (b) to launch a new export development policy operation while channelling the surplus funds in the ongoing EDP. 'Under either alternative the 'transferred' funds would pro- vide some of the foreign exchange required to finance the substantially increased levels of imports expected as a result of the ongoing trade lib- eralization measures and economic recovery'. 3.17 It is to be noted that no attempt was made to explain why these factors would not also lead to an acceleration in the demand for EDP credit under the existing loan structure (and why, then, such special action would 27/ Memo of IDF Division Chief to LAC Projects Director, of November 9, 1984. - 19 - be required). Or rather, in the preamble to the recomendation it was stated, without comment, that the subsidized FONEX credit lines continued to offer "...strong competition to funds available at market rates under the Bank project', but it was not proposed to insist on elimination of the subsidy. Nor was any reason given for not doing so; the issue was not discussed. 3.18 The policy elements on which the proposal wanted to concentrate in retrospect seem useful but also somewhat marginal. They concern further decentralization in the issuance of import licenses, more active promotion and more decentralization in administration of the temporary imports re- gime, an acceleration in the VAT reimbursements to exporters, strengthening of IMCE an of intra-governmental inter-agency coordination. The relative marginality may have been deliberate, for at the same time proposals were already being elaborated for a 'follow-up DPLO which would, if approved, focus on the major trade liberalization issues tariff and import license reductions. 3.19 In the event, none of these recomendations were acted upon. It appears that the simultaneous pick-up of commitments under PROFIDE as the competing sources of funds became fully utilized28 and the growing dynamism of the trade policy discussions reduced the interest of all the parties concerned in tinkering with PROPIDE. 3.20 In late 1984 and early 1985 the balance of payments difficulties became acute once again. Contributing factors were not only the real ap- preciation of the peso against the dollar but also the growing overvalu- ation of the latter currency itself. In addition many of the stabilization targets were not adhered to, economic activity rebounded more than expected and inflation accelerated. Moreover, declining world oil consumption had put petroleum prices under pressure; by 1984 they were some 20Z below their 1982 peak and in 1985 continued to-drift downwards. 3.21 As a result, between mid 1984 and mid 1985 exports fell by 3.2Z while imports rose by 37Z. It was to this point that the major policy issues before the government were, for the first time, confronted without obfuscation. The PROFIDE supervision mission had, until then, repeatedly reported that it was doubtful how serious the liberalization program actu- ally was. These doubts were justified; a member of the economic Team from that period told the Evaluation Team that from 1983 though the first half of 1985 the Government had to react mainly to short term, emergency prob- lems and that resistance--from manufacturers, politicians and from the 281 By year's end I...it is estimated that...both FOMEX pre-export financing in pesos for purchase of domestic inputs and the '1.2 lineO of commercial banks for manufactured export financing have been used in full, with limits imposed for individual firms.* (Memo of Projects Officer to Deputy Projects Director, LAC, December 18, 1984). - 20 - bureaucracy, was great to any attempt to make really deep changes in the protective system. Thus, for example, the DIMEX system--to liberalize imports for exporters--was effectively sabotaged by the import-substituting producers and by their regulators, by means of the quantitative restric- tions. The Export Strategy Paper included in the Loan Documentation as far as can be established now, was not, in and of itself, a principal element in the decision making process, althouLph its existence undoubtedly played a tactical role in Government-Bank relations. 3.22 But in July 1985, when it was clear that the deviations from the Adjustment Program were major and not self-correcting, the internal coun- cils of Government rejected proposals to move back to tighter controls- -trade, prices, investment, etc.--and instead opted for a program of budget cuts, an aggressive trade liberalization and a sharp devaluation. Since this was done in the mdst of a severe balance of payments crisis, the decision to press ahead more, rather than less, vigorously with the trade liberalization program was a quite unusual policy response. 3.23 The discussions with the Bank, on a trade policy based loan by that time had become quite serious. It seems very clear that the key decision by the Government was in no way a response to Bank pressure or persuasion or to the incentive of a few hundred million dollars of Bank loans; it was the result of an internal political debate in which President de la Madrid used his authority to decide. It also seems beyond dispute that the prospect of Bank support--with loans and with commercial banks--to Mexico for a particular economic strategy, made the position of the liberalizers stronger and more credible. But the PROFIDE operation itself had little to do with it except in the sense that for a couple of years- -1983 to 1984--it had given the Bank staff a recognized legitimacy in beginning to address these issues before the Mexican officials might have wanted to discuss them in depth with the Bank. 3.24 For a while concern in the Bank with matters related to the September 19, 1985 earthquake swamped interest in PROFIDE. Eleven days after the earthquake, the Regional IDF Division endorsed a request from Banco de Comercio Exterior allowing the use of US$52 million of uncommitted PROFIDE funds for the reconstruction activities of the telecommunications firms. While these firms did have exporter status, what was proposed was to use PROFIDE funds not for working capital but for local costs and imports for reconstruction. 3.25 This action coincided with a dramatic pick-up on PROFIDE's overall commitments. In April 1985 these had still only stood at US$75 million; nine months later they were US$200 million, exclusive of reconstruction money. Thus the operational and economic problems that had beset the proj- ect for the first two years were largely overcome and PROFIDE began to function effectively enough to call for a follow-up operationt in May 1985 an Initiating Memorandum set the stage for it. - 21 - 3.26 However, this time there was none of the pressure to process the loan expeditiouslys it took seven months to prepare an Issues Paper, another seven months to send a memo to the Loan Committee and six months more for Board approval. This is paradoxical; the expectation--erroneous, as it turned out--that PROFIDE II was urgently needed produced a commend- able, if wasted, sense of urgency in the Bank. On the other hand, the fact that by February 1, 90Z of PROFIDE II was committed (1002 by June) clearly indicated that delay in replenishing it would provide a financing hiatus; nevertheless PROFIDE III only became effective some 14 months later.29 In part, this slowness may be explained by the way the Bank staff interpreted the PROFIDE II experience. In the Issues Paper on PROFIDE III it was stated thatt 'It is now widely recognized by the Mexican officials that the first Export Development Project (Loan 2331-ME) has been an important contribution to the development of Mexico's export promotion strategy, mostly in the fields of policy instruments and institutional development. The recent institutional changes and the creation of the high- level Foreign Trade Promotion Committee...can also be, at least in part, attributed to the Bank's dialogue and exchange of ideas with the Mexican authorities in the context of the design and supervision of EPDI.1 (Issues Paper, December 27, 1985). 3.27 And the recommendati3ns regarding pre-conditions and conditions for a new loan focussed heavily on macro-issues (acceptable exchange rate poliz7 in place, new letter on Export Development Policy with timetable for Action Program, etc.). 3.28 With such a perception of the role of the operation--different both from the original intentions (quick-disbursing emergency assistance and bottleneck breaking export promotion) and from that of the actual expe- rience described above--questions like what impact an interruption in the commitment authority and flow of resources to the project institutions might have on the needs and operations of exporters may have seemed beside the point. But if this was so, the rationale for an operation structured in this particular form also would have required re-thinking and, indeed, three months later already an Issues Paper was presented for the first Trade Policy Loan which would deal with the same issues but in a much sim- pler institutional framework, i.e. not as a credit program. But the PROFIDE III operation went ahead nevertheless.30 29, Two months after Board approval, which is somewhat faster than normal. 301 At present (early 1990) an operation is under preparation (Export Sector Adjustment) that would unite both types of activities. PROFIDE was incorporated into the Banco Nacional de Comercio Exterior (BANCOMEXT) in late 1989, but its operations continue in that institution. - 22 - IV. SPECIAL ISSUES A. Did PROFIDE Facilitate Manufactured Export Growth? 4.01 Might manufactured exports have been lower in the absence of PROPIDB? At first sight, the answer to this question would seem to be self evident and is so treated in the PCR. Manufacturing exports almost tripled between 1983 and 1989 and PROFIDE was used by exporters, so why should we question the link between these two facts? 4.02 Indeed, if one views the issue in its most aggregative terms, one can easily reach the conclusion that perhaps as much as 80 or 90--and almost certainly not less then 402--of the recorded manufactured export growths may have been linked to PROFIDE financing. This is based on the following calculations (a) if the average import content of exports (i.e., the portion financed by PROFIDE) I - Imported Inputs Value of Exports lies somewhere between 252 and 752, and if; (b) the average number of times R which the revolving fund PROFIDE turns over per year is 2.5 to 3.5 times, while31 (c) PROFIDE II and III committed US$400 million during a period at the end of which manufactured exports were US$6,069.3 million larger than at the beginning, then; (d) the total share P of the increased exports that benefitted from PROFIDE financing is P * 400(R) 6069.3(I) 4.03 Using a reasonable range of values for R and I these calculations would lead to the conclusion that almost certainly an important part of total manufactured export growth was associated with PROFIDE; somewhere between one half and two thirds would seem to be a quite conservative guess32 (See Table 4.1). 311 Since the PROFIDE loans are mostly for 90 days the theoretical maximum value of R-4. 321 It should be noted that, as neither R nor I need to be constant over time these are somewhat notional calculations. Moreover, the growth figure itself is preliminary, being based on an estimate for 1989 made from first semester data. - 23 - Table 4.1: PROPORTION (P) OF MANUFACTURED EXPORTS GROWTH 1983-89 LINEED TO PROFIDE II AND III PROFIDE Revolutions Import Content of Exports (1) Per year R 25? 502 752 2.5 0.65 0.33 0.21 3.0 0.79 0.40 0.26 3.5 0.92 0.46 0.31 Note: Figures in rectangle denote range of values considered most probable. 4.04 On the other hand, a slightly more disaggregated view of looking at the issue modifies this conclusion to some extent. For one thing, 4ur- ing the first year of th.. period, 1984, PROFIDE only had minimal disburse- ments (US$46 million), while manufactured exports grew by US$1.5 billion. Using the above method of calculation, at R-30 and 1=0.5 only $276 million33 of this growth could be linked to PROFIDE and it is therefore arguable that a more appropriate way of doing the calculation is to do it separately for each year. This was not done because, while technically more correct, it would not be much more revealing. But it would definitely lower the impact estimate. 4.05 Another, more telling way of looking at this issue is to consider the subsectoral distribution of PROFIDE's lending and to match it with the level and growth of exports from the respective subsectors. Over 902 of PROFIDE's lending went to the four sectors listed in Table 4.2 and these both in 1983 and in 1989 accounted for just over P0% of manufactured ex- ports. Among them PROVIDE picked some winnerst Automobiles and autoparts as well as the &lass, plastics and chemicals group, but at the same time it put about one fifth of its resources into the lagging metals and metals products sector. And it should be noted that the bulk of this lending did not go into the booming non-ferrous metals and steel industries but into the relatively stagnant machinery and equipment (Metal Products) sector which grew by less than 12 per year. 3/ 46 x 3 276 0.5 - 24 - Table 4.21 SICTORAL DISTRIBUTION OF PROFIDE LENDING AND EXPORT GROWTH, 1983-1989 Share of PROFIDE Manufactured Growth Lending Exports 1983-1989 (1) (z Z 1983 1989 Automobiles and Auto Parts 31 19 31 398 Metals & Metal Products 21 54 30 66 Glass, Plastics, Chemicals and Products 36 7 15 509 Textiles, Garments and Leather Products 3 3 5 413 Sub-Total 91 83 81 191 Total Manufactured Exports 100 100 197 Sources: Table 4. 4.06 If one takes the view that the expansion of the more dynamic sec- tors would not have taken place- or rather would have been less--in the absence of PROFIDE lending, then it may also be plausible to conclude that if less PROFIDE money had gone to the less dynamic sectors and more to the most expansive ones, total export growth might have been larger still. Whether it would have possible, however, to spot these possibilities ex ante is doubtful. In any event, the "first-come-first-served, approach precluded such an attempt (see above Chapter II). 4.07 All in all, nevertheless, the original conclusion, that PROFIDE seems to have been a positive, and probably even a powerful factor in the expansion of manufactured exports, remains intact. The deg:ee of its contribution cannot be established precisely, but it does not seem to have been negligible. 4.08 But whether PROFIDE was not only a necessary but also a sufficient condition for the expansion, remains to be considered. B. Why Did Exports Grow? 4.09 As noted above (See Chapter I), the end of the oil boom in 1982 had produced a severe balance of payments crisis. The overvaluation of the peso, which until then had been masked by the prosperity of the oil sector and by the--related--heavy capital inflows, suddenly became unsustainable. - 25 - 4.10 Net foreign investments--direct and portfolio--which in 1981 had been over US$5.0 billion, in 1983-86 were less than half a billion per year, and short-term borrowing fell from US$8.8 billion to -2.9 billion.34 4.11 While only a very detailed analysis of the timing of exchange rate and price movements and of trade transactions could help define the precise quantitative relation between the movements in the real exchange rate and non-oil exports, the broad outline of the association seems clear enough (See Table 4.3). The almost 502 devaluation in real terms betaeen 1981 and 1983 accompanied a 352 increase in manufactured exports; the 212 peso ap- preciation between 1983 and 1985 brought the manufactured export growth down to less than 92--a decline in real terms given prevailing world infla- tion rates; the renewed massive real devaluation between 1985 and 1987 (58Z) was associated with a manufactured export growth of 77Z in the same period and the subsequent 92 appreciation went together with a greatly slowed down manufactured export growth rate (92 in 1989). Table 4.3: EXPORTS, IMPORTS AND REAL EXCHANGE RATES, 1987-1989 (US$ billions and Index) 1981 1982 1983 1984 1985 1986 1987 1988 1989 Exports 20.1 21.2 22.3 24.5 21.7 16.0 20.7 20.7 Oil 14.6 16.5 16.0 16.6 14.8 6.3 8.6 6.7 Non Oil 5.5 4.8 6 3 7.6 6.9 9.7 12.0 13.9 14.9 (Manuf.) (3.4) (3.0) (4.6) (5.6) (5.0) (7.1) (9.9) (11.6) (13.4) Imports 23.9 14.4 8.6 11.3 13.2 11.4 12.2 18.9 Real Exchange Rate (1981=100) 100 137 149 122 118 172 187 155 141 Source: Banco de Mexico 4.12 Thus, if one posits something like a one to two years lag in the response of trade flows to movements in the real exchange rate, and if one accepts that the association is a strong one but not necessarily a statis- tically stable one--i.e. that the elasticity is not constant over time or 341 Already in 1981 the Errors and Omissions item in the balance of payments suggested unrecorded capital outflows of US$5.6 billion. For 1983-86 the corresponding figures were 5.7, 4.5, 3.6 and 0.2 billion, in addition to the outflows referred to in the text above. - 26 - that other events also affect these exports--the movements in the real exchange rate would seem to go a long way towards explaining developments in Mexico's non-oil exports. C. Was the Export Growth Economically Efficient? 4.13 While this question, too, at first sight seems unnecessary--for does not exporting iaply competitiveness and efficiency?--there are several reasons for posing it nevertheless. The most important ones are related to: (a) The rather complex pattern of special incentives and subsidies that had accumulated over the years, partly to offset for particu- lar industries the high costs of protection and partly to favor selected priority sectors; and (b) to the circumstances of the shift towards exports, which occurred for some industries in response to the drastic domestic market contraction in and after 1982. Here it was at least possible--and the Evaluation Team encountered some examples of this--that produ- cers sold abroad as long as they could cover a little more than their marginal production costs, even though this would not suf- fice to keep them in business permanently. There certainly is plenty of evidence of exceptions to the "law of one price",35 and it is not automatically to be taken for granted that the exports that were generated reflected Mexico's industrial comparative advantages. 4.14 Unfortunately, the available data on this matter are not conclu- sive. There are two sets of calculations that are pertinent, although it must be noted that they are not truly independent of each other, being based on the same primary data set. 4.15 The first is the periodic estimates of effective protection, pro- duced by the Government, first in IMCE (Instituto Mexicano de Comercio Exterior) and, after the demise -of that agency, by SECOFI (Ministry of Trade and Industry). It should be expected that the industries with the lowest (or negative) effective protection, were the most efficient and that if they were the ones accounting for most of the export growth, the overall process was leading to an efficient allocation of resources. 351 Almost all the firms interviewed by the Evaluation Team in early 1990 (not, however, a statistically established representativen sample) stated that selling in the domestic market continued to be much more profitable than exporting. But some also stated that the margin was narrowing, partly because of the domestic price restraints imposed on them by the OPacto", i.e. the agreement to keep price (and cost) increases within certain Government-set bounds. - 27 - 4.16 However, it is one of the characteristics of such calculations that they are extremely volatile (see Table 4.4). Moreover, in the situa- tion described above, when exports occur at marginal cost prices while domestic sales reflect full costs and, possibly, a rent payment as well, the effective protection rate is overstated if the price data are based only on domestic sales, as tends to be the case, especially in industries that were not yet exporters in the base year.36 Table 4.4: MEXICO: IMPLICIT Le EFFECTIVE PROTECTION OF SELECTED INDUSTRIES Motor Iron Non- Soft F1ber Footwear Chassis and Ferrous Yarn and and Year Automobiles Parts Steel Metals Text)les Clothing Leather Chemicals 1979 192 85 12 78 0 68 8 51 1986 -1,508 28 88 84 7 119 80 121 1981 -2,074 85 87 62 18 878 124 180 1984 I 29 42 5 7 108 -28 -6S 10 II 26 45 27 -6 187 -29 -86 -1 III 42 S8 14 -4 271 -29 -87 80 IV 25 42 29 12 28 -28 -52 61 1985 I 108 46 16 7 58" -19 -46 89 II 44 89 18 1 580 -28 -42 as III 8 42 8 -1 540 -28 -60 0 IV -1 s0 -2 -10 828 -8s -54 - 1988 I -15 82 -15 -29 211 -89 -1 28 II -29 24 -16 -9 221 -44 - 9 III -86 16 -19 -1 145 -46 -7 11 IV -44 28 -22 -9 174 -$8 -71 -7 1987 I -89 28 -29 -19 264 -51 -7 -7 II -82 89 -27 -80 884 -51 44 -10 III -19 48 -16 -22 460 -48 -64 -18 IV -12 48 -18 0 889 -40 -48 -9 La Implicit here means that the estimates are based on actual price comparisons rather than on tariff schedules. In a country with Important quantitative restrictions, this is conceptually the more correct measure. Source: Adrlaan Ten Kate and Fernando de Mateo Venturi ni: Aperture Comercial Y Estructura do la Proteccion on Mexic, Coercle Exterior, April 1989. 361 I.e. the year of the input-output table used in such estimates. - 28 - 4.17 For all these reasons any conclusions based on a matching of in- dustrial export growth rates with effective protection rates would be quite tenuous, at least in the circumstances applying to Mexico. The other, related, available measure of at least the static economic efficiency of Mexican industries, is the calculation of domestic resource costs.37 This measure gives ratios which can be interpreted as reflecting efficiency: the lower the ratio the greater should be the comparative advantage of the industry that it represents; industries with ratios above 1 impoverish a country while those with ratios below unity enrich it. Since the errors of measurement can be substantial, small differences in ratios, or small de- partures from unity should be disregarded. Following the source of the data,38 in this report only industries with DRC, below 0.90 or above 1.10 will be labelled as clearly efficient or inefficient respectively, while all those between these limits will be treated as borderline cases. 4.18 It is noteworthy that by 1982, out of forty nine industries stud- ied about half were clearly efficient and the remainder were divided be- tween inefficient (14) and borderline (11) cases. But even more noteworthy is the dynamism of the situation; during the preceding decade only 18 of the 49 had been improving, while almost twice as many had been becoming less competitive (See Table 4.5). Indeed, the DRC figures for 1970 and 1982 for the same 49 industries show the extent of the deterioration of the 1970s39 Industries (No.) DRC 1970 1982 Under 0.90 32 24 0.90-1.10 7 11 Over 1.10 10 14 371 Economic Cost of Primary Factors (i.e. labor and capital at shadow prices Domestic Resource Costs (DRC) = in units of foreign exchange Value Added at International Prices 381 The data on DRCs are drawn from Mexico: Trade Policy, Industrial Performance and Adjustment, IBRD Report No. 6215a-ME, June 24, 1986. It, in turn, cites as the source for the empirical estimates Ricardo Samaniego and Associates, The Evolution of Domestic Resource Costs in the Industrial Sector of Mexico, Instituto Tecnologico Autonomo de Mexico, 1986. 39/ The figures for 1970 were derived by applying the growth rates shown in the source cited above backwards to the 1982 levels. - 29 - 4.19 The causes of the deterioration are varied, but a sizeable propor- tion--about one-third--has been attributed to the choice of inappropriate technology, especially overly capital intensive techniques. Another third may be the result of deteriorating price relations and the remainder is, essentially, unaccounted for.40 What is of relevance here is that the choice of technology responds to many market signals besides those associated with trade policyt divergences between market and economic interest and wage rates especially (and, implicitly, of course, exchange rates), and that therefore it cannot be expected that the removal of trade barriers alone will remove all distortions in the productive structure. In Mexico, in the 1970s, market interest rates were clearly well below efficiency rates, and in the case of much public investment often de facto were zero or close to zero (free equity capital and subsidized or unrecovered loans). Table 4.5: HIGHEST AND LOWEST DRCs 1982 AND CORRESPONDING EXPORT GROWTH, 1983-89 DRC Export Growth Highest DRCs Synthetic Fibers 1.60 299 Automobiles 1.51 399 Rubber and Plastics 1.45 /a Tires and Tubes 1.34 524 Secondary Iron and Steel 1.15 ) Primary Iron and Steel 1.12 ) 410 Lowest DRCs Fertilizers 0.27 /a Beer 0.59 448 Farm Machinery 0.63 /b Henequen Products 0.59 b Glass Containers 0.67 99 /a No exports in 1983. L Negative growth. Source: Comercio Exterior, various issues, and Table 5. 40/ In the cited source it appears as a decline in total factor productivity, (TFP), i.e. a less than proportional increase in output for given proportional increases in all inputs. This, however, is merely a statistical expression of the unexplained variations in output; it is well known in the productivity literature and has been much discussed in organizational and sociological terms, but most of these discussions are essentially speculative. - 30 - 4.20 There is no visible systematic association between the estimated DRCs and export growth rates in the 1980s. While this Evaluation has not gone into the matter in all the depth that would be required for a definitive conclusion,41 the fact that some of the highest DRCs were associated with some of the highest export growth rates, and vice versa, is susceptible to several possible explanations, not all of which are mutually exclusive. Among them are the possibility thats (a) The most efficient industries were already fully engaged in exporting and thus had relatively little scope for growth. This is clearly unlikely. (b) The DRC calculations are either wrong or are highly unstable and are thus an unreliable measure of efficiency. There may be some element of truth in this--some of the criticisms against the effective protection measurements apply also to DRCs--but it is not believed that they greatly distort the broad ranking of efficiency. (c) Efficiency itself, under the pressure of the crisis of the 1980s, changed so rapidly that a 1990 DRC table would validate, ex post, the export growth rates. Again, there seems to be some *truth in this for some--perhaps many- -firms, which responded positively to the challenge to become competitive or to go under, but the period is too short to allow us to accept this as the full explanation, since to bring down a DRC from 1.5 to 1.0 in eight years would require annual rate of change of approximately 5.5%, i.e. well above observed past changes (see Table 5). This is not to say that very important improvements in effi- ciency are not occurring; the Evaluation Team encountered some notable examples, but it is unlikely that they, alone, can explain the large growth rates of some of the highest DRC industries. (d) There remains the possibility that some of the new exports do not follow comparative advantages. It is not an unknown phenomenon for firms in industrial countries to price their exports below full production costs for lengthy, if not indefinite periods; many studies comparing international prices and domestic prices in industrial countries of steel, chemical or other high-overhead A1 Since the DRC calculations pertain to industrial groupings which are not identical to those used in the international trade statistics, a full analysis would require very laborious and time consuming statistical reclassifications which would not be warranted by the scope and purpose of this Evaluation. - 31 - industries have remarked on this. The Evaluation Team encountered some examples in Mexico as well but is not able to assess how widespread this practice has become. Vhat is clear, however, is that it is only sustainable when the domestic market is large and stable enough to make up for the "losses" on export account, and in this respect Mexican industries may differ from their competitors in industrial countries. If so, it is at least possible that not all of the observed growth of manufactured exports should be expected to be lasting. V. CONCLUSIONS AND LESSONS FOR THE FUTURE 5.01 To the extent that the objective of the initial operation (Loan 2331-ME) was to provide rapid assistance to Mexico in the balance of pay- ments crisis that began in 1982, it failed. In spite of extraordinary speed in loan proc.-saing, the loan only became effective at the end of 1983 and then failed to disburse significant amounts for two more years. 5.02 The reasons, as was shown, were numerous and complex, but since this experience is not an isolated one,42 they are worth considering in detail. 5.03 In the first instance, after the rather heroic efforts to process the loan (four months), it took another six months b_ tween Board approval and effectiveness. The pressure was evidently of , and for good reason since, during the same six months the US$100 m! lion that were already available, were not disbursing. 5.04 The problem lay on the demand side. Or rather, it lay in the original design of the project as a credit project and in the unwarranted assumption that because the country suffered a foreign exchange shortage, there would be eager demand for credit in forAign exchange on the part of exporters. This assumption proved wrong for the following reasons: (a) Lack of confidence in the ability of the Government to supply the foreign exchange needed for debt service;43 in spite of its commitment to do so; 42/ See, for example, Costa Rica: Export Development Loan (Loan 2274-CR), Project Performance Audit Report of May 31, 1989, (Sec. M89-683). 431 It should be noted that this would not have been a problem of direct exporters if they had been allowed to retain from their export receipts what they would need for debt service. But the exchange control system did not permit this and the Bank made no proposal in this direction. - 32 - (b) Lack of confidence that the exchange needed for debt service could be bought in the official market and fear that the already large gap between that and the parallel market might widen much more. (c) The existence of sizeable alternative cheap peso credit lines and the preference for buying foreign exchange with these pesos in the free market, trading the higher exchange rate for the absence of a foreign exchange risk. (d) The depth of the recession in Mexico which cut general imports much more than had been expected and made foreign exchange relatively easy to acquire by exporters. 5.05 There were other, more project-oriented reasons for the initial slow disbursement--marketing of the new facility lagged, the paperwork initially seemed excessive to intermediaries and ultimate borrowers and the profit margins for the former may not have made it very interesting to them to push this line, but the four aforementioned points seem to have been fundamental. 5.06 One clear inference from this experience is that credit program may not be an efficient vehicle for emergency operations in which lender and Government put a premium on speedy transfer of resources. This would probably be true in any event, but is all the more so when there is not available--and no time to prepare--a thorough analysis of the financial and credit markets of the country. The macro-balance of payments analysis that establishes the approximate size of the foreign exchange gap is necessary, but it is no substitute for real knowledge and understanding of the channels through which resources can flow. And such knowledge is usually only available when appropriate professional staff have been working with and on the financial institutions and markets of the country for some years; it is illusory to think that it can be acquired on an emergency basis. 5.07 In the loan under review, the implications of the existence of alternative subsidized and exchange risk-free credit lines for the perfor- mance of PROFIDE were not thought out carefully at appraisal. And, since discontinuation or curtailment of these credits were not part of the loan conditionality, the Bank could not effectively seek redress once the problem was identified. 5.08 Vhat, then, were the principal effects of the two loans? Even- tually, they were both committed and disbursed, including the earthquake reconstruction component. Did they increase exports, as designed? In Chapter IV above, it was shown how difficult it is to be quantitatively precise about this question. In the particular circumstances of Mexico during the years when its external debt negotiations and re-negotiations made full access to normal commercial bank credit precarious if not impos- sible, conclusions along the lines of those of Chapter IV--that PROFIDE seems to have played a substantial role in facilitating the increase in manufactured exports--seem warranted. - 33 - 5.09 But one has to be careful here; there are at least two caveats that constrain the validity of such findings, one in time, the other one in general. It is not possible to determine at what point and in what amounts commercial banks would have been willing to reopen their trade credit lines, or rather if in the absence of PROFIDE they might have done more. It is believed that for the years in question this is not a serious objec- tion, but after the recent (early 1990) signing of the Government-banks agreement, it may well be that an operation that would provide working capital to exporters would replace rather than complement available exter- nal resources. The second point is similar: the Evaluation Team did encounter occasional PROFIDE borrowers who were subsidiaries of multi- national firms and who said that in the absence of PROFIDE funds they would have received financing from their foreign owners. To the extent that this applies--and it probably is not widely spread--of course it makes the Chapter IV calculations of PROFIDE's impact meaningless. 5.10 'While not, perhaps, quantitatively very important, these cases do raise the question of whether it is wise for the Bank to let firms have access to its credit programs regardless of that potential access to for- eign funds. While in some cases it may be somewhat complicated to estab- lish precise rules and to monitor their implementation, this would not seem to be the case in Mexico. Besides, the possibility of some errors in borderline cases is not a good reason for abandoning altogether the effort to give substance to the Bank's rule--derived from thn Articies of Agree- ment-- of being a lender of last resort, i.e. of not displacing other for- eign funds that would have been available on reasonable terms.44 The issue is particularly relevant in the case of short term funds, since access to foreign money markets for these is much easier than for term capital. 5.11 If in normal times commercial banks can provide the needed trade credits, and in emergency situations such credit programs as PROPIDE are an unreliable and ineffective vehicle for a quick transfer of resources, is there any case for making them anyway? Certainly PROFIDE III proved to be a smoothly functioning device for moving money; by that time the learning experience of PROFIDE II had been absorbed, most--not all--of the competing credit lines had disappeared and the interest differential on the 441 Articles of Agreement of the International Bank for Reconstruction and Development, Article 1, Section (ii), and Article III, Section (ii). The latter states thLt the Bank may make or guarantee loans when "The Bank is satisfied that in the prevailing market conditions the borrower would be unable otherwise to obtain the loan under conditions which, in the opinion of the Bank, are reasonable for the borrower." - 34 - remainder, although still significant, had been much reduced.45 Banco Nacional de Comercio Exterior, from a quite minor public sector intermediary, was changing into one of the Government's most important and professionally most respected institutions and the exporting sector--as well as the financial intermediaries--were increasingly satisfied with the speed and efficiency of the mechanism that had been developed. 5.12 But these advantages can be garnered also if the foreign commercial banks revert to being the external source of funds, provided the Government is indeed interested in keeping Banco de Comercio Exterior as the center-piece of the system because it is efficient. Whatever may have been the original rationale for Bank involvement, there is no strong economic or financial case for a long term continuation of this particular kind of financing.40 And, as noted above, there is a powerful case against it once circumstances are such as to make it likely that commercial bank money would be available again. 45/ An approximate comparison between the costs to domestic borrowers of using the FONEX peso denominated line or the PROFIDE dollar denominated one, can be made as follows: In the first quarter of 1986 the peso depreciated by 22%. Since in the preceding quarter, PROFIDE had charged 6.65Z p.a. (see Table 6). The effective cost was, approximately 1.00 + 0.0665 1.22 - 1.00 = 232 4 At the same time, FOMEX was charging 40Z p.a. for its peso line (as against 82 in 1983), so the above 23% can be compared, again approximately, with 0.40 = 10%. 4 of course, these are ex post calculations. Whether this is the way the cost relations looked to borrowers in late 1985 depends on what were their expectations about the future course of exchange depreciation. But any expectation of depreciation of more than 8.7Z in the next quarter would have made PROFIDE more expensive than FOMEX/Peso line. 46/ Which is not cheap for the Bank; supervision has been very heavyt 178 staff days in 1984, 4 in 1985, 15 in 1986, 50 in 1987 and 40 in 1988. (See PCR, Loans 2331-ME and 2777-ME.). -35- 5.13 There remains the question of the usefulness of this kind of ope- ration in helping a country to re-direct its commercial policies, removing distortions and counterproductive restrictions and using the foreign trade sector as a device to impose more stringent efficiency tests on the produc- tive structure. This is a complex and controverted issue, and it is proba- bly the one in which individual country experience is least useful for generalizations. 5.14 It is relevant to note that Mexico had not been willing, in the 1970s and early 1980s to make its macro-economic management the subject of loan-related negotiations with the Bank. It was felt that it would compromise the national sovereignty to do othervise.47 5.15 Thus the fact that there was no recent tradition of linking lend- ing decisions and macroeconomic performance must be taken into account when assessing the Export Development Loan experience. And the inclusion in the loan documentation of a document on the Government's Export Strategy was at a minimum a major modification in the style of the Bank's lending relations with Mexico. 471 At an earlier time--the late fifties and the sixties--a somewhat different modality had prevailed in Mexico-Bank relations. The Bank would give the Government its macro-economic diagnosis and let it know that it would be willing to finance sizeable programs--e.g. power and road--once certain major macro-economical obstacles--e.g. public savings--had been overcome by measures to be chosen by Government. The approach was considered legitimate by the Government because it was analytically linked explicitly by Mexico's debt servicing capacity and creditworthiness, which were accepted as being a proper concern for a creditor. This practice was abandoned when the Bank spread its areas of interest to so many issues--rural development, income distribution, basic needs, demography, poverty, environment, that it was unable to continue to devote the requisite manpower to the required intensive macro-economic and fiscal analysis. It may well be that this was the chief reason why the Bank was not very successful to either diagnose the impending crisis before it occurred or to engage the Government in serious discussions about preventing it. This is made quite clear by the discussion of the economy and of Bank strategy that accompanied the presentation of the Loan to the Board. (See IBRD Report P-3601-ME of May 31, 1983.) - 36 - 5.16 Whether it was much more than that is a matter of interpretation. The PCR in this respect is relatively cautious in stating that: '...the principal objective of the project was to support the efforts of the Government to expand rapidly non-oil exports by (ij assisting in the formulation and implemen- tation of an export development strategy...* and, taken literally, this may be a fair description of what was done. What it leaves unanswered is how important this assistance was to the deci- sion-making process. 5.17 Given (a) the delicacy and complexity of this process, (b) the varying perceptions of the numerous people who participated in it, (c) the shift and blurring in perceptions that time inevitably produces, (d) the fragmentary nature of the documentary record, this evaluation can only provide a tentative and impressionistic answer. It is that the dialogue at the technical level with Government officials, which took place when Super- vision Missions collected the material that they needed to report to the Bank on trade policy developments, was of use to Mexican officials in clar- ifying inconsistencies and problems and transmitting some of the Bank's thinking. 5.18 But it is also that the Bank did not try--and would not have suc- ceeded if it had tried--to use the loan to influence policies directly. It even eschewed doing so in those policy matters in which their direct bear- ing on the viability of the lending operation itself--such as the subsi- dized interest rates on peso credit lines--would have given it an undoubted legitimate interest and standing. Throughout the period preceding July 1985, when the Bank staff saw fairly clearly that the "Export Strategy,--which itself was not very ambitious--and other Government policies were being implemented in a hesitant and half-hearted manner, there was no suggestion that this was inconsistent with obligations assumed under the Loan and Guarantee Agreements. And when after the above- mentioned date the Government became far more vigorous in pursuing the Nopening of the economy' objectives, it was quite clearly an internal, domestic decision. In any event, the Trade Policy Loan discussions and negotiations, from 1985 onward, tended to be the forum in which trade policy issues were discussed between the Government and the Bank. 5.19 In conclusion, the direct impact of the operation on policy seems to have been small. But as a basis for establishing a dialogue at the technical level, which made the work on the Trade Policy Loans, initiated in 1985, possible, it may well have been very important. - 8? - Table 1: NOMNAL AND EFFECTIVE PROTECTION /a OF SELECTED INDUSTRIES, 1979 Implicit Implicit piCit Implicit Nominal Effective Nominal Effective Alcoholic beverages 48 612 Plastic products 40 481 Nals and beers -28 -89 Glss and products 3 9 Colas and mineral waters -60 -77 Cement 0 21 Tobacco -27 -27 Non-etallic mineral producte 1 8 Soft fibers and cloth 1 0 Iron and steel, beic 1 12 Nand fibers and cloth 10 18 Non-ferrous metals, basie 11 78 Other textiles 0 -8 Metal furniture 14 87 Clothing 24 6 Metallic structural products 0 -2 Shoes and leather 7 8 Other metal products, except machinery 7 18 Sawail products 0 40 Machinery and non-*Iectric equipment 20 8 Other wood and cork products 0 -8 Electric machinery and equipment 17 84 Cardboard and paper 20 57 Domestic electric appliances 86 94 Printed matter 0 07 Electronic equipment so 220 Petrochemicals -42 *85 Automobiles 42 192 Chemicals, basic 12 -15 Chassis, motors, parts 1 36 Fortilizers -18 -15 Transport equipment and material 17 21 Synthetic Resins and fibers -10 -16 Other manufacturing Industry 21 52 Pharmaceuticals 9 18 Soaps, detergents, cosmetics 4 11 Other chemical products 18 s Oil cloth products 10 22 /a The method used Is to calculate Iglicit protection, i.e. to base the calculations on differences between domestic and foreign prices, rather than on tariff schedules. Thus the figures reflect the results of quantitative restrictions and of subsidies as well as of tariffs; given the Importance of non-tariff protection in Mexico, this is a much more meaningful calculation. Source: Aperture commercial Y esbructure de Is protecelon en Mexico by Adrisan Ten Kate and Fernando de Mateo Venturial, Comerlto Extorior, April 1989. - 38 - Table 2: Export Development Loans 2331-HE and 2777-ME Disbursements by Quarters (US$ million) Ln 2331 Ln 2777 1984 Disb. Cum. Disb. Cum. I -* * II 0.9 0.9 III 27.8 28.7 IV 17.4 46.1 1985 I 9.4 55.5 11 28.6 84.1 III 22.7 106.8 IV 8.7 115.5 1986 I 16.4 131.9 II 42.7 174.6 III 6.7 181.3 IV 45.1 226.4 1987 I 35.3 261.7 ** II 23.4 285.1 III - 285.1 IV - 285.1 1988 I 39.1 324.2 118.1 116.1 II 7.1 331.3 9.2 127.3 III 2.9 334.2 43.4 170.7 IV 1.7 335.9 7.5 178.2 1989 I 9.9 345.8 33.6 211.8 II 345.8 6.8 218.6 III 1.6 347.4 5.4 224.0 *Effective 12-27-83 **Effective 3-26-87 Sources - 39 - Table 8: Citwnts and Disbursemente of PROFIDE I-III a Selected D8tes (CumulatIve, US million) I II III USW100 allion, effec6lve U88 275 million, øffective US* 176 milliln, effective fr m 6-28-88 to ald 84 *ince 12-27-89 from 8-26-87 Commitmonte Dlebursoemente Comiltme~ Dlsbursemntso Coiltmønhe Diebursmonte Nov. 18, 1988 2.02 n.. .a. .a. c.a. Feb. 24, 1984 7.60 - - n.a. n.a. June 15, 1984 26.80 22.00 - - n.. n.a. August 8, 1984 na. .. 80.00 (28.7) n.a. a.a. April 80, 1985 n.. n.a. 76.0 n.a. .a. Feb. 1, 1980 .a. a.. 199.50 108.16 .. a.a. April 21, 1987 n.*. n.e. 228.0 190.70 Nov. 81, 1987 226.0 199.80 May 15, 1988 225.0 Dec. 81, 189 175.0 170.12 Soure: Supervision Reporte and Banco Nacional de Comercio Ex~erior Note: o.e. a not appilcable. A blank connoes informaloan not availeble. -40 - Table 4: Sectoral Distribution of PROFIDE 11 and III Commitments and of the Growth of Manufactured Exports, 1983-1989 (US$ million and 2) Z of PROFIDE 1983 1989 a Lending 1983-89 Automobiles & Parts 341.3 Motors, Parts 498.9 Automobiles & Auto Parts 840.2 4180.9 30.9 (2 of Manuf. Exports) (18.62) (31.12) Iron & Steel 181.5 926.0 Non-ferrous Metals 457.3 1194.3 Metal Products 1784.3 1892.3 Metals & Metal Products 2423.6 4012.6 20.6 (Z of Manuf. Exports) (53.6%) (29.92) Chemicals (Incl. Plastic Materials 1549.8 Plastic Products 72.6 Petrochemicals 129.6 Glass 262.8 Glass, Plastics, Chemicals & Products 331.0 2014.8 35.8 (2 Of Manuf. Exports) (7.32) 15.0%) Textiles, Garments 108.4 497.4 Leather Products 9.7 108.8 Textiles, Garments & Leather Prod. 118.1 606.2 2.6 (2 of Manuf. Exports) (2.62) (4.5) Sub-total, Above Groups 3712.9 10414.5 89.9 (2 of Manuf. Exports) 82.2 (80.6) Total Manufactured Exports 4519.3 13408.9 La Estimated by applying to the full 1988 figures the percentage change of Jan.-June 1989 over Jan.-June 1988. Source: BNCE (for Exports) Comercio Exterior and (for PROFIDE), direct communication and IBRD Trade Policy Reform and Economic Adjustment, Rep. 7114-ME which cite Banco de Mexico sources. - 41 - Table: DiMICD: DMSTIC RESURCE COST (DC) a~VELS, 1982 AlS AINDA. RATE OF CANGE (N), 1970-1982 1982 1970-S2 1982 1970-82 DRC DRC Change DRC DC Change (9 p.a.) (s P.a.) Consumer Nod. Heavy Intermediates Processed M~at 1.12 5.18 Deie Chemicale 1.10 -0.74 Condensed Milk 1.28 6.66 FertllIsere 0.27 0.69 Vegetable 01l* 0.68 5.11 Synthelc Fibers 1.00 -0.08 ~6her Food 0.81 1.60 Pharmaceuticals 0.48 -2.78 Bevere@s 0.7 -1.72 øher Industrial CheIal*as 1.16 8.87 Seer ørewing 0.69 6.70 Coke 0.97 1.94 Tobacco 0.51 2.1 Non-etallic Mineral 0.87 -1.16 Text1 le Produchs 0.82 1.44 Ref ractor* 0.80 3.41 Soaps and Deterg~n6s 0.60 8.99 Cement 0.71 2.68 atch.. 0.0 -1.10 Primary Iron and St..l 1.12 -2.87 Secondary Iron and Steel 1.15 -1.27 Ligh Intermediate Iron and Steel Pipes 0.99 -8.24 M.t.I Product 1.06 0.67 Animal Fede 2.78 2.78 Copper and Producte 1.00 0.61 Cotton Tex61es 0.80 2.74 Aluminum and Product 0.94 0.74 Spinning and Waving 0.82 -0.67 Automobile odIes 0.14 -2.89 orsted Text1 e 0.82 1.78 ~ Synhec Texhl l*e 0.84 4.69 Capital oods and Consuner Durables Hennequen 0.69 -0.64 Paper 0.76 -0.29 Metl Castings 1.02 8.26 Cardboard 0.77 0.04 on-lechrlcal Mchinery 1.16 -4.07 ~ood and Products 0.91 1.80 Fare Machinery 0.68 -0.46 Rubber and Plastice 1.46 1.62 Electrical Machinery 1.10 0.85 Tires and Tubes 1.84 -8.61 Transport Equ~pment 0.96 4.25 Painte 1.19 4.04 Metal Furniture 1.08 0.26 Glass Containere 0.67 1.68 Consumer Elechronics 1.14 4.27 0her Glas 0.71 -0.68 Automobils 1.61 4.18 Batteries 1.12 6.45 Souroe: Mexico: Trade Policy Industrlal Performance and Adjustments, IIRD Report No. 82.169-ME, june 24, 1986. 42* Table 6s Interest Rates Charged on 90 Day PROFIDX Dollar Loans 1983-1988 (I per annum) Quarter 1 II III IV 1983 - - 12.20 12.70 1984 12.95 14.20 12.18 8.60 1985 9.10 6.42 6.85 6.65 1986 6.15 6.00 5.25 5.00 1987 5.00 6.70 6.85 6.65 1988 6.20 7.20 Sources Banco Nacional de Comercio Exterior, Special Tabulation - 43 - ATTACHMENT Page 1 of 2 BAmCO mCIO DE COTIERGO EXTERIOR. S nc. 94no DE DESARROtto June 18, 1998 REF: INTL. FINANCIAL ORGANIZATIONS IFO-292 COSIENTS RECEIVED FROM THE BORROWER THE WORLD BANK INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT 698-19th Street, N.W. 20433 Washington, D. C. ATT'N: MR. ALEXANDER NOWICKI DIVISION CHIEF EVALUATION DEPARTMENT Dear Mr. Nowicki: In reference to your letter dated May 7, 1998 whereby you enclosed the *Program Performance Audit Report* (Loans 2331-ME and 2777-ME), we would like to make the following comments: 1. It may be suitable to begin the PPAR with the positive aspects of EDP-I and EDP-II, and then to present the analysis of those issues that hamper the operations. 2. The 1982 economic crisis of Mexico was accompanied by many administrative and institutional changes. The PPAR documents make an extensive assessment of the "crisis condition" but it is brief on the substantial changes under taken by the Mexican Government in 1983 in order to reestablish, as fast as possible, adequate condition for Mexico's development. 3. One aspect that it is completely forgotten in the PPAR .is the fact that the loan 2331-ME was the first operation between World Bank and BANCONEXT. As such, neither IRD nor BANCOMEXT were keen on the way the other institution operated. 4. The PPAR document mentions that it is not clear why it took so long to declare effective the 2331-NE loan. We would like to remind you that there were certain condition for effectiveness which had a slow legal and administrative procedures, such as the transfer of FOMEX from Banco de Mexico to BANCOMEXT. Camino a Santa TeresCNO. 1679 Delev. Alvaro Obreg6n 01900 M xlco, D.F. A.P. 138-29 Tel. 568-21-22 Telex 17 64 394 44 ATTACHMENT Page 2 of 2 SIANC AI OVtItSAaRLVI O"comm 5. Many of the discussions regarding policy issues were based on a document prepared by IMCE "Instituto Mexicano do Comercio Exterior" entitled "Export Strategy Paper". Although, this document had a wide circulation, it was, however, never officially endorse by the Mexican Government. We would like to point out that such an exchange of views in matter pertaining to policy issues did indeed took place, overlapping with the negotiations of the Trade Policy Loans. We would like to take this opportunity to send our regards. Sincerely yours, /BANCO tA AL DE COMERCIO TERIOR, S.N.C. DGH/agm -45- PROGRAM COMPLETION REPORT MEXICO FIRST AND SECOND EXPORT DEVELOPMENT PROJECTS (LOANS 2331-ME and 2777-ME) June 23, 1989 Trade Finance & Industry Operations Division Latin Amer4ca and the Caribbean Country Operations Department II - 47 - PROGRAM COMPLETION REPORT MEXICO FIRST AND SECOND EXPORT DEVELOPMENT PROJECTS (LOANS 2331-ME AND 2777-ME) I. BACKGROUND, SCOPE AND OBJECTIVES OF THE EXPORT DEVELOPMENT LOANS A. EDP I 1. Background. Through much of the last two decades, Mexican econom- ic performance has been largely determined by the interaction of two sets of factors, one internal and the other external. The internal factors derive from the necessity to formulate an economic development strategy appropriate for Mexico which had pursued through the beginning of the 1970s an inward-oriented industrialization approach which had largely exhausted further growth possibilities. The external factor was the highly unstable world market for petroleum. Thus, the negative impact of inadequate domes- tic fiscal and monetary policies in the early 1970s led to serious economic difficulties in 1976 and some attempts at policy reform provided the basis for partial recovery in 1977. However, the opening up of new oil fields, in part responding to the higher prices stemming from the first oil price rise in 1973, combined with the added stimulus of the second oil price rise in 1979, gave rise in both domestic and external circles to euphoric expectations over Mexico's economic growth potential. The incentive for further reform was lost and the country embarked on a highly expansionist trajectory which, in spite of the growth in oil revenue, required a substantial level of foreign borrowing. 2. The boom quickly turned to bust, however, when oil prices began to decline in 1981. In early 1982, the Government was forced to withdraw from the exchange market, resulting in a devaluation of the peso, and announced its intention to curtail the fiscal deficit. At the same time, private international banks began to curtail their lending. In the face of rapidly disappearing exchange reserves, the authorities in August 1982 unilaterally suspended amortization of most of the external debt. On September 1, 1982, President Lopez Portillo nationalized the domestic banking system, further shaking the confidence of the private sector. 3. Thus, by the end of 1982, external and internal imbalances within the Mexican economy had created a crisis of proportions never previously experienced by the country. Capital flight, accelerating inflation, high nominal (as well as real) interest rates on a massive external debt and further declines in the prices for petroleum exports threatened economic viability and put severe strains on both the political and social fabrics. The new administration which took office on December 1, 1982, immediately began to formulate comprehensive measures to deal with the most pressing issues. These were also designed to restore the confidence of both the domestic private sector and the international financial community. - 48 - 4. A medium term stabilization program was submitted to the IMF as the basis for an Extended Fund Facility and was approved on December 23, 1982. In addition to the measures required to bring about an improved internal balance, the program indicated the general direction of structural reforms which would be necessary to-integrate Mexico into the world economy and to restore its development trajectory. Following the IMF action, nego- tiations were accelerated for a restructuring of debt with the private com- mercial banks. Within the Bank, consideration was given to quick actions which could contribute to an easing of the crisis, making available addi- tional foreign exchange resources. Among the measures under review (Special Action Program, SAP) were accelerated disbursements, increased disbursement ratios and the modification of existing loans to meet the changed conditions confronting the economy. 5. An essential ingredient in the longer-term, as well as medium- term, strategy of the Government was the development of non-oil non- traditional (mainly industrial) exports. In the context of stabilization policies which included restraints on domestic credit, exchange controls and controls over both imports and exports, the Mexican authorities sought to design special facilities which would nevertheless encourage an external orientation within the productive sectors. Moreover, as the short-term measures gave way to structural adjustment programs, those efforts would serve as essential ingredients in the future opening of the economy. 6. A project to provide investment financing to export-oriented industries had been under discussion between the Mexican authorities and the Bank beginning in late 1981. Identification and preparation missions which were in the field in the course of 1982 were able to design in quick fashion project features capturing the new needs of the export sector as a result of the events of that year. Moreover, the opportunity was provided for intensive dialogue between Bank staff and the Mexican authorities in the formulation of specific details of the export strategy spelled out in the Export Policy Letter submitted by the Government which appeared as an annex to the President's Report recommending the approval of the project. The loan (2331-ME), for the equivalent of $350 million, was approved by the Board in June 1983. 7. Objectives and Scope of the Project. The principal objective of the project was to support the efforts of the Government to expand rapidly non-oil exports by (i) assisting in the formulation and implementation of an export development strategy and (ii) providing exporters ready access to foreign exchange, on terms comparable to those prevailing in international markets, for imports of production inputs and equipment during a period of critical foreign exchange scarcity. A Bank credit line for the latter purpose was justified at the time due to the inability of Mexico to obtain normal international commercial credit. Given the magnitude of the exchange shortage and the expected demand for foreign currencies from exporters to purchase necessary imported inputs, it was considered that the loan would disburse quickly and would therefore contribute to a rapid transfer of resources. In the context of the macroeconomic constraints, the Government had introduced certain measures and committed itself to take - 49 - further steps to create a "free-trade environment' for exporters. Consid- erable attention was also given to strengthening the institutional infra- structure to assist the export community. 8. Funds provided under the project were to be used for two major purposes. The principal component, $275 million, was initially allocated to be used to establish a revolving fund in foreign exchange (the Export Development Fund or PROFIDE)1 through which working capital subloans would be made to exporters to finance the costs of imported raw materials, compo- nents, spare parts or other production inputs. Since this was designed to be a revolving fund, subloans were to be made in foreign exchange and were to be repaid from the proceeds of the export transactions. A second compo- nent, amounting to $71 million (Programa de Financiamiento de Inversiones para las Exportaciones or FIFE), was allocated to provide medium and long- term subloans for financing fixed investments by industries to help them maintain, expand or generate export capacity, and by hotels to help increase revenues from foreign tourism. In addition, some $3 million was set aside for technical assistance subloans to exporters, for studies to help improve Mexican export development strategy and to strengthen the agencies related to the export sector. B. EDP II 9. Backaround. During 1983 and through most of 1984, substantial progress was made in achieving the stabilization goals of the Government. The fiscal deficit was sharply reduced. Unprecedented trade surpluses resulted from a sharp fall in imports (from $24.0 billion in 1981 to $14.4 billion in 1982 to $7.7 billion in 1983), combined with a continued high level of export earnings (of the order of $25 billion), including a recov- ery in non-traditional non-oil exports which had been stagnant since the late 1970s. A major foreign de*t restructuring was accomplished, including new credits, which contributed further to the reduction of balance of pay- ments constraints. However, inflation remained higher than projected (consumer prices rose 80% in 1983) and GDP growth, which had been slightly negative in 1982 (-0.5%), was even more so in 1983 (-5.3%). In late 1984, in the face of political pressures, fiscal policy began to ease, public sector borrowing increased substantially and monetary policy became accommodating. GDP growth rates became positive once more. 10. As a coasequence, 1985 witnessed the re-emergence of the basic imbalances and the full recognition of the need to match stabilization efforts with long overdue structural reforms. In the middle of the year, major new initiatives were undertaken, including broad measures for import liberalization, reduction in public sector expenditure, rationalization of parastatal operations including the sale of some enterprises to the private 1/ A pilot PROFIDE had been established in April 1983 under the SAP by temporarily transferring $100 million from the existing Capital Goods Industries Development Project (Loan 2142-ME) but these funds, to be lent on short-term, were to be transferred back to the original project as soon as the subloans were repaid. - 50 - sector, and the adoption of an appropriate exchange rate policy. At the end of the year, the Government announced its intention to join the GATT, signifying the fundamental change in its development strategy from an inward orientation behind protective walls to an outward orientation capable of becoming more effectively integrated with the world economy.2 The need for far reaching structural adjustment became even more pressing when oil prices weakened further in late 1985 and 1986 while the earthquake in September 1985 exacerbated the deteriorating situation, resulting in additional expenditures for rehabilitation. 11. Policy dialogue between the Bank and the Mexican authorities which accompanied the implementation of EDPI was intensified and broadened sub- stantially. Following the decision of Bank management to link increased leading to that country with central policy reforms, agreement was reached with the Mexican authorities on the preparation of a package of policy- based loans. The multiyear trade adjustment program elaborated by the Government was supported by a Trade Policy Loan (2745-ME) while the indus- trial adjustments which were expected to be the consequences of the opening of the economy were supported by Industrial Recovery and Industrial Tech- nology Loans (2746-ME and 2747-ME). The three operations were presented simultaneously to the Board and approved on July 29, 1986. 12. Preparation of EDPII was initiated in 1985 to continue the Bank's support to export development efforts under EDPI, to provide additional financial assistance as the funds under the first operation were nearing full commitment and there was need to build up the revolving fund to meet increasing demand from the expansion in exports. At the same time commer- cial policy reform was receiving priority attention from the Government. In this sense, the second EDP was considered complementary to the Trade Policy Loan, given the specific focus of the former on export policies, export finance and improvements in the institutional framework underlying export development. The loan (2777-ME) was approved by the Board in January 1987. 13. Objectives and Scope of the Project. As with EDPI, the essential objective was to contribute to the expansion and diversification of non- petroleum exports through support to Mexico's export development strategy. This objective would be achieved bys (a) providing finance to exporters through comprehensive financial services for imported inputs and equipment; and (b) strengthening, streamlining and expanding the non-financial incentive framework for exporters. 14. The Bank loan of $250 million comprised three components: (a) provision of $175 million for working capital finance (PROFIDE) for exporters for imported raw materials, compo- nents, spare parts, and services, $75 million of which was set aside for indirect exporters (i.e., enterprises supply- ing inputs to final ex1orters); 21 A number of the measures which Mexico subsequently undertook, for example reducing the maximum tariff to 20Z, went beyond its commitment to GATT as outlined in the formal accession document. - 51 - (b) provision of $74.5 million for long-term finance (FIFE) for fixed Investments by exporters for the establishment, expansion or improvement of export capacity, and for con- struction, rehabilitation or expansion of hotels generating predominantly foreign exchange revenuest and (c) a techaical assistance component of $0.5 million for stud- ies designed to improve the financial and administrative support system to exporters and the productivity and efficiency of selected product groups and for supporting indirect exporters. II. THE EXPORT SECTOR 15. Export Performance. The measures introduced by the Government at the end of 1982 were, in part, designed to reverse the unfavorable trends in non-petroleum exports which had developed at the end of the 1970s. Fot the longer-term, it was also essential to increase the proportion of indus- trial production which was being exported, estimated at some 3.7% in 1980. From about one-half of total merchandise exports in 1978 and 1979, the share of manufactured exports declined to around 14% in 1981 and 1982 (see Annex I). In 1983, the value of manufactured exports rose by more than 30% as compared to the previous year. This improvement reflected not only the substantial real devaluation included in the Government's stabilization program but the depressed state of domestic demand, as well as the begin- ning of economic recovery in the United States. High growth rates contin- ued into the first half of 1984 but the subsequent real depreciation of the peso (see Annex IV) ane the resumption of growth in domestic markets led to a slowing down of export expansion. In 1985, there was actually a decline in the value of these external sales. 16. The macro policies adopted during 1985, liberalizing the trade regime and substantially reversing the incentive structure combined with another substantial devaluation of the peso, were quickly reflected in the renewed dynamism shown by manufactured exports which in 1986 rose once again in value by almost 40Z. Moreover, as a result of the decline in oil prices experienced in that year, the value of manufactured exports exceeded that of oil-related products for the first time in the decade of the 1980s. The expansion of non-traditional exports continued into 1987 and 1988, with further increases of the order of 40% and 15? respectively. The slowdown in the expansion rate in the latter year is associated with the real appre- ciation of the peso (see Annex II). As a measure of the increasing open- ness of the sector, detailed output and export data available for 1987 indicate that exports of manufactures represented some 12? of the gross value of non-oil industrial output, compared to 4Z in 1980. 17. Transport equipment and components, basic steel products and petrochemicals currently represent some 60Z of manufactured exports and about three-fourths of the expansion experienced in the current decade (see 52 - Annex II). Nevertheless, external sales are highly diversified involving a broad range of products among the different industrial subsectors. This reflects the excellent resource base of the country, the level of industri- alization already achieved and the relatively abundant supply of labor cap- able of absorbing in quick fashion basic technical skills. The proximity of sizeable markets in western and southwestern United States also offers important advantages to Mexican producers. 18. Analysis of the performance of Mexican exports must also take into account developments affecting the assembly or Imaquila" industries, based on imports of parts and components from the United States with re-export of final goods to that country under special customs tariff arrangements. The Mexican regime controlling this trade was established at the end of the 1960s. In contrast to most other countries, Mexican trade statistics for these items are separately reported, reflecting basically the value added in the country. Preliminary data indicate that these exports exceeded $2 billion in 1988, some 302 higher than in the previous year and more than three times the level recorded at the beginning of the decade. Of particu- lar importance in the Mexican case is the high labor content of this trade. It is estimated that the maquiladoras currently employ almost 400,000 per- sons, equivalent to about 10% of the labor force employed in the industrial sector. 19. The bulk of the maquila plants are located along the border with the United States, although the Mexican regulations are not restrictive. This trend has reflected internal transport difficulties, as well as the advantages of "twin-cities" relations developed between neighboring cities on both sides of the border. In recent years, however, there has been some growth of these facilities within the country, due to labor shortages in the border areas combined with high turnover. Moreover, as a result of the growing sophistication (higher value added) of the products being re- exported, shipping costs have become less important in total costs, permit- ting greater flexibility in decisions on location. 20. Export Strategy. The Government's Export Policy Letter accompany- ing the documentation for EDPI put emphasis on maintaining an attractive exchange rate to provide incentive for export activity. It was recognized that the eventual reversal of the anti-export bias arising from commercial policy prevailing under the stabilization program would require elimination of quantitative restrictions on imports and the reduction of tariffs. In the interim, the Government intended to simplify and streamline administra- tive procedures relating to import licenses for inputs for exporting enter- prises, duty drawback and temporary admission facilities, and export per- mits, as well as to provide priority within the exchange control system so that exporters could obtain the foreign exchange required for their imports. A timetable indicating the expected dates of key policy actions was attached to the letter. The basic objective was to create a de facto free trade zone for exporters. 21. As part of the improvement in the institutional framework support- ing exports, the intention to create a "single window* service to advise - 53 - and assist enterprises on meeting administrative requirements for their exports was included. Responsibility for this service was to be given to the Instituto Mexicano de Comercio Exterior (IMCE), the basic public sector export promotion agency attached to the Secretario de Comercio y Fomento Industrial (SECOFIN) which in turn was primarily responsible for adminis- tration of the regulations affecting commercial transactions. IMCE's pro- motional activities were also to be strengthened. 22. During the second half of 1983 and through 1984, the Government took numerous steps consistent with the program outlined in its Export Policy Letter. For example, the 'single-window* facility was established in IKCE,3 import duties were reduced on a broad list of products, prior licenses for temporary imports for export production were no longer required, coverage of quantitative import restrictions was reduced, and regulations for an expanded and simplified temporary admissions system were established. Many of these measures were outlined in a national program of industrial development and foreign trade (PRONIFACE) issued in July 1984. 23. As noted earlier in this section, the deteriorating export perfor- mance at the end of 1984 and the beginning of 1985 combined with the re- emergence of internal imbalances forced the Government to undertake a com- plete re-evaluation of its development strategy. In the middle of 1985 the Government announced a series of measures to achieve fundamental structural change in the Mexican economy. 24. On the trade policy side, restrictions on exports for all but a small number of products were removed, the coverage of quantitative restrictions on imports was sharply reduced, a schedule of tariff reduc- tions was established which would eventually result in a maxim tariff of 20Z, and the system of official reference prices (arbitrary prices on which tariff levels were imposed) was scheduled to be phased out. The basic elements for the establishment of the free trade status for exporters were spelled out in the Integrated Export Development Program (PROFIEX) pub- lished in the second quarter of 1985, including a special program (PITEX) for smaller and medium sized firms unable to use the existing temporary admission system,4 and a modification of the duty-drawback scheme. 25. In connection with EDPII, the Government submitted a statement on Export Development Policy summarizing the main elements of the measures affecting macro policies which had been taken in the context of the earlier 3/ In practice, however, this facility did not prove effective as the various agencies with responsibilities for administering prevailing export controls were not willing to delegate that responsibility to IMCE. Thus, the essential function which the single-window served was to assist in familiarizing exporters with administrative requirements and in identifying the relevant institutions. 4l Mexico has had for many years a temporary admission system under which large enterprises with substantial import requirements could make use of bonded warehouses under Customs supervision. - 54 - Trade Policy Loan and the specific measures for export development taken in late 1985 and 1986 to implement PROFIEX. These included a wide range of matters including improving access of exporters to the full value of their exchange earnings within the prevailing exchange control system, and fur- ther improvements in tax rebate procedures. In addition, many of the sup- port measures (e.g. PITEX) were extended to indirect exporters, those sup- plying inputs to final exporters. In this connection, a new financial doc- ument was created, the domestic letter of credit, to be provided by final exporters to their domestic suppliers, which would be used by the banking system as the basis for providing the latter with working capital credits. 26. At the present time, the principal policy objective of the two operations, the establishment of free trade status for exporters, has been virtually completely achieved. Export controls remain on a small number of products, amounting to about 252 of non-oil exports. These are primarily in the agricultural sector where domestic sector policy considerations are paramount, or in those instances where there exist external trade restric- tions (e.g. textile exports to the US which are subject to quotas). In the case of imports, existing controls affect products which account for about 25% of total domestic production but they are similarly concentrated in the agricultural (or agro-industrial) sector and are closely linked with domes- tic sector policy. While in the macro sense the remaining restrictions on imports and exports cover items representing a substantial portion of total output of tradeables, further liberalization is not possible without con- fronting domestic agricultural sector policy. 27. Experienced exporters report little difficulty in coping with the vestigial controls.5 But it must be noted that there remains a learning process for new exporters, albeit at a small cost. Within the private sector, it is felt that, as confidence grows in the Government's intention to pursue basic structural change in the orientation of the economy, small- er enterprises will be increasingly willing (indeed, in order to survive, will be forced) to undertake the investment of time and effort necessary to cope with remaining administrative requirements, as well as to develop an export marketing capability, either individually or in some cooperative form with other firms. 28. The major current administrative procedure which appears to pre- sent difficulties, again particularly to new exporters, relates to exchange control which is regulated through the commitment to surrender foreign exchange (CVD) to the Banco de Mexico. Obviously, once full convertibility has been achieved, this barrier will disappear. It should also be noted that the system of temporary admissions which was designed for generally medium-sized enterprises (PITEX) has been generally well received and, through 1987, there were sharp increases in its utilization However, at the end of 1987, tariffs on a number of inputs were reduced to zero which obviated the need for many firms to use PITEX, resulting in a decline in 5/ Aside from the quantitative restrictions noted in the previous paragraph, there are some prior export and import license requirements stemming from health and sanitary regulations. - 55 - those operations in 1988. The decision to raise once more tariff levels on a number of these items, taken in early 1989, may result in an increase in utilization of the system during the current year. 29. Recent surveys of the private sector, some of which were conducted in connection with monitoring the impact of the Trade Policy Loans of the Bank, indicate general acceptance and support of the basic liberalization policies of the Government but, at the same time, point up the need for stability in those policies. Interviews undertaken in connection with this completion report suggest that the main problems in the further expansion of exports, particularly promoting the emergence of new exporters among small and medium sized exporters, now lie outside the area of trade policy. It has been stressed that there is great need for improving the efficiency, and reducing the possibilities for corruption, in customs administration and in the utilization of transportation facilities. Measures to deregu- late truck transportation and to reduce the restrictions on the number of customs brokers have been cited as steps which could be effective in these particular areas and would further advance the objective of the present administration to open up the economy. III. IMPLEMENTATION OF THE PROJECTS 30. PROFIDE. The borrower, under both projects, was the Banco Nacional de Comercio Exterior (BANCOMEXT), a bank created by the Government in 1937 which had acted, and continues to act, as its financial agent, and had assisted in the financing of official imports as well as in financing primary product exports in the difficult periods before and during World War II. In the period before 1980, BANCOMEXT had been active in tradi- tional financial activities associated with international trade (e.g. provision of letters of credit and acceptances) and in contracting and administering foreign lines of (suppliers') credits. The new administra- tion indicated at the end of 1982 its intention to reinforce the activities of BANCOMEXT to make it the principal import-export bank. 31. Implementation of the working capital lending component, PROFIDE, would be the responsibility of the Fondo de Fomento a las Exportaciones de Productos Manufacturados (FOMEX). This second-tier trust fund was created by the Banco de Mexico in 1962 at a time when there was little interest within the financial system to meet the financing needs of manufactured exports. FOMEX provided, through the existing banking system, both pre- and post-export financing for manufactured products. As a condition of effectiveness of EDPI, BANCOMEXT was made trustee of FOMEX. 32. Utilization of EDPI funds under the PROFIDE component was initial. ly quite slow, particularly as compared to appraisal expectations (see - 56 - Annex III).6 Among the factors were the need to integrate FOMEX into BANCOMEXT and to introduce the procedures for the new financing program. While FOMEX, as well as the first-tier banks, had had experience in trade financing, the criteria which had been established for eligibility for PROFIDE involved additional paper work and adjustments had also to be made to existing operational procedures to conform with Bank disbursement regu- lations. Supervision missions undertaken by Bank staff in the early stages of project implementation reported that both the intermediary banks and potential customers found the administrative requirements excessively bur- densome, not sufficiently flexible for trade finance which needs to be cap- able of quick response. Moreover, enterprises objected to the requirement to submit detailed export marketing plans which they considered as confi- dential commercial information. 33. At the same time, however, these missions found that existing FOMEX local currency financing for working capital for exporting enter- prises continued to be available at subsidized rates, highly negative in real terms. The substantial decline in imports in 1983 had reduced the demand for foreign exchange while exchange control implementation was directed at assuring that exporters would have acce.a to required foreign exchange for their imports. In these circumstances, '-Iorters were able to borrow in local currency to meet working capital requirements and had no need to use the PROFIDE line. Moreover, in spite of the nature of the PROFIDE loans, which linked exchange requirements for imports with export earnings, there was some reluctance by exporters to incur foreign,exchange liabilities. 34. While the Bank was prepared to agree to the simplification of eligibility criteria, it found itself in a difficult position regarding the FOMEX interest rate on domestic currency loans. During appraisal, the Mexican authorities had indicated that one of their policy objectives was reform of the entire interest rate system in order to eliminate implicit subsidization and to achieve positive real lending rates. It became clear during supervision that interest rate issues, in particular the FOMEX rate, were being discussed by the Mexican authorities with the United States Government in the context of bilateral negotiations focussing on the possi- ble existence of export subsidies which the US considered countervailable. As a consequence, the Mexican Government was prepared to take appropriate action on the interest rate for the competing local currency credit line only after those negotiations were completed, although some increases in the rate structure were introduced in the interim. In the event, the bi- lateral agreement was not reached until April 1985, requiring, inter alia, programmed increases in the FOMEX rate until a positive real rate was achieved. 61 Utilization of the pilot PROFIDE project (see para. 8 above), created by temporarily transferring funds from an on-going project, was also slow. Of the $100 million made available, only about $30 million was actually used. - 57 - 35. Commitment of PROFIDE funds accelerated in the second half of 1984 (see Annex V) and was attributed to% (i) the simplification of application procedures and the growing familiarization of BANCOMEXT-FOMEX personnel, as well as the first-tier bank personnel, with the program (ii) the impact of promotional efforts in making exporters more aware of the facility and of the absence of foreign exchange risks; (iii) and the reduction in the interest rate differential between the FONEX local currency credit line and PROFIDE. In addition, PROFIDE clients have noted several characteristics of these credits which make them attractive. Given credit scarcity, FOMEX local currency credits usually do not cover the full amount of the loan request and banks generally require compensating balances, as compared to full coverage under PROFIDE. Moreover, disbursement and repayment proce- dures under the latter also give greater flexibility to the exporter- importer as compared to other payment procedures prevailing in Mexico.7 36. Commitments under PROFIDE further accelerated in the next two years but the balance of uncommitted funds continued to present a problem to the Bank which had anticipated a much faster pace of disbursement (See the table comparing estimated disbursement with actual, appearing in Annex III). Discussions were pursued with the Mexican authorities on several occasions concerning a possible cancellation of uncommitted balances and/or transfer of some PROFIDE funds to FIFE. The subsequent full utilization of the project funds followed upon the extraordinary measures taken to meet emergency needs after the earthquake in September 1985 when $52 million of PROFIDE funds were shifted to FIFE to finance reconstruction needs. A. EDP II 37. The more rapid utilization of the Bank's funds for PROFIDE under EDPII as compared to EDPI reflected the decision made by BANCOMEXT-FOMEX management to obtain quick disbursement by making several large subloans above the maximum of $10 million permitted under the agreement with the Bank; in these cases, the Bank agreed to waive the limit but did not agree to the $20 million requested by BANCOMEXT, approving instead the amounts of $15 million. As a consequence, the rate of disbursement was considerably faster than anticipated in the appraisal (see Annex IV). The loan became effective in March 1987 and the original allocation of $100 million was fully committed by September of that year. In August 1988, the Bank agreed to transfer to PROFIDE $35 million from the unutilized component for indirect exporters. This additional amount was also rapidly used and a further $20 million was transferred in December 1988 and just as quickly committed. The balance from this component was transferred to the main PROFIDE account in June 1989. 7/ For example, an importer of crude hides noted that the form of his foreign exchange drawing under PROFIDE permits him to buy directly from meat-packing plants avoiding wholesalers and resulting in considerable savings. - 58 - 38. At the same time, the increased promotional activities undertaken by BANCOMEXT and the growing familiarity within the financial system with the facility have led to a substantial growth of operations under the revolving fund. In 1988, total use of PROFIDE funds amounted to some $1.3 billion, representing a turnover-ratio of over 3 for the year. By the end of 1988, 332 enterprises had made use, or were making use, of the facility and the number of operations exceeded 2000 (see Annex VIII), with an average size of about $600 thousand. 39. This experience suggests that the learning curve for this activ- ity, not only at the level of the second-tier institutions but perhaps more importantly at the levels of the fi-st-tier intermediaries, is longer than expected and the effort required to develop an adequately experienced staff at the various operational levels is substantial. The growing importance of foreign trade transactions, particularly exports, has imposed upon the commercial banking system the need to train a large staff in the mechanics of such operations. While numerous training programs have been undertaken, much under BANCOMEXT sponsorship, there is clearly need for more substan- tial efforts. This is especially the case for financial institutions outside the federal capital and with the further exception of the Monterrey area which has developed more expertise in this field. 40. To illustrate this point, second-tier operations under FOMEX which originate in its regional offices account for less than one-third of total, about half of that in the Monterrey area. In the case of Guadalajara, the third most important industrial center in Mexico, PROFIDE second-tier operations in 1987 were less than $2 million but in 1988 the figure rose to almost $40 million and is expected to exceed $100 million in 1989. To a great extent, this expansion is due to active intervention of BANCOMEXT; the first-tier intermediaries in most regional centers are still largely passive and further effort is required to build up and strengthen the staff of those banks who deal with export financing. 41. As a result of the changes in the components which were introduced during the implementation of the two projects, the total amount of funds committed under EDPI for PROFIDE amounted to $225 million (compared to the original $275 million); these were fully committed by February 1987. Under EDPII, PROFIDE funds amounted to $155 million (compared with the original $100 million) which were fully committed by the end of March 1989. 42. The subsectoral pattern of utilization of PROFIDE funds (see Statistical Annex Table 7) corresponds generally to the pattern of Mexico's industrial exports. The main branches of activity among PROFIDE borrowers include transport equipment, basic metal and manufactures, machinery and electrical equipment, and chemical and plastics. However, little use has been made of this funding by the food, beverage and tobacco industries which represent the third largest grouping among exports, reflecting the - 59 - low import content of those activities, not only for direct production inputs but for indirect inputs such as packaging materials.8 B. FIFE 43. EDP I. Allocation of funds under EDPI to finance fixed asset ex- penditures of exporting enterprises through the mechanism designated FIFE was designed to assist such units to upgrade, or to expand, their produc- tive capacity to meet export standards, to eliminate bottlenecks or to adapt products to export markets. It was considered at the time that such investment could provide rapid expansion of industrial exports. Given the existing situation, there was not expected to be much demand for finance of new export-oriented projects. As a consequence, limits were put on the size of subloans to be provided under this component to ensure wide cover- age among potential exporting enterprises. At the request of the Mexican Government, it was also agreed to extend eligibility to urgently needed expansions of hotel facilities primarily attracting foreign tourists. 9 44. In order to ensure rapid implementation of this component, given the limited experience at the time of BANCOMEXT in industrial finance,it was decided to obtain the participation of the Fondo de Equipamiento Industrial (FONEI), a second-tier trust fund of the Banco de Mexico estab- lished in 1971, with the assistance of the Bank, which had developed con- siderable expertise in providing term financing for the expansion of Mexican industry. For tourism projects, it was also decided to obtain the participation of FONATUR, a trust fund established in 1974 which was devoted to both infrastructure and direct investment in this particular sector. It was expected that FONEI would be able to on-lend some $35 million, FONATUR $25 million and the balance of $11 million would be directly lent by BANCOMEXT. 45. Commitments under FIFE were also slow in developing due to the delays in designing and approving operating regulations for the participat- ing institutions and establishing appropriate working relationships. In addition, the overall low level of demand in the economy resulted in low demand for investment. By the end of 1984, one year after effectiveness, only $13.2 million had been committed (see Statistical Annex Table 5). In the first half of 1985, however, commitments accelerated with FONEI accounting for about half of the loan approvals at the time. 81 At appraisal of EDPI, there was the expectation that agro-industries would have substantial need for imported packaging materials but the development of secondary petro-chemicals in Mexico has led to expansion of domestic production of plastics, meeting a considerable proportion of local needs for those items. 9/ Foreign tourism has been considered a priority activity by Mexican authorities because of its employment-generating capability, both direct and indirect, in addition to the foreign exchange it generates. - 60 - 46. Following the September 1985 earthquake, the Government requested, and the Bank approved, a transfer of $50 million from the PROFIDE component to the FIFE component to meet emergency needs.10 A loan of $30 million from BANCOMEXT to reconstruct the severely damaged telephone line, particularly affecting international communications, was quickly approved. The remaining $20 million was used by BANCOMEXT for direct lending for other FIFE operations. 47. By September 1987, the revised FIFE component amounting to $121 million was fully committed. Loans had been approved to 89 enterprises with an average size of $1.3 million. Of the total, BANCOMEXT was respon- sible for $64 million, including $30 million for the telephone reconstruc- tion, while FONEI was responsible for $37 million and FONATUR for $19 mil- lion. Lending by FORATUR fell below the level expected at appraisal ($25 million) largely due to the decline at the time in demand for construction of new hotels; a large share of the actual lending was devoted to other types of tourist accommodations with smaller investment requirements. C. EDP II 48. Under EDPII, FIFE was allocated $74.5 million with the expectation of continued participation of FONEI and FONATUR. This participation, however, did not take place as agreements between both institutions with BANCOMEXT were never finalized. In the case of FONEI, the conditions of lending under FIFE were not as favorable as was the case with its other operations receiving support from the Bank. In those instances, FONEI was able to capitalize the repayments it receives on its subloans since the Government is responsible for repaying the Bank. This procedure, moreover, was being followed for BANCOMEXT under EDPII but had not been the case for EDPI. FONEI requested the extension of that procedure to its participation in the FIFE component of EDPII but no agreement was reached on the issue. 11 49. In the case of FONATUR, a number of problems led to the failure to conclude the necessary agreement. FONATUR itself was going through a difficult period with a major reorganization and change in its management which led to a long delay in dealing with the issue. At the same time, the agency was delinquent in meeting certain requirements under covenants with the Bank, in particular, failing to provide an external auditor's report which would have led the Bank to refuse to disburse against any of its 10/ An additional $2 million was transferred from the component for technical assistance to exporting enterprises which was never used; subsequently, this was transferred to the studies component for sectoral analyses (see below, para. 73). 11) Under a recently adopted decision of the Government, financial institutions receiving Bank loans will no longer be permitted to use the proceeds for capitalization. - 61 - commitments. As a consequence of these problems with the two prior cooperating institutions, the Bank did not object to the full utilization of FIFEII by BANCOMEXT. 50. By the end of 1987, some nine months after effectiveness, BANCOMEXT through direct lending had committed about $16 million under this component. By June 30, 1988, commitments amounted to $47 million and almost all of the full amount of the component had been committed by March 1989. The rapid rise in commitments was largely due to approval of two large loans, one for $14 million and the other for $20 million; although the latter exceeded the maximum size provided in the agreement, the Bank agreed to waive the limit in this case. A total of 13 loans have been approved with an average size of $5.7 million, four times the average under FIFE I. 51. In October 1987, BANCOMEXT signed a cofinancing agreement with the Export-Import Bank of Japan providing an untied loan of 84 billion yen, equivalent at the time to $240 million. These funds are to be used for fixed asset financing (FIFE) and the conditions of lending are similar to those applied to Bank funds. BANCOMEXT expects to use the bulk of these funds to help finance a number of large projects in its pipeline. IV. BANK PERFORMANCE 52. The administrative procedures originally used to determine eligi- bility for PROFIDE funding which were subsequently simplified reflected to some extent the limited experience at the time of both Mexican authorities and the Bank in dealing with this type of commercial transaction. In addition, it is important to note that the intent of the Bank staff in designing these procedures was to promote export-strategy planning among the productive sectors. This experience confirms that such a mentality derives essentially from the economic policy and regulatory environment and cannot be promoted by "administrative" measures which, in fact, may be counterproductive. 53. Under the first loan, Bank supervision missions were staffed with a broad range of expertise which permitted them to actively pursue a number of major issues affecting export development in addition to the Implementa- tion of the project component and the Implementation of the policy package. Drawing on the Bank's experience in other countries with intensive export development programs, Bank staff examined, among other matters, programs designed to help finance domestic enterprises supplying inputs to exporting firms which themselves might have import needs (the so-called *indirect exporters"), reviewed the promotional activities of IMCE, at the time the principal export promotion agency, and, at the request of BANCOMEXT, analyzed the existing system for export insurance and guarantees, as well as the experience of export consortia. Recommendations on the credit insurance and guarantee systems were incorporated by BANCOMEXT in its operational activities while suggestions on IMCE activities were incorpo- rated into the terms of reference of studies financed under the project. - 62 - 54. The issue of the needs of 'indirect exporters' occupied a critical position i the preparation of EDPII and led to the establishment of a new financial document for commercial transactions, the domestic letter of credit. In 1986, BANCOMEXT initiated a program to rediscount these docu- ments in pesos, using its own funds. In that first year, funds provided under this program amounted to the equivalent of $29 million, rising to $186 million in 1987 and $242 million in 1988. By the end of 1988, a total of 269 enterprises had been supported through these operations. 55. Under EDPII approved in 1987, a component amounting to $75 million was set aside for financing the foreign exchange requirements of indirect exporters. Demand for such financing did not materialize and these funds have been transferred to the PROFIDE component. 56. The evidence in this instance, as well as in other countries where this practice has been established, suggests that the use of the domestic letter of credit to permit indirect exporters to obtain their foreign exchange requirements may be an important issue in those instances where exchange controls are particularly rigid. This appears to have been the case when EDPII was being prepared and was among the main justifications for the inclusion of the component. The situation, however, rapidly changed in Mexico and these suppliers apparently now have few difficulties in obtaining the small amounts of exchange which they may need.12 57. Nevertheless, the establishment of the domestic letter of credit has proven to be a useful instrument for promoting exports in the current conditions of Mexico where there continues to be credit constraint, facilitating access to peso financing for smaller enterprises supplying exporters. There are, however, indications that both financial intermedi- aries and final exporters still do not fully understand either the domestic letter of credit or the procedures for its use. There is therefore need for strengthening educational and promotional programs to permit a wider and more efficient use of the document. This is becoming even more urgent as Mexico's industrial structure is becoming more complex and the chain of production relationships is growing. 58. In recent years, Bank supervision inputs (for both field missions and subproject reviews at Headquarters) for the two projects combined have been at about the same levels as the ones earlier prevailing for EDPI, although some key elements are now being dealt with in the context of supervision of Trade Policy operations. 121 There is some evidence suggesting that, in the case of Mexico, exporting enterprises are highly vertically integrated, if one excludes the imported components, reflecting in great part the prior policy framework. Thus, where consideration is being given in other countries to the use of domestic letters of credit, an effort should be made to examine more 'carefully the extent of intra-industry dependence to provide some quantitive measure of demand for that instrument. - 63 - V. GENERAL CONCLUSIONS 59. The design and implementation of these two projects have taken place in the context of an important evolution in the Bank's operational strategy for lending to Mexico. In designing EDPI, it was recognized that the dimensions of the crisis which the Government was then facing required an imediate stabilization program which would be restrictive in nature, accompanied by measures which could result' in quick transfer of resources (see above, para. 4). At the same time, it was important that the Mexican authorities provide a policy framework for the longer-term which would indicate the nature of the structural reforms required to restore the country to a growth path. It was not considered possible at the time to elaborate on the measures to achieve that objective but the Export Policy Letter submitted by the Government and the draft export policy paper which accompanied it (which was later replaced by a more comprehensive export strategy document) represented significant advances in the desired direction. 60. Moreover, the agreement of the Mexican authorities to engage with the Bank in a periodic review of progress under the prograln and of the implementation of the loan permitted the development of an intensive dialogue on trade and related policy matters involving key decision makers within the Government structure. Given the limited and less structured dialogue which had characterized previous periods, this represented an important milestone in the relationship between the Bank and the Government, marking the beginning of the period of fruitful economic dialogue which pervades in the present relationship between the Bank and the Mexican authorities. 61. With the re-emergence of the basic imbalances in 1985 and the new initiatives for opening the economy, the Bank decided to link increased lending to those central policy reforms (see above, para. 11). The policy dialogue which had been initiated under EDPI was intensified and provided the basis for the design of the two Trade Policy Loans in 1986 and 1988, as well as the second EDP in 1987.13 62. While the policy content of both EDPI and EDPII was limited, they did focus on support for means to stimulate exports. In the case of EDPI, in the context of stabilization measures including exchange, import and export controls, the principal goal was to provide a free trade-status for exporters. EDPII, complementing the earlier Trade Policy Loan, continued the effort. That objective has essentially been met (see above, para. 28). It is difficult to quantify the precise impact on exports of the measures undertaken to implement the policy but the expansion in the level of exports and the increase in the openness of the industrial sector (see above, para. 16) which have been achieved are generally associated with 13/ A PCR for the two Trade Policy Loans, analyzing the principal macro- economic reforms, is now In preparation. - 64 - them.14 At the same time, the implementation process and the continuing dialogue with the Bank have had a substantial impact in providing to the Mexican authorities important guidelines in formulating the broader liber- alization actions undertaken in mid-1985. The setback in export growth preceding those actions was convincing evidence of the need for more fundamental reform.15 63. On the operational side, considerable success has also been achieved in establishing a mechanism for channelling foreign exchange and providing credit to exporters. on terms comparable to those prevailing in international markets, to permit them to import inputs, particularly in the early periods of foreign exchange constraints, as well as under prevailing credit constraints including high real interest rates on domestic borrow- ing. This achievement, however, occurred at a much slower pace than originally anticipated and the expectation that EDPI could also be fast- disbursing was overly optimistic in view of the institutional changes required. In addition, at the outset inexperience in dealing with this kind of commercial activity led to the imposition of lending conditions which were not suitable but this was subsequently corrected. The recent improved performance of PROFIDE reflects the fact that the banking system is becoming more familiar with the problems connected with the financial needs of exporters. Nevertheless, further efforts are required to build up the necessary expertise, particularly in financial institutions outside Mexico City and Monterrey. 64. Having concluded that the projects have been successful, is it possible to measure the role of PROFIDE in the expansion of exports? There are a number of considerations which limit the estimation of any direct correlation, including the differences in import content among firms and the availability in some cases of suppliers' or other credits to supplement the exchange made available under PROFIDE. What emerges from interviews with clients who have recently entered into export marketing is their opinion that the availability of this credit in foreign exchange, and at reasonable cost, played an important role in that decision. 65. Moreover, the trend of FOMEX lending activities relative to the performance of manufactured exports indicate a growing importance of PROFIDE. In the early 1980s, FOMEX financing of export sales was equiva- lent to about 40? of the value of manufactured exports while its pre-export financing was equivalent to 20% of that trade. In 1988, the importance of 14/ It is obvious that these developments have complex roots, involving the entire macro economic context, trade and exchange rate policies, as well as external demand. 15/ This experience may be relevant to other countries which may be considering export development programs in the absence of basic macro economic reforms to reverse production incentives. - 65 - sales financing had marginally decreased (38?) but pre-export financing had risen to the equivalent of 292 of industrial exports of which PROFIDE represented some 112. This confirms the view that the prevailing domestic credit constraints and limitations on exchange convertibility have encouraged exporters to make extensive use of the PROFIDE facility. 66. The rapid commitment and disbursement of PROFIDE funds under EDPII is associated with the decision of BANCOMEXT to extend lines of credit, each of $15 million, to four multinational vehicle and parts manufacturers operating under the special regimen for the automobile industry and to two petrochemical firms. As a consequence, there was not only a quick transfer of resources and a rapid build-up of the revolving fund, but BANCOMEXT was able to avoid a lengthy period of commitment fees which had proven to be a burden under the first operation. Large credit lines with other multi- national -ito companies have also been provided through revolving PROFIDE funds so that the overall weight of these transactions in the total of PROFIDE operations has been rather substantial (see Annex VIII). 67. The issue of whether such transactions represent the most effi- cient use of PROFIDE funds from the point of view of the Mexican economy is complex and a number of factors must be kept in mind. In the first place, from the legal point of view, within the PROFIDE system, there was and is no basis for rejecting applications for loans from such enterprises; in fact, one of the achievements of EDPI was to reform the regulations of FOMEX which previously could only lend to Mexican-owned operations. To have refused the applications would therefore have represented re-introduc- tion of undesirable discrimination. At the same time, it should be acknowledged that the Bank was correct in not agreeing to the limits as requested by BANCOMEXT, irrespective of the volume of exports each enter- prise was capable of exporting. 68. Secondly, while it can be argued that these companies may have access to funding from their "casas matrices', it is often the case that the optimum allocation of total resources from the point of view of each corporation, which must operate within the constraints imposed by its overall market and financial situation, may not represent the optimum from the point of view of the individual subsidiary and the country where it is located. BANCOMEXT officials stress that the enterprises, even if they are subsidiaries, should be able to have recourse to local resources so as to have flexibility in their decision-making. Given the size of both import needs and the actual value of exports, PROFIDE funds represent a small proportion of requirements of these firms but they have provided an important "seeding, function in the mobilization of domestic resources to achieve their export goals. 69. Finally, there is no evidence that, in prevailing circumstances, the use of PROFIDE funds in this manner prevented other eligible firms from obtaining credits. Further growth of exports is likely to require addi- tional finance from PROFIDE. To meet those needs, it may well be necessary to expand its available resources rather than to reduce its existing credit lines. - 66- 70. Both loans contained relatively large components for technical assistance and studies. Under EDPI, some of the $3 million set aside for these purposes was expected to be used to provide technical assistance through IMCE to exporting firms. For various reasons, no programs of this type were carried out. Among the factors were the difficulties in estab- lishing priorities and eligibility criteria, and in managing and supervis- ing the assistance at the level of individual enterprises. This experience confirms the lessons emerging from similar attempts, largely unsuccessful, in other countries with relatively advanced industrial sectors to involve public sector institutions in what are essentially commercial and confiden- tial transactions. It must be noted that, from the outset, INCE officials were not enthusiastic about the activity. 71. A substantial portion of the studies components was devoted to financing a major research project dealing with the measurement of effec- tive protection. Originally based in INCE, the project was transferred to SECOFI when the former was dismantled in 1985. In recent years, it has been able to generate a mass of information which has been extremely useful in policy formulation, shedding light on the expected impact of the trade liberalization measures, as well as in the monitoring of the Bank's two trade policy loans. The essential point emerging from this experience is that these kinds of policy-oriented studies require a sustained effort and appropriate institutionalization in order to be able to contribute to policy formulation; these are not 'one-shot' ventures. The Bank should actively promote, indeed should insist upon, the continuation of this work. 72. Several subsector studies have also been financed under these two loans, including auto parts, agro-industries, textiles (clothing), shoes and furniture. While BANCOMEXT is the sponsor and provides general super- vision, the studies have been carried out by different consulting groups with somewhat varying terms of reference. As one would expect, the recep- tion of the industrial sectors to these studies has been mixed,16 ranging from criticisms concerning the generality of findings to expressions of appreciation for the specificity of recommendations. Some concern has been expressed over the slowness of BANCOMEXT in dissemination of the documents and particularly over the need for brief action-oriented summaries which could be more widely circulated and could be sold at prices well below those being charged for the full studies. 73. Given the substantial amount of funds for studies which have already been set aside in on-going loans and are planned for new loans under negotiation, there is clearly need for the Mexican authorities to review its policies on issues such as the selection of topics, methodology, qualifications of consultants and selection of audience to be served. In the case of sectoral studies to identify export-oriented activities, early participation of the concerned private groups in product identification and study design would be essential and the approach in each case should reflect the specific characteristics of the subsector being analyzed. 161 The studies have also been used by the Bank in designing the Industrial Restructuring Loan (Loan -ME) which was presented to the Board in April 1989. - 67 - Moreover, consideration should be given to providing some funds within the overall allocation to assist in dissemination of the recommendations arising from this work. Decisions on the use of funds within the study component are clearly the responsibility of the Mexican authorities. Nevertheless, the Bank can play an Important role in ensuring the useful- ness of the studies, provided it is -repared to devote the necessary staff resources to that task. 74. The contribution of the projects to the development of the insti- tutional infrastructure supporting exports must also be noted, particularly the role in helping BANCOMEXT emerge as a major participant in formulating export strategy. At the end of 1985, BANCOMEXT's status was confirmed in its new organic law and important tasks were assigned to it as a member and secretariat for an inter-agency trade promotion and development committee.17 The expansion of BANCOMEXT's activities, however, raises some questions as to principal orientation and appropriateness. There may arise the possi- bility of conflict of interest as regards the institution's responsibility for broad promotional activities, particularly its responsibility for man- aging external delegations or what are essentially commercial attaches. In reviewing the question of responsibility for promotional efforts, attention should be given to a better definition of the relative roles of the private and public sectors in these activities. 75. Considerable emphasis is now being put on further expansion of BANCOMEXT investment operations under FIFE. Given the present macro- economic policy environment, it is not hard to imagine that, for the next few years at least, much of new private sector investment will have a heavy export-orientation. In this sense, therefore, the mandate for FIFE opera- tions by BANCOMEXT, to expand productive capacity for export (or, in the case of tourist projects, for foreign exchange generation), can provide it with substantial financing opportunities. At present, limitations on the size of loans under FIFE have resulted in joint financing with other finan- cial institutions of even medium-sized projects. Nevertheless, this activ- it-, and particularly the leading promotional role which BANCOMEXT has been playing (no doubt due in large part to its access to Bank funds), absorbs the time of a substantial portion of the human resources of the institu- tion. Given the relatively advanced nature of the financial system in Mexico, is this an area of comparative advantage for BANCOMEXT? 76. It is likely that, in the very near future, the growing diversity of Mexico's exports will require not only an increase in funds for financ- iLg those sales, but also a search for additional instruments. BANCOMEXT has already been involved in export financing, including high-technology capital goods and engineering services. It can be expected that the demand for this type of financial activity will increase. As demonstrated in other newly industrializing countries, a sophisticated financial institu- tion with appropriate promotional activities can play 'a major role in expanding those sales through the use of innovative financial packages encompassing other elements of the banking system. Under the present work 171 It was not possible to review any of the work which may have stemmed from the activities of this committee but this matter could be followed up in a future operation in the trade policy area. - 68 - program of BANCOMEX?, little attention is being given to preparing itself for this function. Within the recently approved Financial Sector Adjust- ment Loan, a review will be undertaken of the functions and organization of BANCOMEXT as part of a study of the public sector banking institutions. 77. Finally, there is need to expand efforts at reaching small and medium enterprises to increase their utilization of PROFIDE funds. For this purpose, it may be useful to undertake studies of the characteristics of exporting firms to deepen existing knowledge of the export sector. Most of the reports already completed have focussed on subsectoral problems. 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ANNEX 11 PROJECT COMPLETION REPORT MEXICO INDEX OF THE REAL EXCHANGE RIATE (1980 - 100) 1980 1 103.5 1985 1 85.9 11 101.2 11 88.2 111 99.4 111 103.9 IV 96.0 IV 116.3 1981 1 90.0 1986 1 128.1 11 84.6 11 139.4 111 80.9 111 152.8 IV 81.6 IV 160.5 1982 1 95.4 1987 1 162.4 11 112.7 11 163.0 111 135.8 111 152.9 IV 117.5 IV 152.8 1983 1 131.5 1988 1 143.3 11 125.1 11 132.2 111 120.7 111 120.7 IV 117.6 IV 121.6 1984 1 109.7 11 105.7 111 99.9 IV 95.0 Sourcet Banco de Mexico 71- ANNEX III PROJECT COMPLETION REPORT MEXICO FIRST EXPORT DEVELOPMENT PROJECT (Loan 2331-ME) Estimated and Actual Disbursement Schedule (in US$ million) Estimated Cumulative Disbursements /a Actual FY84 Dec. 31, 1983 60.0 - Mar. 31, 1984 120.0 0.9 Jun. 30, 1984 180.0 0.9 FY85 Sep. 30, 1984 250.0 28.7 Dec. 31, 1984 290.0 46.1 Mar. 31, 1985 310.0 55.5 Jun. 30, 1985 320.0 84.1 FY86 Sep. 30, 1985 330.0 106.8 Dec. 31, 1985 340.0 115.5 Mar. 31, 1986 345.0 131.9 Jun. 30, 1986 350.0 174.6 FY87 Sep. 30, 1986 181.3 Dec. 31, 1986 226.4 Mar. 31, 1987 261.7 Jun. 30, 1987 285.1 FY88 Sep. 30, 1987 Dec. 31, 1987 Mar. 31, 1988 324.2 Jun. 30, 1988 331.3 FY89 S4p. 30, 1988 334.2 Dec. 31, 1988 335.9 Mar. 1989 345.8 a At appraisal. - 72 - ANNEX IV PROJECT COMPLETION REPORT MSXICO SECOND EXPORT DEVELOPMENT PROJECT (Loan 2777-MR) Estimated and Actual Disbursement Schedule (in US$ million) IBRD Fiscal Year Estimated / and Quarter Cumulative (Ending Date) Disbursements Actual FY87 Mar. 31, 1987 5.0 0 Jun. 30, 1987 15.0 0 FY88 Sep. 30, 1987 32.5 Dec. 31, 1987 63.0 Mar. 31, 1988 100.5 118.1 Jun. 30, 1988 131.5 127.3 FY69 Sep. 30, 1988 160.0 170.7 Dec. 31, 1988 184.5 178.2 Mar. 31, 1989 203.5 211.8 Jun. 30, 1989 218.0 FY90 Sep. 30, 1988 229.0 Dec. 31, 1988 236.5 Mar. 31, 1989 242.0 Jun. 30, 1989 246.5 FY91 Sep. 30, 1988 250.0 L At appraisal. 73 - ANNEX V PROJECT COMPLETION REPORT MEXICO FIRST EXPORT DEVELOPMENT PROJECT (Loan 2331-MB) Cumulative Commitments (Net) By Principal Components la (in US$ million) PROPIDE FIFE September 1984 30.4 5.9 December 1984 38.1 13.2 June 1985 120.6 44.0 December 1985 187.3 80.0 June 1986 207.6 105.2 December 1986 223.9 108.5 June 1987 225.0 115.3 December 1987 225.0 121.0 /a As amended. - 74 - ANNEX VI PROJECT COMPLETION REPORT MEXICO SECOND EXPORT DEVELOPMENT PROJECT (Loan 2777-ME) Cumulative Commitments (Net) By Principal Components /a (in US$ million) PROVIDE FIFE September 30, 1987 99.9 6.9 December 31, 1987 99.9 16.3 March 31, 1988 99.9 35.7 June 30, 1988 99.0 47.0 September 30, 1988 122.6 47.0 December 31, 1988 122.6 53.9 March 31, 1989 122.6 73.9 - 75 - ANNEX VII PROJECT COMPLETION REPORT MEXICO FIRST AND SECOND EXPORT DEVELOPMENT PROJECTS (Loan 2331-E and Loan 2777-ME) PROPIDE Financing by Principal Industrial Subsectors, 1984-1988 (in US$ Million) 1984 1985 1986 1987 1988 Animal Products 0.00 0.08 0.03 0.00 2.48 Vegetable Products 0.00 1.43 0.00 1.04 18.20 Fats and Oils 0.00 0.01 0.00 1.94 0.26 Manufactured Food Products 0.00 0.00 0.82 0.00 5.47 Mineral Products 0.00 1,45 0.46 1.98 76.88 Chemical Products 3.88 15.11 41.67 122.62 280.68 Plastic Materials 0.62 0.18 2.34 13.43 54.70 Hides and Leather Products 0.09 0.24 0.84 1.98 2.99 Wood and Wood Products 0.44 0.83 2.44 11.14 39.18 Paper and Paper Products 0.00 0.05 0.46 4.07 16.98 Textile and Products 1.00 1.68 3.71 7.76 17.62 Shoes, Hats, Umbrellas and Artificial Flowers 0.00 0.14 0.11 0.18 0.09 Stone, Limestone and Glass Products 0.02 0.93 1 19 1.99 3.41 Precious Stones and Pearls 0.00 0.00 0.00 0.06 0.30 Basic Metal and Manufactures 19.12 9.09 65.96 82.00 193.90 Machinery and Electrical Equipment 0.11 2.61 17.68 36.78 118.36 Transport Equipment and Components 14.28 36.30 88.46 289.90 471.74 Medical and Precision Instruments, including Music and Sound 0.00 0.00 0.00 0.55 1.78 Miscellaneous Merchandise 0.00 0.00 0.17 0.31 1.02 Services 0.00 0.00 0.21 0.12 0.00 TOTAL 39.56 70.13 226.55 577.85 1306.06 - 76 - ANNEX VIII PROJECT COMPLETION REPORT MEXICO FIRST AND SECOND EXPORT DEVELOPMENT PROJECTS (Loan 2331-ME and Loan 2777-ME) PROFIDE Average Size of Loan Operations Total Number of of Average Operations Operations Size (in million US$) (in thousand US$) 1984 39.6 91 435.2 1985 70.1 177 396.0 1986 226.9 359 631.2 1987 577.9 1070 540.2 1988 1306.1 2076 629.1 Source: BANCOMEXT