Mexico - Export Sector Loan Project

Document of The World Bank FOR OFFICIAL USE ONLY 6 A ~) .I y/ Report No. P-5427-ME REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED EXPORT SECTOR LOAN IN AN AMOUNT EQUIVALENT TO US$300.0 MILLION TO BANCO NACIONAL DE COMERCIO EXTERIOR, S.N.C. WITH THE GUARANTEE OF -THE UNITED MEXICAN STATES FEBRUARY 25, 1991 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURREPCY UNIT - PESO (MEX$) On Fetruary 7, 1991, the exchange rate in the controlled market was US$l = Mex$2955.4; and in the free market US$1 = Mex$2962.25. The controlled exchange rate is currently being devalued by four-tenths of a peso a day. FISCAL YEAR January 1 - December 31 WEIGHTS AND MEASURES 1 hectare (ha) = 10,000 square meters (m2) 1 kilometer (km) = 0.62 mile (mi) 1 square kilometer (km2) = 0.39 square miles = 100 ha 1 kilogram (kg) - 2,205 pounds (lbs) 1,000 kilograms = 1 metric ton (t) = 0.98 long ton 1 liter (1) = 2.26 gallons (gal) PRINCIPAL ABBREVIATIONS AND ACRONYMS USED Bancomext Banco Nacional de Comercio Exterior, S.N.C. CETES Certificados de Tesoreria (Treasury Bill) COI Comite de Operaciones Internacionales (Committee for International Operations) DGC Directorate General of Customs EDP I First Export Development Project EDP II Second Export Development Project ESL Export Sector Loan FIFE Programa de Financiamiento de Inversiones Fijas para Exportaciones (Program of Financing Fixed Investment for Exports) FOMEX Fondo para el Fomento de las Exportaciones de Productos Manufacturados (Fund for the Development of Exports of Manufacturers) FSAL Financial Sector Adjustment Loan GATT General Agreement on Tariffs and Trade GDP Gross Domestic Product GOM Government of Mexico IDB Inter-American Development Bank IMCE Instituto Mexicano de Comercio Exterior (Institute of Foreign Trade) IMF International Monetary Fund ISPL Industrial Sector Policy Loan NAFIN Nacional Financiera, S.N.C. Pacto Economic Solidarity Pact PECE Pact for Stabilization and Growth PROFIDE Programa de Financiamiento de Exportaciones en Divisas (Program of Financing Exports in Foreign Exchange) QRs Quantitative Restrictions SECOFI Ministry of Trade and Industrial Development SHCP Ministry of Finance and Public Credit SSI Undersecretariat of Revenues (SHCP) TPL I First Trade Policy Loan TPL II Second Trade Policy Loan  FOR OFFICL USE ONLY MEXICO EXPORT SECTOR LOAN TABLE OF CONTENTS Page No. Loan and Program Summary ............ ........ . I i I. THE MACROECONOMIC CONTEXT . . . . . . . . . . . . . . . . . . 1 Macroeconomic Developments. 1 The Debt Restructuring Package of 1989/90. 2 Oil Prices and the Macroeconomic Situation. 3 The Real Exchange Rate. 4 Fiscal Consistency, Debt Management and the Stabilization Program 6 The Pacto and the Decline in Inflation since 1987. 7 Medium Term Finance for Growth. 9 External Debt and Creditworthiness .10 II. THE SECTORAL CONTEXT .10 A. Trade and Customs Reforms ..10 Trade Liberalization Since 1985 ..10 Itnpact on Trade .................... . . 12 Customs Process Reform ..15 The New Process and Policies ..15 B. Bancomext: Financial and Export Promotion Activities .18 Financial Activities .19 Bancomext's Interest Rate Policy . . . . . . . . . . . . . . 22 Credit Guarantees .25 Promotional Activities. 25 Resource Mobilization .26 Financial Statements .29 Administrative Controls . . . . . . . . . . . . . . . . . . . 29 III. BANK STRATEGY . . . . . . . . . . . . . . . . . . . . . . . 30 Government Strategy . . . . . . . . . . . . . . . . . . . . . 30 Bank Assistance Strategy .31 Sector Strategy: Supporting Private Sector-led Growth . . . 32 Sectoral Composition of Bank Lending ..32 Collaboration with IFC ..35 This document has a restricted distribution and may be used by recipients only in the peKoromance of their official duties. fts contents may not otherwise be disclosed without World Bank autlhorizatjn.  IV. THE PROPOSED LOAN . . . . . . . . . . . . . . . . . . . . . . 35 Loan History . . . . . . . . . . . . . . . . . . . . . . 35 Loan Objectives . . . . . . . . . . . . . . . . . . . . . . . 36 The Borrower, the Guarantor and Project Implementation . . . 36 Loan Components and Disbursement . . . . . . . . . . . . . . 36 Procurement .............. .37 Loan Administration and udi . . . . . . 39 Loan Reviews ................... . 39 Poverty Impact . . . . . . . . . . . . . . . I . . . . . . . 39 Environmental Impact ................... 40 Benefits and Risks . . . . . . . . . . . . . . . . . . . . 40 Compliance with the Financial Sector Operations Report . . . 41 V. COLLABORATION WITH THE IMF . . . . . . . . . . . . . . . . . 4Z VI. RECOMMENDATION. . . . . . . . . . . . . . . . . . . . . . . 42 ANNEXES Annex I.1 - Mexico: Economic Indicators . . . . . . . . . . . 43-44 Annex 1.2 Status of Bank Group Operations in Mexico . . . . 45-46 Annex I.3 - Supplementary Loan Data Sheet . . . . . . . . . . 47 Annex I.4 - Loan Disbursement Schedule . . . . . . . . . . . . . 48 Annex 1.5 - Export Sector Program Matrix . . . . . . . . . . . 49-50 Annex IIA.1 - The Merchandise Trade Regime . . . . . . . . . . 51-60 Annex IIA.2 - Trade Statistics: Table 1 - Structure of Trade, 1980-1990 . . . . . 61 Table 2 - Merchandise Exports, 1980-1990 . . . 62 Table 3 - Merchandise Imports, 1980-1990 . . . . . 63 Table 4 - Maquiladora Industry Indicators . . . . . 64 Annex IIB.1 - Bancomext's Policy Letter . . . . . . . . . . . . 65-71 Annex IIB.2 - Bancomext's Program Statistics and Projections, 1985-1994 Table 1 - Bancomext: Financial Program, 1985-1994 . 72 Table IA - Bancomext: Financial Program (X), 1985-1994 . . . . . . . . . . . . . . . . . 73 Table 2 - Bancomext: Financial Program by Currency, 1985-1994 . . . . . . . . . . . . . . . . . 74 Table 3 - Bancomext: Financial Program by Tier, 1985-1994 . . . . . . . . . . . . . . . . . 75 Table 4 - Bancomext: Financial Program and COI Scheme, 1985-1994 . . . . . . . . . . . . . 76 Table 5 - Bancomext: Credit Distribution by Financial Institution, 1989 . . . . . . . 77 Table 6 - Bancomext: Funding Program, 1985-1994 . . . 78 Table 6A - Bancomext: Funding Program (%), 1985-1994 . 79 Table 7 - Bancomext: Guarantees Program, 1985-1994 . 80 Table 8 - Bancomext: Expenditures on Promotional Activities, 1986-1994 . . . . . . . . . . . . . 81 Annex IIB.3 - Market Reference Interest Rate . . . . . . . . . . 82-83  Annex IIB.4 - Bancomext Financial Statements, 198!-1994 . . . 84-86 IBRD Map No. 20343 - Mexico  MEXICO EXPORT SECTOR LOAN LOAN AND PROGRAM SUMMARY Bortower Banco Nacional de Comercio Exterior, S.N.C., (Bancomext) and Beneficiary: Guarantor: United Mexican States Executing Agency: Bancomext Amount: US$300 million equivalent Terms: Repayment in 17 years, including five years of grace. at the standard variable rate. Relending Terms: Bancomext would onlend the credit line component of the proceeds of the loan to exporters for pre-shipment financing including acquisition of inputs, fixed assets and permanent working capital, mainly through the commercial banking system. Subloans would be denominated in US dollars. Bancomext administratively sets the interest rates for final borrowers, and the rates vary by program. The current export financing benchmark is 10.5 percent p.a. for short-term financing of less than one year and 13.5 percent p.a. for longer term financing of more than one year. Rediscount margins range from 1.5 to 3 percent to cover intermediation costs. Maturities range from 180 days (pre-shipment financing) and up to 5 years (for fixed capital investment). Within the context of the transition to a more efficient development bank in a market-oriented en-vironment, Bancomext's interest rate policy will reflect the average market rate of interest for export credits in Mexico. The exchange risk would be borne by the Borrower. Objectives: The ESL is part of a program of Bank support to the Government's objectives of promoting efficient private sector development and increasing the effectiveness of public sector institutions so as to enable the resumption of economic growth. The loas. would support: (i) trade and customs reforms aimed at encouraging efficiency and expanding the tradeables sector; and (ii) the transition of Bancomext, to a more efficient role in trade financing in a more competitive financial system, and provide financing for that role. Description: The program includes measures to help implement: (i) trade and customs reforms and (ii) a more efficient role for Bancomext. The proposed loan would support policy changes through Component A of $25 million, and provide trade-related financing through Component B of  - {i - $275 million. Most of the trade-related financing would be onlent to final borrowers through first-tier commercial banks. Benefits and Risks: If the objectives outlined above are achieved, then the benefits accruing from the project will be significant. Continuing liberalization of trade and strengthening public administration of trade will improve resource allocation and expand trade. The transition of Bancomext to a more efficient institution will improve and expand trade-related financing. There are few risks to this program. Bancomext is a sound institution, well experienced in evaluating and implementing Bank-financed sub-loans. The Government has resolutely carried through its prograwm of trade and financial liberalization as part of the broader program of stabilization and structural reform over the past five years. This program enjoys strong public support. Policy reversals which would endanger the program are considered rather unlikely. Even if either for external or internal reasons Mexico were unable to stay the course of broader program of stabilization and structural reforms, the programs that the ESL would support in customs reform and Bancomext's transition, would have a good chance of staying in place and yielding benefits to the economy. In a broader sense, the prospects of Mexico's trade sector are always tied to the health of the world economy, but this is independent of the program. Disbursementst The proceeds of the loan would be disbursed against eligible import expenditures (Component A) and documented expenditures of eligible subloans (Component B). The loan proceeds component will be disbursed in three equal parts of US$100 million. The first part including all of Component A would become available upon loan effectiveness. The second part would become available after January 31, 1992, and the third part after July 31, 1992 consequent on satisfactory reviews of actions taken by the Borrower. The loan is expected to be fully disbursed by December 31, 1993. Retroactive US$30 million will be made available for retroactive Financing: financing of expenditures incurred from up to six months prior to the signing of the Loan Agreement. Rates of Return: Eligible subloans would have satisfactory FRRs and ERRs in line with Bancomext's policies.  - iii - APpraisal Report: This is a combined Staff Appraisal and President's Report. Schedule of Disbursements: Schedule of Disbursements Bank Fiscal Yeer FY91 FY92 FY93 FY94 Annual 50 125 100 25 Cumulative 50 175 275 300  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED EXPORT SECTOR LOAN TO BANCO NACIONAL DE COMERCIO EXTERIOR, S.N.C. I submit thte foillowing report and recommendation on a proposed loan to Banco Nacional de Comercio Extetior, S.N.C. (Bancomext), with the guaratitee of the United Mexican States, for the equivalent of US$300 million in support of a program for export sector reform. The loan will lhave a term of 17 years, including 5 years of grace, at the standard variahle interest rate. PART I - THE MACROECONOMIC CONTEXT Macroeconomic Developments 1. Between 1950 and 1974, Mexico enjoyed a remarkable period of high growth, low inflation and moderate external debt accumulation. Real growth averaged 6.4 percent, and inflation was in single digits throughout the period. This era came to an abrupt end in the early seventies. Government involvement in the economy expanded rapidly, and increased public expenditure pushed up aggregate demand and the rate of economic growth. However, the higher government expenditure was not matched by rising public sector revenues. As a result, the inflation tax and external debt became increasingly important sources of public finance. At the same time, a decline in private savings incentives (real interest rates turned sharply downward) prevented a matching increase in private savings; external debt thus increased, increased oil revenues notwithstanding. The period of single digit inflation etnded in 1973, the peso started to appreciate in real terms and the accumulation of external debt accelerated above the GNP growth rate. A comparatively brief crisis in 1976 terminated following major oil discoveries in 1977. The ensuing prosperity lasted until 1982, when falling international oil prices, rising world interest rates, and massive capital flight led to a refusal by external creditors to roll over Mexico's short-term debt and a subsequent suspension of Mexican payments of interest on its external debt. 2. The onset of the financial and economic crisis of 1982 brought in its wake explosive inflationary and balance of payments difficulties. Initial strong fiscal and monetary adjustment efforts were undermined by external shocks such as the collapse in international oil prices in 1986. Inflation, rather than slowing down, accelerated, partially in response to the sharp real devaluation of the exchange rate necessitated by the 1986 downturn in the terms of trade. The subsequent de facto targeting of the real exchange ratel/, together with an increase in the frequency of wage and cost adjustments, introduced an element of inherent instability into l/ The real exchange rate is defined as the price of foreign goods relative to domestic goods. Appreciation thus implies a decline in this relative price.  - 2 - the system, culminating in a run on the peso in the last quarter of 1987 and ttip)le-digit inflation. 3. The Governiment responded with the "Ecconomic Solidarity Pact" (Pacto). an agreement between business, labor, and government. This agreement called for accelerated structural reform, further tightening of fiscal and monetary policy, a freeze of minimum wages and of basic public and private sector prices. and, the cornerstone of the Pacto, a freeze of the nominal excthange rate against the U.S. dollar. This partial freeze was extended at three-month intervals throughi the end of 1988, and renewed. with sonte modifications, by the new Mexican Administration under the name of "Pact for Stabilization and Growth" (PECE). The main change under the PECE was a daily adjustment of the exchange rate of about one peso against the U.S. dollar, a rate that has since been lowered to first 0.8 pesos and, most recently, 0.4 pesos per day. The PECE was recently extended until end of 1991. The fiscal measures, backed by the temporary exchange rate freeze and an array of formal and informal wage and price controls, have had dramatic success in reducing the rate of inflation, from 159 percent in 1987 to 20 percent in 1989 and an estimated 28 percent in 1990. 4. Mexico has, throughout this period of macroeconomic turmoil, transformed itself into one of the most open economies In the world through an extensive trade reform. Trade liberalization, most of which took place between 1985 and 1988, has lowered the percentage of domestic (non-oil) tradeable production covered by import quotas from 100 percent in 1984 to less than 15 percent at present. Maximum import tariffs were cut by similar magnitudes. Non-oil merchandise exports, which represented less than one-tlhird of total exports in 1984, have doubled their share since then. 5. These "core' reforms have been complemented by many others. In May 1989, foreign investment regulations were considerably relaxed and made more transparent. The tax system underwent a series of reforms bringing marginal tax rates more in line with levels in major industrial countries, encouraging the repatriation of flight capital, and increasing the sanctions for tax evasion. The impact of inflation on the (corporate) tax system was eliminated by removing purely inflationary gains from the tax base. The Government initiated a parallel process of financial market liberalization. Ceilings on commercial banks' deposit interest rates were abolished; forced allocation of commercial credit towards favored sectors has been abolished too and credit subsidies through official development banks have been reduced. Most recently, privatization of the commerciai banks, which were nationalized in 1982, has been announced. The Debt Restructuring Package of 1989190 6. Despite the far reaching reforms implemented in Mexico, international capital markets did not provide the resources needed to bridge the period between the current costs and the future benefits of the reform program. The uncertainty caused by future transfer problems, through its impact on perceived sustainability of the exchange rate regime and from there on domestic real interest rates, thus became a direct threat  to the survival of the stabilization program and the restoration of economic growth. The GoM therefore initiated negotiations to restructure its external debt in early 1989. 7. On September 15, 1989, the Government of Mexico and tne Bank Advisory Conmmittee replresenting the commercial bank creditors reached agreement on a financing package covering the period 1989-92, restructuring US$48.9 billion of Mexico's external debt. The agreement consists of a menu of financing options which includes two debt and debt service reduction facilities and four new money facilities and was implemented over the next 8 months. A total of US$2Z.8 billion was exchanged for par bonds at a fixed rate of 6.25 percent and US$19.8 billion (US$1.0 billion of which was brought in by Mexican creditors) for discount bonds at market rates but with the principal reduced by 35 percent. 8. The debt relief package has reduced the net transfer Mexico needs to make to its creditors by almost $4 billion per year over the 1989- 1994 period, or on average slightly below 2 percent of GDP. Half of this amount is due to the lengthening of maturity implied by the deal, with the rest coming from lower interest payments and new money disbursements from the Banks that did not choose one of the two debt service reduction options. The reduction in required external transfers has a direct beneficial impact on Mexico's fiscal situation and its likely output growth. However, at least as important have been the indirect, "secondary" effects through renewed confidence; reduced net external transfers mean reduced pressure on the exchange rate, which greatly reduces the risk associated with Peso-denominated public sector debt. Nominal interest rates fell from 56 percent to around 36 percent immediately after the details of the package became known, and have since fallen a further twelve points to about 25 percent in early 1991. At the same time, the maturity structure of public debt has lengthened considerably, another indication of private confidence. Oil Prices and the Macroeconomic Situation 9. Just as Mexico was putting the debt package behind it and starting to look forward to a feasible although somewhat precarious recovery of economic growth, the entire short term outlook changed because of events in the Middle East. Mexico stands to gain from the crisis to the extent that it leads to higher oil prices. But the increased volatility of oil markets since late August has increased uncertainty concernling Mexico's future BoP outlook and hence complicated macroeconomic management. Because of anticipations of future disruptions in oil supply, the bench mark West Texas Intermediate oil price, at $16 per barrel as recently as last July, shot up to more than $37 pb in October 1990. Mexico's oil price follows this benchmark with about a one month lag and a typical negative price difference of around $3.50 (changes in Mexico's export mix may affect this difference). Since the war started, however, the West Texas oil price dropped to around US$21 pb. And there is a possibility that oil prices may fall substantially below current levels once the war ends. This illustrates how uncertain Mexico's oil export prospects remain. While the Gulf crisis has clearly boosted Mexico's oil revenue in the last four  - 4 - months of 1990, at current oil prices the value of Mexican oil expcrts in 1991 will in fact be lower than in 1990. 10. Aside from oil price volatility, other factors may play against Mexico in this (-cvsis. First, all of Mexico's major tradlng partnerts except Canada are net energy importers and may thus be adversely aftectett. Higher oil prices would cause a slowdlown in economic growth and thus dlemand for Mexican exports, and higher inflation. Second, contrary to the two previous oil shocks in the seventies, there is unlikely to be an upwatd shitt in the world savings schedule; lower real interest rates are thus equally unlikely. 11. With oil prices so unpredictable, the right question is not Leally how highi future oil prices will go, but which assumption about future oil prices is least likely to lead to costly mistakes if the assumption is proven wrong. And this question does have a very clear answer. Assuming the oil windfall to be permanent could lead to expentliture programs that could be impossible or very costly to reverse should the windfall turn out to be temporary. Assuming the windfall is temporary, and at current oil prices this already appears to be the case, will just lead to a pleasant surprise if it turns out to be permanent instead. The GoM has therefore stated that it intends to devote the entire windfall gain to the repurchase of public debt, and submitted a budget to congress based on this strategy (the budget assumes $17 per barrel on average for 1991). 12. Before the recent increase in oil prices, Mexico had already set out on a somewhat precarious path of higher growth. Higher oil prices would improve Mexico's outlook, but would add problems of their own. In particular, the sources of Mexico's external funding have, at a time of a noted deterioration in the non-oil current account, become very volatile. First of all, the level of future oil prices is extremely uncertain as the recent volatility suggests. As noted above, with so much uncertainty attached to future oil prices, the GoM has decided not to translate the higher revenues into higher expenditure, but instead to devote them to debt reduction. The second major source of external funding, the massive return of flight capital that took place in 1990 (over US$5 bn), could as easily be reversed. Thus, while the short term outlook has improved a great deal, obtaining stable sot .ces of external funds remains a high priority. The Real Exchange Rate 13. Exchange rate policy in Mexico is complicated because the nominal exchange rate remains an important ingredient of the Pacto/PECE. But with price and wage rigidities still prevalent in Mexico, also because of the PactolPECE, nominal exchange rate policy cannot be separated from real exchange rate developments. 14. Mexico's real exchange rate shows a somewhat ambiguous trend (Fig. 1). Measured against US wholesale prices, much of the increase in competitiveness obtained during the 1986-87 real depreciation has been lost; however the economy is now back at where it was around 84-85, with  -5- ompetitiveness about thirty-six pertcent imptoved over the clearly MEXIC0: REAL EXCHANGE PATE unsustainable level of 1981. Since W hwof f Price (eM9 s=t) 1981, ttle real price of oil has I" _ dropped by close to 30 percent, _f_ f_ ____ trade barriers have been reduced .e and Government expenditure (most of s-1 which falls on Mexican goods) has a.1_ been reduced drastically. All that would call for a real depreciation, although it is hard to judge _ _ __E_. whether the thirty percent against to. ofeo