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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 oftheir ofcial duties. Its co ftals my not otherwise be disclesed Wedd okn n

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CUnaENCY EQUIVALENT

Currency Unit - Peso (Mex$)

At the present time, the exchange rate policy of the MexicanGovernment is to permit a marginal daily devaluation of the peso.

In December 1988, the following (selling) rate prevailed in the*free" markets

US$1.00 - Mex$ 2,330Mex$1,000 - US$0.43

In May 1989, the following (selling) rate prevailed in the *free'market:

US$1.00 - Mex$2,481Hex$1,000 - US$0.40

ABBREVIATIONS AND ACRONYMS

BANCOMEXT - National Foreign Trade Bank (Banco Nacional deCorvrcio Exterior - also referred to as BNCE)

CVD - Commitment to Sell Foreign Exchange (Compromiso deVender Divisas)

FIFE - Program for Financing Fixed Investments forExports (Programa de Financiamiento de InversionesFijas para Exportaciones)

FOMEX - Trust Fund for Promotion of Exports ofManufactured Products (Fondo de Famento a lasExportaciones de Productos Manufacturados)

FONATUR - Trust Fund for Tourism Development (Fondo Nacionalde Fomento al Turismo)

ONZ! - Trust Fund for Industrial Equipment (Rondo deEquipamiento Industrial)

InCE - Mexican Foreign Trade Institute (InstitutoMexicano de Camercio Exterior)

GATT - General Agreement on Tariffs and TradeGIRA - General Interest Rate AgreementIMF - International Monetary FundPITEX - 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 ONLYTHE WORLD BANK

Washwnton. DC 20433U.S.A.

Oace Of 0.ctor-CeleralOpatmas Evalawan

June 29, 1990

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND TE PRESIDENT

SUBJECT: Program Performance Audit Report on MexicoFirst 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 ExportDevelopment Projects (Loans 2331-M and 2777-Mg)* prepared by theOperations Evaluation Department.

A

Attachment

This document has a restricted distribution and may be used by recipients 601y in the performanceof their ofRcial duties. Its contents may not otherwise be disclosed without World Bank authoriation.

FOR OFFICIAL USE ONLYPROGRAM 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................................. . ...................... iiiEvaluation Summary. .................... . ........ # .......... * .......... vii

I. ECONOMIC BACKGROUND ..... .............. ............ 1

II. GENERATION OF THE FIRST LOAN............................. 8

III. imPLEMENTATION OF THE FIRST LOAN, GENESIS ANDIMPLEMENTATION OF THE SECOND ............................. 11

TV. SPECIAL ISSUES ........................**..........o........ 22

A. Did PROFIDE Stimulate Manufactured Export Growth? .... 22B. Why Did Exports Grow? ................................ 24C. 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 372 - Export Development Loans 2331-ME and 2777-ME Disbur ments

by quarters ............................................... 383 - Commitments and Disbursements of PROFIDE I-III at Selected

Dates ........ . . . . . ......... #....... .. . . . .... 394 - Sectoral Distribution of PROFIDE II and III Commitments and

of the Growth of Manufactured Exports, 1983-1989 .......... 405 - MEXICO: Domestic Resource Cost (DRC) Levels, 1982 and

Annual Rate of Change (Z), 1970-1982 ...................... 416 - 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 performanceof 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 EXPORTDEVELOPMENT LOANS# ..... ...... **** ............. 47

t. EDP I ........... ........... *.. .... *....... 47B. EDP II .*. ........ . .. ..... **........... . . ........ 49

11. THE EXPORT SECTOR ....... ..... ......... .* .. o .. 51

III. IMPLEMENTATION OF THE PROJECTS ......................... 55

A. EDP II .......... .................... 57B. FIFE ....................... *.......... ... .. . ..... 59C. EDP I ....... ................... ............. 60

ZV. BANK PERFORMANCE ................ *...................... 61

V. GENERAL CONCLUSIONS .................................... 63

ANNEXES

I - Exports 1975-1988 ........................................ 69II - Index of the Real Exchange Rate .......................... 70

III - Estimated and Actual Disbursement Schedule (Loan 2331-ME) 71IV - Estimated and Actual Disbursement Schedule (Loan 2777-ME) 72V - Cumulative Commitments (Loan 2331-ME) .................... 73VI - Cumulative Commitments (Loan 2777-ME) .................... 74

VII - PROFIDE - Financing by Principal Industrial Subsectors,1984-1988 ....................... ...................... 75

VIII - PROFIDE - Average Size of Loan Operations ................ 76


MEXICO


PREFACE

This is a Project Performance Audit Report (PPAR) on two ExportDevelopment Projects in Mexico, involving two IBRD loans of US$350.0 andUS$250.0 million to Banco Nacional do Comercio Exterior, with the objectiveof supporting the growth of non-traditional exports through the creation ofan export development fund. The first loan was approved on June 23, 1983,and became effective on December 27, 1983. The second loan was approved onJanuary 20, 1987 and became effective on March 26, 1987. The originalclosing 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 bedisbursed on schedule.

The PPAR was prepared by the Operations Evaluation Department(OED) and the Program Completion Report (PCI) was prepared by the LatinAmerica Regional Office of the Bank. The PPAR is based on the attachedPCR, the Staff Appraisal and the President's Reports, the loan documents,study of the project files, and discussions with Bank staff. An OEDmission visited Mexico in January 1990, and discussed the effectiveness ofBank'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 thepreparation of this report is gratefully acknowledged.

The PCR provides an account and assessment of the project'sexperience and discusses the performance of the Bank and the prcjectlsexecuting agencies. The PPAR analyses particular aspects of the twooperations further, such as the evolution and achievement of the variousobjectives, their implementation, the pattern of disbursements, the role ofinterest and exchange rates, and the volume, efficiency and sustainabilityof the export performance, as well as the relation between the loans andgeneral trade policies.

The draft PPAR was sent to the Borrower for comments. Thecomments received from BANCOMEXT are reproduced as an Attachment to thePPAR.

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. 1990Original 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 EMaAppraisal Estimate (US$ million) 180.0 320.0 350.0 350.0 350.0 350.0Actual (US$ MitLLon) 0.9 84.1 174.6 285.1 347.2 348.5 LaActual 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 06/23/83Signing (Loan Agreement Date) 9/28/83 09/25/83Effectiveness 12/83 12/27/83Closing 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 - - - - - 12.5Appraisal - - 70.5 - - - - 70.5Negotiations - - 14.5 - - * - 14.5Supervision - - .4 36.0 33.7 34.4 21.8 7.7 134.0Other . -. - - -

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.

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ISSIQ DATA

Date No. of No. of man Date of(ma.(. ,J. D Persons 2M Relport

Appraisal 6/83 15 7 105 3/08/83Supervision I 2/84 12 2 24 2/24/84Supervision II 4/84 12 6 72 6/19/84Supervision III 9/84 15 6 90 10/15/84Supervision IV 4/85 4 1 4 4/30/85Supervision V 2/86 5 3 15 3/05/86Supervision VI 3/87 10 2 20 4/22/87Supervision 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 ProjectLoan 2777-MEAmount (US$ million)Approval Date


SECON EZORZ EVLPHM PROJECT(LOAN 2777-ME)

BASIC DATA SHEET

LOAN POSITION(Amounts in US$ million)

As of Mar. 31. 1990Original 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) 15.0 131.5 218.0 246.5 250.0Actual (US$ million) 0 127.3 211.8 237.5 gActual as Z of Appraisal (2) 0 97 97 96.3 99.6

-PROJECT DATES

Original Plan Acal

Board Approval 01/87 01/20/87Signing (Loan Agreement Date) 93/87 03/18/87Effectiveness 06/87 03/26/87Closing 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 - - 30.8Appraisal - - * - - 21.2 4.1 25.3Negotiations - - * * - 1.3 11.9 - 13.2Supervision - - - - * - 6.9 28.3 35.30Othe 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.

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MISSIN DATA

Date No. of No. of Man Date of(mo./vn Das&. Persons py Reqort

Appraisal 11/10/85 10 4 40 12/27/85Supervision I 03/23/87 10 2 20 4/22/87Supervision II 11/19/87 5 3 15 12/16/87Supervision III 04/25/88 10 4 40 6/06/88

OTHER PRWECT DATA

Borrower: Banco de Comercio Exterior (BANCOMEXT)Executing Agencies: BANCOMEXT

- vii -


MEXICO


EVALUATION SUMMARY

Introduction

1. Under the influence of rapidly rising oil export revenues and oflarge scale external borrowing, production, consumption, imports and in-vestments in Mexico grew fast in the late 1970s. This process, to theextent that it depended on foreign loans, would only have been sustainableif oil prices had continued to rise indefinitely; when they levelled off in1982 the vulnerability of the economy--a balance of payments on currentaccount deficit of 11% of GDP, negative public sector savings, a stagnantnon-oil export sector and en overvalued currency--became apparent. Privatelenders refused to renew credits, Mexican capital left the country and aserious crisis, affecting investments, output and employment, spread fromthe 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 ofthe situation, it concluded tLat a multi-pronged strategy was required. Onthe one hand, external assistance was urgently needed to relieve immediatebalance of payments pressure; for this, agreements had to be sought withcreditors to reschedule debts and money had to be found to meet currentobligations. New money as well as accelerated disbursements of existingloans (and some shifting of designated end-uses of such loans) mightaccomplish the latter objective. But at the same time, major correctiveactions would have to be taken to enable the economy to resume a moresustainable 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 inadequatesavings levels (or excessive investment levels). They would also have toaddress the deeper causes holding back growths the distortions caused byuneconomic administered prices, including interest and exchange rates, bysubsidies 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 tookthe initiative in preparing and implementing such a program. The IMFsigned an EFF Agreement in December 1982 and the commercial banks commencedrescheduling discussions. The Bank endeavored to participate and behelpful in several of the spheres mentioned. On the one hand, it hoped to

add to the flow of urgently needed freely disposable foreign exchangethrough its Special Action Progtam (SAP)* adopted in 1982 (for countriesaffected by the oil price increases). It also modified loans to let moneyoriginally destined to finance fixed investments be used for current im-ports. And it tried to design a quick-disbursing project, the first of thetwo considered in this Report, for the same purpose (PPAR, para. 1.15).

5. However, neither the Bank nor the Government were ready, at thattime, to enter into the sort of relationship that would have been involvedin direct and simple balance of payments support in exchange for policyunderstandings, namely a Structural Adjustment Loan (SAL). Instead, it wasdecided to try to design a quick-4isbursing project loan, with two specialfeaturess (a) the *project* would establish a revolving fund to allowexporters access to importtd current inputs, and (b) the framework ofpolicies affecting ex-ports would be the subject of a continuing dialoguebetween the Government and the Bank. A certain ambiguity regarding thesituation that would ensue in case of major disagreement in the course ofthis dialogue was allowed to exist from the beginning (PPAR, paras.1.16-1.17).

6, Nevertheless, the operation as designed represented a considerableadvance 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--ifnot negotiations--between the two parties. A Letter on Export Strategy wasincorporated into the legal documents and was supplemented by a more de-tailed draft document--submitted to the Board with the Loan, though itnever became part of the legal agreements--spelling out actions to be takenand 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 asmight have been required under a SAL, there is no doubt that they dealtwith important issues. As a framework, these included, in particular,adherence to, '...a realistic exchange rate as a priority to facilitate theexpansion 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 shifttoward greater reliance on tariffs and less on licensing (imposed, for allproducts, when the crisis broke). Other items dealt with--not so much asprograms 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 anevaluation of the loan depends, to some extent on the relative ranking oneassigns to them.

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(a) Resource Transfet. A quick-disbursing loan, to providebalance of payments support at a critical mc-aent, was oneof the avowed objectives (PPAR, para. 2.07, 3.01).

(b) Bottleneck Breaking. Related to the above, but notidentical vwith it, was the hope to remove a bottleneck toexport exi -sion by giving exporters assured access toimported .aputs by permitting them to borrow scarceforeign ex-hange from the revolving fund.

(c) Policy Improvement. To "...support Mexico's strategy toexpand non-petroleum exports' (President's Report of Loan2331-ME) and to become an active partner in shaping thisstrategy was a further objective. The means to achievethe latter was to be the dialogue structured around aregular joint review mechanism dealing with the executionof the Export Development Strategy outlined in the Letteron it. It should be noted that it was taken for grantedthat the overall macroeconomic management was satisfactoryand was being monitored by the IMF.

Implementation

9. The first loan did not succeed as a device to respond quickly toMexico's foreign exchange crisis. It took two and a half year- aftereffectiveness before substantial disbursements were achieved, andeffectiveness itself came six months after Board approval. Moreover, partof the loan (US$52 million) was disbursed only after a new emergency--the1985 earthquake--had made it necessary to re-allocate some loan proceeds toreconstruction 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 analyticalflaws in the design of the operation as well as unforeseen events. It hadbeen assumed at appraisal that because there was a foreign exchangeshortage, exporters would be eager to borrow loan funds to pay for theirimported inputs. The balance of payments analysis was not complemented bya credit market analysis. In the event, demand for the facility wasvirtually nil becauses

(a) Exporters did not trust the Government's assurance thatforeign exchange for future debt service for loans thatmight be contracted by them would be readily available inthe official market (where they had to deliver theirforeign exchange receipts) (PPAR, para. 3.03); and

(b) were not willing to risk having to buy the exchange in thefree market at an unpredictable but possibly large (in1984, it was 50%) premium (PPAR, para. 3.03);

(c) there were large subsidised peso credit lines availablewhich, even if exchange was bought in the free market, hadthe advantage of being not only cheaper but exchange riskfree (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 importsto collapse to such an extent that the supply of foreignexchange was much less tight than had been originallyestimated (PPAR, para. 3.05).

11. There were also other, more ephemeral reasons for the early lackof borrowers. The formalities to be complied with initially seemed forbid-ding to banks and exporters and the facility was not widely known; moreovernot all participating banks promoted it actively because the profit marginswere modest compared to what they were used to. But the above-mentionedfour economic causes were fundamental. After they disappeared, demandpicked up.

12. The second objective--export expansion by bottleneck breaking, bydefinition could not be achieved until the loan began to disburse. Whileprecise calculations are problematic, it is estimated in this Report that asignificant portion--between 40Z and 80%--of the sizeable growth ofMexico's manufactured exports between 1983 and 1989 (US$8.9 billion) wereassociated with the operations of the revolving fund (PROFIDE) (PPAR, para.3.10).

13. This conclusion is predicated on the assumption that during thisperiod, because of debt negotiations, corresponding amounts of commercialbank trade credits would not have been available as an alternative sourceof funds. This seems a reasonable assumption for the period, but futurelending for working capital to exporters would have to be justified byevidence that commercial banks 2re not willing to supply such credits.Given the recent (early 1990) signing of a formal rescheduling agreementwith the banks, this may no longer be the case. And it would be acontravention of the Articles of Agreement of the Bank--which make it alender of last resort--to displace private funds available on reasonableterms. The fact remains, nevertheless, that while PROFIDE played animportant part in the sizeable expansion of manufactured exports and itssustainability is no longer in doubt, the export drive was reinforced byappropriate foreign exchange rate management; the existence of specialincentives and subsidies; and attempts by manufacturers (though not alwaysthe most efficient ones) to make up for the slack domestic demand byexporting 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 theGovernment's efforts to expand exports rapidly by: (i) assisting the Gov-ernment in the formulation and implementation of a comprehensive export

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development strategy..." (President's Report, para. 90). The formal ve-hicle for this was the Letter on Export Policy Strategy, the implementationof which was to be reviewed jointly twice a year. During these review,Government and Bank would '...agree on adequate additional measures to betaken regardingi (i) actions being taken by the (Government) to put intoeffect the policies and administrative actions set forth in the ExportStrategy Paper...I (Guarantee Agreement, Sect. 3.02).

15. This process did not take place as envisaged. A certain amount ofexchange of views did occur at the technical level, during the frequentSupervision Missions and this seems to have been very useful in developinga common understanding regarding the nature of the policy issues, methodsfor analyzing them and directions of possible solutions. This process ofdeveloping 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 werenot. (Many Supervision Mission recommendations to the Bank were not actedupon.) The first formal review, which under the Guarantee Agreement was totake place a...no later than March 1, 1984' was finally scheduled forNovember of that year. The record of what transpired is skimpy, but bythat time work had just been initiated on a trade policy loan and itappears that the policy discussions from that time on were dominated by theexigencies 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 apositive development.

The Second Loan

16. By comparison with Loan No. 2331-ME, the processing and executionof Loan 2777-ME was anticlimatic. By 1987, when it was signed, the ob-stacles to disbursements had been largely overcome, most of the competingsubsidized lines had disappeared and the process functioned smoothly asexporters, intermediaries and, especially, the by now very efficient Bancode Comercio Exterior, had gotten accustomed to it. At the same time, thetrade policy issues had been clearly transferred into the discussions sur-rounding the first Trade Policy Loan (TPL) and, in any event, these hadbeen 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 early1990 the issue was no longer whether PROFIDE could place additional sums--BANCOMEXT clearly could--but whether further Bank lending of this kind wasneeded or whether more conventional sources of funds would soon beavailable again.

Lessons

17. Export credit financing is not an efficient device for achievingquick resource transfers in emergency situations.

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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 rarelyaccomplished--a credit market analysis in which demand for foreign exchangedenominated loans is assessed, with particular attention to such issues as:

(i) the existence of local currency credit lines, their costto borrowers and the latter's access to foreign exchangeif they have borrowed domestic currency (PPAR, para.5.04(c);

(Ci.) the perceived and actual risks of exporters when theyborrow 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 ratesand exchange rates with those of institutional capabilities and con-straints, requires financial-economic staff well-acquainted with the sectorin the particular country in question. It cannot be improvised on shortnotice. This is another reason why such operations are normally unsuitableif quick action is especially important (PPAR, para. 5.06).

20. The provision of working capital to exporters by the Bank requiresexplicit proof that the conventional sources of such funds--commercialbanks--cannot be expected to be available for reasons other than theinherent commercial unprofitability of the operation. 'While such situa-tions exist--as they did in Mexico in the 1980s--they are usually temporaryand it is therefore important for the Bank not to help to create structuresthat are predicated on a long-term borrowing relations with the Bank or tocreate expectations that such a relation is intended. It must be madeclear to borrowers that the Bank, as lender of last resort, normally cannotundertake such operations.

21. A related, albeit unwieldy, problem is ensuring that Bank loansare not channelled to sub-borrowers who could normally be expected to haveaccess to foreign sources of funds on reasonable terms. At present, thereis no Bank policy on this issue neither for term nor for short termcapital. It may therefore be worth considering the possibility ofreviewing this matt..* to the end of devising workable guidelines--at leastfor 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 norprudent to link major general policy objectives to operations of this kind.If the conditions are relatively undemanding--as was adherence to theLetter on Export Strategy--the harm done with the Review Process in thiscase--only makes it more obvious that little importance is attached tothem. If loan conditions are stringent and not enforced, the processdiscredits the value of loan covenants besides not doing any good. And ifthey are stringent and enforced, they may lead to suspension ofdisbursements and thereby create serious difficulties for intermediariesand/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 themacroeconomic settings that are needed to make the project succeed.

23. There may, nevertheless, occur situations in which there is valuein finding devices that help the Supervision Missions to focus on thegeneral policy framework in which the project operates, and to engage theborrower in dialogue about it. This may be the case particularly in asituation like that prevailing in Mexico in which trade policy had not beenpart 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 misinterpretedand 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 overwhelminglyinfluenced by events related, directly or indirectly, to the petroleumsector. Four elements may be distinguished:

(a) the world market developments, with major price rises in1973-74 and in 1979-80;

(b) the announcement of major new reserve discoveries inMexico in the mid seventies;

(c) the reaction to these events of successive MexicanGovernments in the management of the economy;

(d) the concurrent reaction of the Mexican and foreign privatesectors, including especially foreign commercial banks.

1.02 Some of the main ingredients of this story are well known, havingbeen dealt with exhaustively in Bank and other reports. On (a), suffice itto recount that the international price of oil by 1974 was 650Z above its1970 level, then moved within a relatively narrow range until 1978 and in1979 began to rise sharply again, averaging in 1981 25 times the 1970level, (nine and a half times in real terms) (See Table 1.1.).

1.03 This price explosion might have had a positive but only relativelyminor effect on the Mexican economy, had it not been for the multiplicationof reserves that became public knowledge in 1976-77. The Mexican oilindustry is relatively old and production had been declining for a numberof years, as the major traditional fields were being depleted. The newdiscoveries 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.

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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 1001971 1.65 127 103 1231972 1.90 146 108 1351973 2.70 208 122 1701974 9.76 751 145 5181975 10.72 825 158 5211976 11.51 885 166 5331977 12.40 954 176 5421978 12.70 976 189 5141979 17.26 1327 213 6221980 28.67 2205 244 9061981 32.50 2500 265 9411982 33.47 2575 271 9491983 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 thatwould only have been sustainable if it could have been assumed that the newwealth would not only last indefinitely but that oil prices were destinedto continue to rise without major interruptions.1 Instead of using thewindfall to retire debt or to add it to domestic savings for productiveinvestments, they did the latter while simultaneously greatly increasingpublic 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 to1995 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 buteven in nominal terms (to around $18 p.b.). See also the publicationsof the Club of Rome and Energy Future, Report of the Energy Project atthe Harvard Business School (Robert Stobaugh and Daniel Yergin Editors,Ballantine 1980) which forecast oil prices for around 1990 at a minimumof US$65 per barrel. (It is not absolutely clear what the inflationassumption for this projection were, but of course if it was made at aconstant general price level, than it implied on even higher nomial oilprice once inflation was factored in).

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that stimulated private consumption as well. The aim was to accelerategrowth and improve living standards quickly; the means were to borrow (SeeTable 1.2). And, given the euphoria in the world's 7inancial communityabout the future of oil, borrowing abroad proved easy as long as oil priceswere 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 23.8Current 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 publicsector accounts, these figures cannot be totally reconciled withothers, including those of the national accounts. But it is be-lieved that they correctly reflect the prevailing majortendencies.

1.05 Initially, the strategy seemed relatively successful. Output,consumption and investment grew at 7, 6.5 and 9.5Z per annum, respectivelyand although in each category it was the public sector that grew fastest,private investment, too, grew faster than output. Even domestic savingsseemed to rise at a very satisfactory rate (over 8% per year). But it wasin this area that the actual weakness of the strategy lay: the increase inthe 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 capitalcharges have been paid--actually rose more slowly than GDP (See Table 1.3).

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Table 1.3: SHARES AND REAL GROWTH OF SELECTED GROSS DOMESTIC PRODUCTAND EXPNDITURE CATEGORIES, 1975-81

Share in GDP (%) Growth1975 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 45.0Public 8.9 9.1 52.8

Fixed Investment 21.7 24.9 71.1

Private 12.7 14.1 64.7Public 9.0 10.8 79.7

Change in Stocks 3.0 5.1 150.2

Memorandum Items

Gross Domestic Savings 21.4 23.1 60.5Gross National Savings 19.6 19.1 44.7Net Factor Income -1.8 -4.0 236.1B.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 beenpreferable to use current price data for the share figures, but thiswould have introduced some inconsistencies with the real growth databecause of some oddities in the deflators.

1.06 Another way of looking at the same phenomenon is that already bythe mid-seventies--as a result of the previous Government's fiscal policies--the current account deficit of the balance of payments was almost twiceas high as it had been historically--including the period of the fiftiesand sixties when the economy had grown steadily at about 62 per annum. Atover 52 of GDP it was uncomfortably high, but in the rest of the decadethis proportion rose to almost 11Z, and thus Mexico became increasinglydependent on the continued confidence of its creditors. But these couldonly look to continuing increases in Mexico's oil revenues as a basis forany expectation that they would be paid on time and in full.

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1.07 The processes by which this excessive borrowing was brought aboutwere varied and complex. One important one was relative neglect of themaintenance of export-competitiveness in Mexico's non-oil economy, whichwent counter to a long tradition of careful monetary and exchange manage-ment. After 1976--i.e., as soon as oil became Important--the real exchangerate was permitted to appreciate (30% between 1976 and 1981) and non-petro-leum exports virtually stagnated in real terms during the following fouryears (See Table 1.4). Had it not been for the expansion in petroleumexports--which by 1981 accounted for 69X of all merchandise exports.against virtually zero in 1970--the balance of payments crisis would havecome to a head much sooner.

Table 1.4: NON-PETROLEUM EXPORTS AND THE REAL EXCHANGE RATES, 1970-81

Non-Petroleum Non-Petroleum Exports RealExports (US$ million in Exchange

(US$ nillior) 1970 Prices) Rate Index

1970 1290 1290 100.01971 1366 1322 99.61972 1666 1544 101.11973 2072 1698 98.91974 2816 1942 95.91975 2627 1655 94.81976 3112 1877 129.81977 3662 2081 111.11978 4290 2261 103.41979 5033 2357 98.31980 5702 2341 92.1

. 1981 6115 2302 91.1

Source: Mexicot Recent Economic Developments and Prospects, IBRD ReportNo. 4996-ME, May 7, 1984.

A subsequent Bank Report describes the resultst

"The country's financial situation on the eve of 1982 wasprecarious indeed. The exchange markets were unstable andthe official exchange reserves were negligible. Internationalinterest 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 rolledover2 and capital flight reached dizzying dimensions in the

./ When oil prices levelled off. [Notes Not in original.)

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first few weeks of 1982, when the authorities no longer couldsupport the peso... Throughout the year the economic andfinancial situation remained virtually out of control, withbthe government appearing to be responding to, rather thanguiding, the events. Various attempts were made to rectifythe situation, and different measures (trade restrictions,public expenditure cuts, devaluation, exchange controls andeventually nationalisation of the domestic banks were triedbut they either proved to be insufficient or came too late.3Hexico: Recent Economic Developments and Prospects, IBRDReport No. 4996-ME, March 7, 19849.

1.08 The above adjectives, while dramatic, are not exaggerated. Someof the dimensions of the crisis were, inde-d, dizaying. In particular thereversal of a net short term capital inflows of over US$10 billion in 1981to 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% of1981 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 5.5Direct Foreign Investments 0.8 1.3 1.2 0.7 0.4Long Term Capital (Net) 3.8 5.6 10.5 9.7 3.8

Public (Net) 3.1 4.1 8.7 8.9 3.5Private (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 toUS$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 between1981 and 1983 and unemployment rose substantially (See Table 1.6).

1.10 The dimensions of the crisis were such that it was clear that anyremedial policies had to contain, inter alia, major macro-economic reorien-tation. The excess of investment over national savings had to be broughtdown from its unsustainable 112 of GDP; consumption had to be reduced,arrangements with creditors for refinancing and/or rescheduling had to besought, the public finances had to be brought into better balance and thedependence of the economy on oil had to be reduced. The latter requiredrecovering 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 wasinsufficient or came too late.

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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 5.6IV 4.9 9.5 4.2

1982 11 5.4 8.3 5.5IV 5.8 7.7 6.0

1983 II 7.7 13.2 13.6IV 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 elementin this, there was an increasing body of opinion, both in Mexico and in theBank, that held that in Mexico a favorable exchange rate was a necessarybut not a sufficient condition for a resumption of sustainable economicexpansion 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 planthad been built up, including some very efficient units, but it was feltthat renewed expansion and especially moving into increasingly technologi-cally sophisticated processes and products, would require a substantiallydifferent strategy.

1.13 Although much--not all--of Mexico's industrial growth in the postWorld 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 Financieraand through other devices the government supplied equity capital and oftensubsidized 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 dispersionof nominal tariffs made for a highly irrational pattern of effective pro-tection, (See Table 1) that increasingly potential export industries werehurt by the high costs of protected inputs, that the quantitative restric-tions were conducive to the toleration of inefficiency and high costs andthat the time had long past where many industries could justifiably demandprotection on *infant industry" grounds.

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1.15 A certain amount of sophisticated technical work was done on theseissues in the early 1980s by Bank staff in collaboration with Mexicanofficials and investigators.4 It had documented many of the above thesesand had laid the intellectual foundation for the view that structuraladjustments of the Mexican economy, to enable it to overcome the crisis, inaddition to macro-economic, demand-oriented measures, should involve adrastic realignment and rationalization of the protective systems with aview to letting comparative advantages have a more determining role inresource allocation. It was thought that this would add efficiency, flexi-bility and dynamism to the industrial sector, lower the costs of efficientindustries 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 livksuch measures to Bank loans, it laid the foundation for at least discussingthem, in particular, in connection with lending in the industrial sector.

1.17 It should be noted, especially, that in the early and mid-1980sthese trade policy issues engaged Mexican officials and economists verydeeply. An active controversy took place over several years within theGovernment, in which the level of the debate was high on both sides andwhich only around 1985 wa definitely decided--at the politicallevel --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 missionvisited Mexico to develop a fast disbursing project loan operation underthe Bank's SAP.5 It was by no means the only Bank action for Mexico at thattime--a proposal to modify an existing Capital Goods Industries Developmentproject (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, comparingprotective policies in a number of countries. See Bela Balassa (Ed.)The Structure of Protection in Developing Countries (IBRD/Johns HopkinsUniversity Press, 1971).

5/ Adopted in 1982 by the Bank to increase disbursements quickly in allcountries that were affected by the second oil shock--although obviouslyMexico's case, as an oil exporter, was rather atypical--provided thiswas achievable under sound project and/or program criteria.

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Development Fund was also being processed, for example--nor was the Bankalone in considering emergency assistance to Mexico since the IMF was alsodoing so.6 The mission proposed a project that would provide resources forthe above-mentioned Export Development Fund.

2.02 The mission did its work one month after the assumption of officeby 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 andgeneral, although some indications of their underlying thrust seemed to bediscernible.

2.03 Actually the mission came back with a gloomy short-term outlookslicensing of all imports was to remain in place, as was the dual exchangerate system (although an early convergence of the official and free-rateswas 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 wereexpected to stagnate, not curprisingly given the 502 gap between the offi-cial rate at which exporters had to deliver their foreign exchangeearnings, and the free market rate.

2.04 The mission proposed to address some of the policy issues ratherdelicately: the Government would issue an Export Development Strategydocument. "...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 tothe Bank prior to presenting the loan to the Executive Directors.07 Jointperiodic reviews of the execution of these policies would take place duringthe disbursement period.

2.05 The question of formal loan conditionality of these policy matterswas thus left somewhat ambiguous. Given the lack of precedence in formalunderstandings between the Government of Mexico and the Bank on broadmacroeconomic management issues such an approach seemed prudent, albeit notdevoid of some risk of possible future disagreements. It left a certainamount of leeway to both parties for subsequent interpretations of what wasa 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 whichUS$275 million would be allocated to EDF, a revolving fund to provideshort-term loans in foreign exchange to exporters to finance the cost oftheir imported inputs; US$72 million would be allocated to provide mediumand long-term investment subloans to provide fixed investments to export

61 An Extended Fund Facility for SDR 3.6 billion had been approved inDecember 1982.

7/ See Mexico--Export Development Loan Issues Paper, March 8, 1983.

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industries 8 and US$3 million would be devoted to technical assistance andexport 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 remainderin a further 18 months. It was stated clearly that the size of the loanwas 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 focusedessentially on Mexico's foreign exchange requirements and had not includeda study of the special issues related to the demand for foreign exchangedenominated credit at (more or less) competitive interest rates (see below,Chapter III).

2.08 The loan was processed considerably faster than usual; already onMay 11 draft documents were submitted to the Loan Committee. The LoanCommittee was concerned about a number of issues; an analysis of laterevents 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 seemedpersuasive 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 onlyone consistent with a true market orientation. Instead, it demared thatafter six months the allocation (i.e. rationingl) criteria for EDF shouldbe 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 fixedinvestments financing Capital Goods Industries Loan to the current inputfinancing EDF (see above, para. 2.01), while simultaneously making a newUS$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 (Directcommunication from a Team Member).

9/ It will be seen below that not only was this too pessimistic a view butthe question may have been too narrowly framed by focusing only on banksand not on the displacement of any private funds.

10/ This decision does not seem to have been followed up on, if--as must bepresumed--sectoral or subsectoral allocation criteria were meant. Onlypre-allocations among the intermediaries were later imposed (to makemany banks participate) and credit ceilings on ultimate borrowers wereset (to prevent excessive concentration of funds on a fewbeneficiaries).

* 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, inspite of the above concerns, the Committee expressed itself in quite posi-tive terms, influenced apparently by the fact that a project financingapproach would be combined with at least some dialogue and understandingson policy matters.

2.11 The loan negotiations took place a week later (May 18-20) and didnot yield major changes. The transfer of FOMEX (the Trust Fund handlingthe 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 theadministrative requirements had been completed.12 The loan was thusprocessed with admirable speed up to that point; some four months after thereturn of the first mission it had been negotiated and a month later it wasapproved by the Executive Directors. The record is not clear on why itthen took as long again until it was signed (September 25) and why it onlybecame effective December 27, 1983. The point is not a trivial one: theoperation was conceived to provide emergency assistance to Mexico andclearly the management and staff initially made a major effort to actexpeditiously.13

III. IMPLEMENTATION OF THE FIRST LOAN, GENESISAND 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 producerswho are not themselves direct earners of foreign exchange, borrow froma revolving fund whose characteristic is that it lends and must recoverforeign exchange.

13/ It may be argued, however, that in the second semester of 1983 it wasalready clear that there was less cause for special speed than had beenassumed: the US$100 million passed to EDF from the Capital GoodsIndustries Loan had been effective since June 23, 1983 and were notdisbursing.

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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 monthsto observe the behavior of the first US$100 million PROFIDE 115 from thevery 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 aboutthe relative strength of the various operative causes and besides theseclearly fluctuated over time. Thus, the early complaint by exporters thatthe 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 somenecessary formalities as the financial advantages of the program to thembecame greater or clearer.16

3.03 Similarly, the quite unexpected initial unwillingness of Mexicanentrepreneurs to indebt themselves in foreign exchange was a composite ofseveral concerns. In part it was the instinctive reaction of firms thathad suffered large exchange losses when the devaluations of 1981-82 hadcaught them with sizeable foreign exchange debts. And since most exportersalso sell in the domestic market--indeed most sell mostly in the domesticmarket--no real distinction between 'safel and Ounsafe" external debts wasmade. But there was more to it than that. It could be argued that as longas they only borrowed to finance re-exported inputs, there was no rationalreason to fear a foreign exchange risk. Actually, however, there were twovery good reasons. One was that they could not retain their foreign ex-change earnings for needed debt service. They had to sell all exchangeinflows and buy back what they needed for debt service. To borrow PROFIDEfunds thus required confidence in the Government's willingness--and abil-ity--to always make available the exchange for debt service. In the earlyto mid-1980s this confidence was very weak; the continuing debt crisis, thelack of decisiveness in the Government's stabilization program, andperception of discontinuity in other policies all contributed to makingsuch borrowing appear very risky.

14/ See Chapter II.

151 Following the PCR and previous Bank reports, the EDF will henceforth bereferred to by its Spanish initials PROFIDE (Programa de Financiamientode Exportaciones). PROFIDE I refers to the US$100 million from Loan2142-HE and PROFIDE II refers to the current inputs financing underLoan 2331-ME.

161 FOMEX also became more adept at selling itself. Its original PROFIDEOperational Manual, which exporters and bankers had to understand andto follow, was a rather formidable 50 single-spaced pages documents;without much change in substance the 1990 version has shrunk to 18double-spaced pages.

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3.04 The other, complementary reason was the dual exchange rate. Ifthe exporter who sold his exchange at the official rate could not buy hisdebt service requirements on the official market he would have to go to thefree market and incur--perhaps--an unpredictable loss. This, too, madePROFIDE borrowing look much riskier than the Staff Appraisal Report hadsuggested. In both respects, the present high demand for PROFIDE/typefunds can, inter alia, be interpreted as a sign of a major revival ofprivate sector confidence both in the continuity of Government policies andin the continuation of the virtual disappearance of the gap between theofficial and the free market exchange rates.17

3.05 But there were other reasons for the absence of demand for PROFIDEfunds between mid-1983 and mid-1985. The contraction of the economy wascited by the staff, and although there is no direct way in which this canhave caused a decline in the demand for imported inputs for exports, it ispossible--direct evidence is lacking--that the depressed domestic indus-tries increased their offer of domestically produced inputs to the exportindustries. In other words, there may have been import substitution on theinput side in the export industries. The other mechanism by which therecession reduced the demand for PROFIDE funds was that more foreignexchange was available to finance imported inputs, as domestic absorptionof imports fell.

3.06 Quantitatively the most important factor seems to have been themaintenance by the Government of credit lines to exporters at preferentialinterest rates. There were several of these lines. One was-the FOMEX pesofund fed by 2Z of all import duties since 1962 (1% in the eighties) andrelent to exporters at a mere 8% per annum. It was estimated that in 1983over US$1.2 billion of such credits were disbursed. Another was the--alsovery large--flow deriving from the Central Bank Rule that commercial bankshad to lend 1.21 of their assets to exporters. These funds were lent atthe 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). Thisline continued in existence for four years (i.e. until the second loan).Obviously, both these credits were far more attractive--being withoutforeign exchange risk--than PROFIDE or even than the about US$1 billionExport-Import lines made available by Mexico's 12 major trading partners(Japan excluded) at a cost--to the ultimate borrower--about one percentagepoint below that of PROFIDE. These export-import lines also hardly movedin 1983.

3.07 Finally, contrary to staff assumptions at the time the loan wasmade (see above, Chapter II) some foreign commercial banks seem to havereappeared, somewhat surreptitiously--given the delicacy of this during the

17/ One interviewed exporter complained to the Evaluation Team that he wasstill penalized by the difference between the buying and the sellingrate (i.e. he would prefer to retain his foreign exchange) but incomparison to the official-free market differential of the mid-1980sthis is trivial.

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debt negotiations--so that figures were hard to come by, but supervisionmissions repeatedly cited reports of reopened trade credits. By February1983 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 ofPROPIDE, exportlimport procedures, credit policies and institutional ar-rangements. If no agreement was reached, the remaining US$80 million ofPROFIDE I should revert to the Capital Goods Industries Loan and up toUS$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 subsidized8Z credit lines (the rate of inflation in 1983 had been 1082 and in 1984was 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 theirimported inputs with foreign exchange, preferably foreigncredit lines... ...introduce a new pre-shipment creditpolicy in FOMEX to limit preferential peso financing for(to 7) domestic imports and to require foreign exchangefinance for imported inputs--as a key feature it is recom-mended that peso financing for domestic inputs be coupledwith PROPIDE financing for the imported inputs along pro-portions (Omezcla") to be justified by the cost structureof the specific export project.... Supervision Report,February 24, 1984.

Other parts of the proposed package included a reduction in PROFIDEinterest rates to ultimate borrowers, simplification of documentation re-quirements, elaboration within three months of a proposal to financeindirect exporters, and some promotional and administrative measures. Theproposal to reduce interest rates to ultimate borrowers to 1.5 percentagepoints above Bankers Acceptance Rate (BAR) from the original BAR + 3percentage points was not rationalized, except as a counterproposal to aMexican request to go down to BAR +0.5 points.

3.09 In April 1984 the Government informed the Bank--apparently motuproprio as no record of a Bank request could be found--that the 82 pesodenominated FOMEX line of credit had been eliminated but that FOMEX wouldcontinue to give preferential terms (352-50% of ACF) to exporters forlocally produced inputs. The staff took the position that some of thesefunds would leak to exporters for their imported inputs and would continueto undercut PROFIDE. 1 9

18/ The Ministry of Trade and Industry.

191 Memo, IDF Division Chief to Regional Vice President, April 17, 1984.

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3.10 It appears that by mid-year the Bank's thinking about the projecthad become increasingly dualistic. On the one hand, during the Spring 1984PIR Meeting of June 4, 1984, when the SVPOP questioned whether the projecthad not best be converted from a credit project to an export fund (i.e.selling foreign exchange to exporters rather than lending it) the regionalmanagement responded that:

I...working level agreements had been reached on changesin procedures and reduction in interest rates to increasethe speed of commitment. While there was some problem ofavailability of competing lines of credit, demand forfunds provided by the loan was building up...Finally, itwas expected that the current relative abundance of for-eign exchange would be reduced in 1985, increasing thedemand for subloans still further. If there is insuffi-cient progress by the time of the loan review scheduledfor November, the corresponding portion of the operationwould be cancelled.*

(Memo to files: Spring 1984 PIR, June 18, 1984. Emphasisadded.)

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 theMexicans on a limited package of procedural and operation-al adjustments to the existing loans,21 except for theinterest rate issue22 which is still under considerationby the Government. The mission made some limited progressin developing a Government consensus on the status andprospects of the two loans...In essence, the missionargues that even the full package of agreed revisions ofloan regulations would not ensure a major acceleration inthe disbursement of these loans"i over the near termbecause there are more fundamental issues relating to thedepressed economic environment and the implementation ofthe Government's institutional and policy reformobjectives, as discussed below. The structure of policyand institutional authority is so divided and diffusedthat 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.

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consensus with the Government. While a number of keyofficials effectively acknowledged the correctness of themission's findings, in many cases they were constrained indoing so by considerations relating to the still unsettleddistribution of authority and definition of hierarchy, andby the fact that there are appreciable differences ofviews on policy.' (Supervision Report of June 18, 1984,Annex I.)

It is not clear how the report to the top management came to differ sodrastically from that of the Supervision Mission; 2 4 although theconclusion--that a decision on cancellation should be postponed until theNovember consultations--was the same (the mission reported that this wasthe Government's wish), the assumptions underlying it clearly differedgreatly. Nor is it totally clear what the alleged differences of views onpolicies were and how they affected disbursements. Regarding the firstquestion, it seems that nhat was meant was the well known debate within theGovernment regarding trade liberalization, to which there was substantialintellectual and bureaucratic opposition...in addition to that emanatingfrom the productive sectors that felt themselves threatened. But the linkwith the slow disbursements was not spelled out.

3.11 It seems to have been around this time that the idea of makingloans to Mexico tied to policy packages rather than to fixed investmentsor--as in the case of PROFIDE--to specific activities, acquired newimpetus. Not only did the mission note that

I...any future project and/or program/sector operationwill have to take into consideration the record of experi-ence with Capital Goods Industries Development and ExportDevelopment Projects...it will be necessary not only todevelop an appropriate high-level framework for cleardefinition of policy but also to ensure project designthat reflect our understanding of current institutionalarrangements and jurisdictions... "3

24/ One team member who was consulted has speculated--his direct knowledgeand memory are limited--that negotiations between the US and MexicanGovernments on interest rates had reached a satisfactory conclusionbetween the return of the Supervision Mission and the PIR Meeting andthat the Regional Management was therefore reporting more up-to-dateinformation than the Supervision Mission. This is possible--the US andMexico were discussing the issue because U.S. interests had complainedabout the Mexican interest subsidies and the U.S. had threatenedcommercial policy retaliation. But no corroboration of thishypothetical connection between the two matters could be found in thewritten record.

25/ Emphasis added.

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3.12 The staff vent even further in pushing the idea of policy-basedlending, arguing that the time for such initiatives was rapidly runningouts

"The mission's report also strikes a note of concern,regarding its conclusion that much of the initial impetusfor the restructuring of Mexican industry and trade, asenvisioned in the managerial plans of President de laMadrid, has already been substantially dissipated. Giventhat the 'window' for important policy initiatives islikely to close toward the end of 1985 (the start of thesecond half of the current presidential term), the missionwould recommend that the Bank move forward as quickly aspossible in the area of industry and trade. There is aparticular 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 fut4reof the "apertural policies;

(b) that this was viewed as a challenge for more Bank policyinvolvement rather than a reason for caution;

(c) that for the first time the supervision of the loan waslinked to the joint review of trade policy measures thathad been considered one of the most interesting aspectsof the loan (see above, para. 2.04) but that had receivedvirtually no attention so far.26

3.14 The written record does not yield evidence of such an exchange ofviews having taken place by June 1984; previous supervision reports haveonly description references to the Missions' observations on events in thisfield. 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: "TheGuarantor shall, every six months, starting not later thanMarch 1, 1984, until the completion of the project, exchangeviews with the Bank and the Borrower, and agree on adequateadditional measures to be taken, regardings (i) actions takenby the Guarantor to put into -effect the policies andadministrative actions set forth in the Export StrategyPaper...' The Guarantor, of course, was the Government.

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Policy Loan became more intensive, it preempted center stage of tradepolicy discussions between Mexico and the Bank. This, of course, removedwhatever formal commitment character the Export Strategy Paper might havehad and thus obviated the possible difficulties that might have arisen frominsisting on particular measures. It is an open question whether thisadvantage outweighs the possible longer term costs to the Bank in terms ofits credibility and of the inviolability of its legal agreements, to ignoreor tacitly disregard important covenants.

3.15 Four months later the staff's thinking had advanced even furtherin the direction of policy related lending. But instead of seeking newquid pro quo commitments relating disbursements to new policy measures, theOctober 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 temporaryimport scheme for exporters, we believe there would bejustification for the Bank to consider a fast disbursementmechanism (e.g. a one-shot disbursement against documentedgeneral imports for exporters) of the order of US$100 toUS$125 million under the loan (the estimated amount offunds expected to be otherwise uncommitted under the proj-ect by year-end 1985).'

This recommendation--rather similar to the proposal of the SiPOP during theSpring 1984 PIR meeting--was made before the proposed November 1984 policyreview. It did, however, follow closely acceptance by the Government ofthe Bank's proposal on how to revise PROFIDE interest rates for foreignexchange loans (BAR + 1.65 p.c. points).

3.16 This idea was refined further when the staff sought guidance fromthe Regional Management regarding the position to take in the forthcomingreview meetings.27 Two alternatives were proposed either (a) reassignUS$125--US$150 million (*the amount likely to be uncommitted by the end ofthe year") to a fast disbursing mechanism'...cum conditionality... (i.e.these funds could be disbursed from the ongoing EDP upon compliance with aset of policy conditions discussed below)*, or (b) to launch a new exportdevelopment policy operation while channelling the surplus funds in theongoing EDP. 'Under either alternative the 'transferred' funds would pro-vide some of the foreign exchange required to finance the substantiallyincreased 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 thesefactors would not also lead to an acceleration in the demand for EDP creditunder 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.

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be required). Or rather, in the preamble to the recomendation it wasstated, without comment, that the subsidized FONEX credit lines continuedto offer "...strong competition to funds available at market rates underthe Bank project', but it was not proposed to insist on elimination of thesubsidy. Nor was any reason given for not doing so; the issue was notdiscussed.

3.18 The policy elements on which the proposal wanted to concentrate inretrospect seem useful but also somewhat marginal. They concern furtherdecentralization in the issuance of import licenses, more active promotionand more decentralization in administration of the temporary imports re-gime, an acceleration in the VAT reimbursements to exporters, strengtheningof IMCE an of intra-governmental inter-agency coordination. The relativemarginality may have been deliberate, for at the same time proposals werealready being elaborated for a 'follow-up DPLO which would, if approved,focus on the major trade liberalization issues tariff and import licensereductions.

3.19 In the event, none of these recomendations were acted upon. Itappears that the simultaneous pick-up of commitments under PROFIDE as thecompeting sources of funds became fully utilized28 and the growing dynamismof the trade policy discussions reduced the interest of all the partiesconcerned in tinkering with PROPIDE.

3.20 In late 1984 and early 1985 the balance of payments difficultiesbecame 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 stabilizationtargets were not adhered to, economic activity rebounded more than expectedand inflation accelerated. Moreover, declining world oil consumption hadput petroleum prices under pressure; by 1984 they were some 20Z below their1982 peak and in 1985 continued to-drift downwards.

3.21 As a result, between mid 1984 and mid 1985 exports fell by 3.2Zwhile imports rose by 37Z. It was to this point that the major policyissues before the government were, for the first time, confronted withoutobfuscation. The PROFIDE supervision mission had, until then, repeatedlyreported that it was doubtful how serious the liberalization program actu-ally was. These doubts were justified; a member of the economic Team fromthat period told the Evaluation Team that from 1983 though the first halfof 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-exportfinancing in pesos for purchase of domestic inputs and the '1.2 lineOof commercial banks for manufactured export financing have been used infull, with limits imposed for individual firms.* (Memo of ProjectsOfficer to Deputy Projects Director, LAC, December 18, 1984).

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bureaucracy, was great to any attempt to make really deep changes in theprotective system. Thus, for example, the DIMEX system--to liberalizeimports for exporters--was effectively sabotaged by the import-substitutingproducers and by their regulators, by means of the quantitative restric-tions. The Export Strategy Paper included in the Loan Documentation as faras can be established now, was not, in and of itself, a principal elementin the decision making process, althouLph its existence undoubtedly played atactical role in Government-Bank relations.

3.22 But in July 1985, when it was clear that the deviations from theAdjustment 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 budgetcuts, an aggressive trade liberalization and a sharp devaluation. Sincethis was done in the mdst of a severe balance of payments crisis, thedecision to press ahead more, rather than less, vigorously with the tradeliberalization program was a quite unusual policy response.

3.23 The discussions with the Bank, on a trade policy based loan bythat time had become quite serious. It seems very clear that the keydecision by the Government was in no way a response to Bank pressure orpersuasion or to the incentive of a few hundred million dollars of Bankloans; it was the result of an internal political debate in which Presidentde la Madrid used his authority to decide. It also seems beyond disputethat the prospect of Bank support--with loans and with commercial banks--toMexico for a particular economic strategy, made the position of theliberalizers stronger and more credible. But the PROFIDE operation itselfhad 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 inbeginning to address these issues before the Mexican officials might havewanted to discuss them in depth with the Bank.

3.24 For a while concern in the Bank with matters related to theSeptember 19, 1985 earthquake swamped interest in PROFIDE. Eleven daysafter the earthquake, the Regional IDF Division endorsed a request fromBanco de Comercio Exterior allowing the use of US$52 million of uncommittedPROFIDE funds for the reconstruction activities of the telecommunicationsfirms. While these firms did have exporter status, what was proposed wasto use PROFIDE funds not for working capital but for local costs andimports for reconstruction.

3.25 This action coincided with a dramatic pick-up on PROFIDE's overallcommitments. In April 1985 these had still only stood at US$75 million;nine months later they were US$200 million, exclusive of reconstructionmoney. Thus the operational and economic problems that had beset the proj-ect for the first two years were largely overcome and PROFIDE began tofunction effectively enough to call for a follow-up operationt in May 1985an Initiating Memorandum set the stage for it.

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3.26 However, this time there was none of the pressure to process theloan expeditiouslys it took seven months to prepare an Issues Paper,another seven months to send a memo to the Loan Committee and six monthsmore 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 factthat by February 1, 90Z of PROFIDE II was committed (1002 by June) clearlyindicated that delay in replenishing it would provide a financing hiatus;nevertheless PROFIDE III only became effective some 14 months later.29 Inpart, this slowness may be explained by the way the Bank staff interpretedthe PROFIDE II experience. In the Issues Paper on PROFIDE III it wasstated thatt

'It is now widely recognized by the Mexican officials thatthe first Export Development Project (Loan 2331-ME) hasbeen an important contribution to the development ofMexico's export promotion strategy, mostly in the fieldsof policy instruments and institutional development. Therecent institutional changes and the creation of the high-level Foreign Trade Promotion Committee...can also be, atleast in part, attributed to the Bank's dialogue andexchange of ideas with the Mexican authorities in thecontext of the design and supervision of EPDI.1 (IssuesPaper, December 27, 1985).

3.27 And the recommendati3ns regarding pre-conditions and conditionsfor a new loan focussed heavily on macro-issues (acceptable exchange ratepoliz7 in place, new letter on Export Development Policy with timetable forAction Program, etc.).

3.28 With such a perception of the role of the operation--differentboth from the original intentions (quick-disbursing emergency assistanceand bottleneck breaking export promotion) and from that of the actual expe-rience described above--questions like what impact an interruption in thecommitment authority and flow of resources to the project institutionsmight have on the needs and operations of exporters may have seemed besidethe point. But if this was so, the rationale for an operation structuredin this particular form also would have required re-thinking and, indeed,three months later already an Issues Paper was presented for the firstTrade 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 thePROFIDE 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 (ExportSector Adjustment) that would unite both types of activities. PROFIDEwas incorporated into the Banco Nacional de Comercio Exterior(BANCOMEXT) in late 1989, but its operations continue in thatinstitution.

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IV. SPECIAL ISSUES

A. Did PROFIDE Facilitate Manufactured Export Growth?

4.01 Might manufactured exports have been lower in the absence ofPROPIDB? At first sight, the answer to this question would seem to be selfevident and is so treated in the PCR. Manufacturing exports almost tripledbetween 1983 and 1989 and PROFIDE was used by exporters, so why should wequestion the link between these two facts?

4.02 Indeed, if one views the issue in its most aggregative terms, onecan easily reach the conclusion that perhaps as much as 80 or 90--andalmost certainly not less then 402--of the recorded manufactured exportgrowths may have been linked to PROFIDE financing. This is based on thefollowing calculations

(a) if the average import content of exports (i.e., the portionfinanced by PROFIDE)

I - Imported InputsValue of Exports

lies somewhere between 252 and 752, and if;

(b) the average number of times R which the revolving fundPROFIDE turns over per year is 2.5 to 3.5 times, while31

(c) PROFIDE II and III committed US$400 million during a periodat the end of which manufactured exports were US$6,069.3million larger than at the beginning, then;

(d) the total share P of the increased exports that benefittedfrom PROFIDE financing is

P * 400(R)6069.3(I)

4.03 Using a reasonable range of values for R and I these calculationswould lead to the conclusion that almost certainly an important part oftotal manufactured export growth was associated with PROFIDE; somewherebetween one half and two thirds would seem to be a quite conservative guess 32

(See Table 4.1).

311 Since the PROFIDE loans are mostly for 90 days the theoretical maximumvalue of R-4.

321 It should be noted that, as neither R nor I need to be constant overtime these are somewhat notional calculations. Moreover, the growthfigure itself is preliminary, being based on an estimate for 1989 madefrom first semester data.

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Table 4.1: PROPORTION (P) OF MANUFACTURED EXPORTS GROWTH 1983-89LINEED TO PROFIDE II AND III

PROFIDE Revolutions Import Content of Exports (1)Per year R 25? 502 752

2.5 0.65 0.33 0.213.0 0.79 0.40 0.263.5 0.92 0.46 0.31

Note: Figures in rectangle denote range of valuesconsidered most probable.

4.04 On the other hand, a slightly more disaggregated view of lookingat 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 thata more appropriate way of doing the calculation is to do it separately foreach year. This was not done because, while technically more correct, itwould not be much more revealing. But it would definitely lower the impactestimate.

4.05 Another, more telling way of looking at this issue is to considerthe subsectoral distribution of PROFIDE's lending and to match it with thelevel and growth of exports from the respective subsectors. Over 902 ofPROFIDE's lending went to the four sectors listed in Table 4.2 and theseboth in 1983 and in 1989 accounted for just over P0% of manufactured ex-ports. Among them PROVIDE picked some winnerst Automobiles and autopartsas well as the &lass, plastics and chemicals group, but at the same time itput about one fifth of its resources into the lagging metals and metalsproducts sector. And it should be noted that the bulk of this lending didnot go into the booming non-ferrous metals and steel industries but intothe relatively stagnant machinery and equipment (Metal Products) sectorwhich grew by less than 12 per year.

3/ 46 x 3 2760.5

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Table 4.21 SICTORAL DISTRIBUTION OF PROFIDE LENDINGAND EXPORT GROWTH, 1983-1989

Share ofPROFIDE Manufactured GrowthLending Exports 1983-1989

(1) (z Z1983 1989

Automobiles and Auto Parts 31 19 31 398Metals & Metal Products 21 54 30 66Glass, Plastics, Chemicals

and Products 36 7 15 509Textiles, 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 theabsence of PROFIDE lending, then it may also be plausible to conclude thatif less PROFIDE money had gone to the less dynamic sectors and more to themost expansive ones, total export growth might have been larger still.Whether it would have possible, however, to spot these possibilities exante is doubtful. In any event, the "first-come-first-served, approachprecluded such an attempt (see above Chapter II).

4.07 All in all, nevertheless, the original conclusion, that PROFIDEseems to have been a positive, and probably even a powerful factor in theexpansion of manufactured exports, remains intact. The deg:ee of itscontribution cannot be established precisely, but it does not seem to havebeen negligible.

4.08 But whether PROFIDE was not only a necessary but also a sufficientcondition 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 1982had produced a severe balance of payments crisis. The overvaluation of thepeso, which until then had been masked by the prosperity of the oil sectorand by the--related--heavy capital inflows, suddenly became unsustainable.

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4.10 Net foreign investments--direct and portfolio--which in 1981 hadbeen over US$5.0 billion, in 1983-86 were less than half a billion peryear, 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 rateand price movements and of trade transactions could help define the precisequantitative relation between the movements in the real exchange rate andnon-oil exports, the broad outline of the association seems clear enough(See Table 4.3). The almost 502 devaluation in real terms betaeen 1981 and1983 accompanied a 352 increase in manufactured exports; the 212 peso ap-preciation between 1983 and 1985 brought the manufactured export growthdown 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 sameperiod and the subsequent 92 appreciation went together with a greatlyslowed 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 6.7Non 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 ExchangeRate (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 theresponse of trade flows to movements in the real exchange rate, and if oneaccepts 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 ofpayments suggested unrecorded capital outflows of US$5.6 billion. For1983-86 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.

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that other events also affect these exports--the movements in the realexchange rate would seem to go a long way towards explaining developmentsin Mexico's non-oil exports.

C. Was the Export Growth Economically Efficient?

4.13 While this question, too, at first sight seems unnecessary--fordoes not exporting iaply competitiveness and efficiency?--there are severalreasons for posing it nevertheless. The most important ones are relatedto:

(a) The rather complex pattern of special incentives and subsidiesthat had accumulated over the years, partly to offset for particu-lar industries the high costs of protection and partly to favorselected priority sectors; and

(b) to the circumstances of the shift towards exports, which occurredfor some industries in response to the drastic domestic marketcontraction in and after 1982. Here it was at least possible--andthe Evaluation Team encountered some examples of this--that produ-cers sold abroad as long as they could cover a little more thantheir marginal production costs, even though this would not suf-fice to keep them in business permanently. There certainly isplenty of evidence of exceptions to the "law of one price",35 andit is not automatically to be taken for granted that the exportsthat were generated reflected Mexico's industrial comparativeadvantages.

4.14 Unfortunately, the available data on this matter are not conclu-sive. There are two sets of calculations that are pertinent, although itmust be noted that they are not truly independent of each other, beingbased 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 ComercioExterior) and, after the demise -of that agency, by SECOFI (Ministry ofTrade and Industry). It should be expected that the industries with thelowest (or negative) effective protection, were the most efficient and thatif they were the ones accounting for most of the export growth, the overallprocess 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 moreprofitable than exporting. But some also stated that the margin wasnarrowing, partly because of the domestic price restraints imposed onthem by the OPacto", i.e. the agreement to keep price (and cost)increases within certain Government-set bounds.

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4.16 However, it is one of the characteristics of such calculationsthat they are extremely volatile (see Table 4.4). Moreover, in the situa-tion described above, when exports occur at marginal cost prices whiledomestic sales reflect full costs and, possibly, a rent payment as well,the effective protection rate is overstated if the price data are basedonly on domestic sales, as tends to be the case, especially in industriesthat 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 FootwearChassis and Ferrous Yarn and and

Year Automobiles Parts Steel Metals Text)les Clothing Leather Chemicals

1979 192 85 12 78 0 68 8 511986 -1,508 28 88 84 7 119 80 1211981 -2,074 85 87 62 18 878 124 180

1984 I 29 42 5 7 108 -28 -6S 10II 26 45 27 -6 187 -29 -86 -1III 42 S8 14 -4 271 -29 -87 80IV 25 42 29 12 28 -28 -52 61

1985 I 108 46 16 7 58" -19 -46 89II 44 89 18 1 580 -28 -42 as

III 8 42 8 -1 540 -28 -60 0IV -1 s0 -2 -10 828 -8s -54 -

1988 I -15 82 -15 -29 211 -89 -1 28II -29 24 -16 -9 221 -44 - 9

III -86 16 -19 -1 145 -46 -7 11IV -44 28 -22 -9 174 -$8 -71 -7

1987 I -89 28 -29 -19 264 -51 -7 -7II -82 89 -27 -80 884 -51 44 -10

III -19 48 -16 -22 460 -48 -64 -18IV -12 48 -18 0 889 -40 -48 -9

La Implicit here means that the estimates are based on actual price comparisons ratherthan 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 YEstructura do la Proteccion on Mexic, Coercle Exterior, April 1989.

361 I.e. the year of the input-output table used in such estimates.

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4.17 For all these reasons any conclusions based on a matching of in-dustrial export growth rates with effective protection rates would be quitetenuous, at least in the circumstances applying to Mexico. The other,related, available measure of at least the static economic efficiency ofMexican industries, is the calculation of domestic resource costs.3 7 Thismeasure gives ratios which can be interpreted as reflecting efficiency:the lower the ratio the greater should be the comparative advantage of theindustry that it represents; industries with ratios above 1 impoverish acountry while those with ratios below unity enrich it. Since the errors ofmeasurement can be substantial, small differences in ratios, or small de-partures from unity should be disregarded. Following the source of thedata,38 in this report only industries with DRC, below 0.90 or above 1.10will be labelled as clearly efficient or inefficient respectively, whileall 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 noteworthyis the dynamism of the situation; during the preceding decade only 18 ofthe 49 had been improving, while almost twice as many had been becomingless competitive (See Table 4.5). Indeed, the DRC figures for 1970 and1982 for the same 49 industries show the extent of the deterioration of the1970s39

Industries (No.)DRC 1970 1982Under 0.90 32 24

0.90-1.10 7 11Over 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 exchangeValue Added at International Prices

381 The data on DRCs are drawn from Mexico: Trade Policy, IndustrialPerformance and Adjustment, IBRD Report No. 6215a-ME, June 24, 1986.It, in turn, cites as the source for the empirical estimates RicardoSamaniego and Associates, The Evolution of Domestic Resource Costs inthe Industrial Sector of Mexico, Instituto Tecnologico Autonomo deMexico, 1986.

39/ The figures for 1970 were derived by applying the growth rates shown inthe source cited above backwards to the 1982 levels.

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4.19 The causes of the deterioration are varied, but a sizeable propor-tion--about one-third--has been attributed to the choice of inappropriatetechnology, especially overly capital intensive techniques. Another thirdmay be the result of deteriorating price relations and the remainder is,essentially, unaccounted for.40 What is of relevance here is that thechoice of technology responds to many market signals besides thoseassociated with trade policyt divergences between market and economicinterest and wage rates especially (and, implicitly, of course, exchangerates), and that therefore it cannot be expected that the removal of tradebarriers alone will remove all distortions in the productive structure. InMexico, in the 1970s, market interest rates were clearly well belowefficiency rates, and in the case of much public investment often de factowere zero or close to zero (free equity capital and subsidized orunrecovered loans).

Table 4.5: HIGHEST AND LOWEST DRCs 1982 AND CORRESPONDINGEXPORT GROWTH, 1983-89

DRC Export GrowthHighest DRCsSynthetic Fibers 1.60 299Automobiles 1.51 399Rubber and Plastics 1.45 /aTires and Tubes 1.34 524Secondary Iron and Steel 1.15 )Primary Iron and Steel 1.12 ) 410

Lowest DRCsFertilizers 0.27 /aBeer 0.59 448Farm Machinery 0.63 /bHenequen Products 0.59 bGlass 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 factorproductivity, (TFP), i.e. a less than proportional increase in outputfor given proportional increases in all inputs. This, however, ismerely a statistical expression of the unexplained variations inoutput; it is well known in the productivity literature and has beenmuch discussed in organizational and sociological terms, but most ofthese discussions are essentially speculative.

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4.20 There is no visible systematic association between the estimatedDRCs and export growth rates in the 1980s. While this Evaluation has notgone into the matter in all the depth that would be required for adefinitive conclusion,41 the fact that some of the highest DRCs wereassociated with some of the highest export growth rates, and vice versa, issusceptible to several possible explanations, not all of which are mutuallyexclusive. Among them are the possibility thats

(a) The most efficient industries were already fully engagedin exporting and thus had relatively little scope forgrowth. This is clearly unlikely.

(b) The DRC calculations are either wrong or are highlyunstable and are thus an unreliable measure of efficiency.There may be some element of truth in this--some of thecriticisms against the effective protection measurementsapply also to DRCs--but it is not believed that theygreatly distort the broad ranking of efficiency.

(c) Efficiency itself, under the pressure of the crisis of the1980s, changed so rapidly that a 1990 DRC table wouldvalidate, ex post, the export growth rates. Again, thereseems to be some *truth in this for some--perhaps many--firms, which responded positively to the challenge tobecome competitive or to go under, but the period is tooshort to allow us to accept this as the full explanation,since to bring down a DRC from 1.5 to 1.0 in eight yearswould require annual rate of change of approximately 5.5%,i.e. well above observed past changes (see Table 5). Thisis not to say that very important improvements in effi-ciency are not occurring; the Evaluation Team encounteredsome notable examples, but it is unlikely that they,alone, can explain the large growth rates of some of thehighest DRC industries.

(d) There remains the possibility that some of the new exportsdo not follow comparative advantages. It is not anunknown phenomenon for firms in industrial countries toprice their exports below full production costs forlengthy, if not indefinite periods; many studies comparinginternational prices and domestic prices in industrialcountries of steel, chemical or other high-overhead

A1 Since the DRC calculations pertain to industrial groupings which arenot identical to those used in the international trade statistics, afull analysis would require very laborious and time consumingstatistical reclassifications which would not be warranted by the scopeand purpose of this Evaluation.

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industries have remarked on this. The Evaluation Teamencountered some examples in Mexico as well but is notable to assess how widespread this practice has become.Vhat is clear, however, is that it is only sustainablewhen the domestic market is large and stable enough tomake up for the "losses" on export account, and in thisrespect Mexican industries may differ from theircompetitors in industrial countries. If so, it is atleast possible that not all of the observed growth ofmanufactured 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 (Loan2331-ME) was to provide rapid assistance to Mexico in the balance of pay-ments crisis that began in 1982, it failed. In spite of extraordinaryspeed in loan proc.-saing, the loan only became effective at the end of 1983and then failed to disburse significant amounts for two more years.

5.02 The reasons, as was shown, were numerous and complex, but sincethis experience is not an isolated one,42 they are worth considering indetail.

5.03 In the first instance, after the rather heroic efforts to processthe loan (four months), it took another six months b_ tween Board approvaland effectiveness. The pressure was evidently of , and for good reasonsince, during the same six months the US$100 m! lion that were alreadyavailable, were not disbursing.

5.04 The problem lay on the demand side. Or rather, it lay in theoriginal design of the project as a credit project and in the unwarrantedassumption that because the country suffered a foreign exchange shortage,there would be eager demand for credit in forAign exchange on the part ofexporters. This assumption proved wrong for the following reasons:

(a) Lack of confidence in the ability of the Government tosupply the foreign exchange needed for debt service;43 inspite 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 ofdirect exporters if they had been allowed to retain from theirexport receipts what they would need for debt service. But theexchange control system did not permit this and the Bank madeno proposal in this direction.

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(b) Lack of confidence that the exchange needed for debtservice could be bought in the official market and fearthat the already large gap between that and the parallelmarket might widen much more.

(c) The existence of sizeable alternative cheap peso creditlines and the preference for buying foreign exchange withthese pesos in the free market, trading the higherexchange rate for the absence of a foreign exchange risk.

(d) The depth of the recession in Mexico which cut generalimports much more than had been expected and made foreignexchange relatively easy to acquire by exporters.

5.05 There were other, more project-oriented reasons for the initialslow disbursement--marketing of the new facility lagged, the paperworkinitially seemed excessive to intermediaries and ultimate borrowers and theprofit margins for the former may not have made it very interesting to themto push this line, but the four aforementioned points seem to have beenfundamental.

5.06 One clear inference from this experience is that credit programmay not be an efficient vehicle for emergency operations in which lenderand Government put a premium on speedy transfer of resources. This wouldprobably be true in any event, but is all the more so when there is notavailable--and no time to prepare--a thorough analysis of the financial andcredit markets of the country. The macro-balance of payments analysis thatestablishes the approximate size of the foreign exchange gap is necessary,but it is no substitute for real knowledge and understanding of thechannels through which resources can flow. And such knowledge is usuallyonly available when appropriate professional staff have been working withand on the financial institutions and markets of the country for someyears; it is illusory to think that it can be acquired on an emergencybasis.

5.07 In the loan under review, the implications of the existence ofalternative subsidized and exchange risk-free credit lines for the perfor-mance of PROFIDE were not thought out carefully at appraisal. And, sincediscontinuation or curtailment of these credits were not part of the loanconditionality, the Bank could not effectively seek redress once theproblem was identified.

5.08 Vhat, then, were the principal effects of the two loans? Even-tually, they were both committed and disbursed, including the earthquakereconstruction component. Did they increase exports, as designed? InChapter IV above, it was shown how difficult it is to be quantitativelyprecise about this question. In the particular circumstances of Mexicoduring the years when its external debt negotiations and re-negotiationsmade full access to normal commercial bank credit precarious if not impos-sible, conclusions along the lines of those of Chapter IV--that PROFIDEseems to have played a substantial role in facilitating the increase inmanufactured exports--seem warranted.

- 33 -

5.09 But one has to be careful here; there are at least two caveatsthat constrain the validity of such findings, one in time, the other one ingeneral. It is not possible to determine at what point and in what amountscommercial banks would have been willing to reopen their trade creditlines, 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-banksagreement, it may well be that an operation that would provide workingcapital to exporters would replace rather than complement available exter-nal resources. The second point is similar: the Evaluation Team didencounter occasional PROFIDE borrowers who were subsidiaries of multi-national firms and who said that in the absence of PROFIDE funds they wouldhave received financing from their foreign owners. To the extent that thisapplies--and it probably is not widely spread--of course it makes theChapter IV calculations of PROFIDE's impact meaningless.

5.10 'While not, perhaps, quantitatively very important, these cases doraise the question of whether it is wise for the Bank to let firms haveaccess 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 seemto be the case in Mexico. Besides, the possibility of some errors inborderline cases is not a good reason for abandoning altogether the effortto 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 issueis particularly relevant in the case of short term funds, since access toforeign money markets for these is much easier than for term capital.

5.11 If in normal times commercial banks can provide the needed tradecredits, and in emergency situations such credit programs as PROPIDE are anunreliable and ineffective vehicle for a quick transfer of resources, isthere any case for making them anyway? Certainly PROFIDE III proved to bea smoothly functioning device for moving money; by that time the learningexperience of PROFIDE II had been absorbed, most--not all--of the competingcredit lines had disappeared and the interest differential on the

441 Articles of Agreement of the International Bank for Reconstruction andDevelopment, Article 1, Section (ii), and Article III, Section (ii).The latter states thLt the Bank may make or guarantee loans when "TheBank is satisfied that in the prevailing market conditions the borrowerwould be unable otherwise to obtain the loan under conditions which, inthe opinion of the Bank, are reasonable for the borrower."

- 34 -

remainder, although still significant, had been much reduced.45 BancoNacional de Comercio Exterior, from a quite minor public sectorintermediary, was changing into one of the Government's most important andprofessionally most respected institutions and the exporting sector--aswell as the financial intermediaries--were increasingly satisfied with thespeed and efficiency of the mechanism that had been developed.

5.12 But these advantages can be garnered also if the foreigncommercial banks revert to being the external source of funds, provided theGovernment is indeed interested in keeping Banco de Comercio Exterior asthe center-piece of the system because it is efficient. Whatever may havebeen the original rationale for Bank involvement, there is no strongeconomic or financial case for a long term continuation of this particularkind of financing. 40 And, as noted above, there is a powerful case againstit once circumstances are such as to make it likely that commercial bankmoney would be available again.

45/ An approximate comparison between the costs to domestic borrowers ofusing the FONEX peso denominated line or the PROFIDE dollar denominatedone, can be made as follows:

In the first quarter of 1986 the peso depreciated by 22%. Since in thepreceding quarter, PROFIDE had charged 6.65Z p.a. (see Table 6). Theeffective cost was, approximately

1.00 + 0.0665 1.22 - 1.00 = 2324

At the same time, FOMEX was charging 40Z p.a. for its peso line (asagainst 82 in 1983), so the above 23% can be compared, againapproximately, with 0.40 = 10%.

4

of course, these are ex post calculations. Whether this is the way thecost relations looked to borrowers in late 1985 depends on what weretheir expectations about the future course of exchange depreciation.But any expectation of depreciation of more than 8.7Z in the nextquarter would have made PROFIDE more expensive than FOMEX/Peso line.

46/ Which is not cheap for the Bank; supervision has been very heavyt 178staff 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, removingdistortions and counterproductive restrictions and using the foreign tradesector 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 forgeneralizations.

5.14 It is relevant to note that Mexico had not been willing, in the1970s and early 1980s to make its macro-economic management the subject ofloan-related negotiations with the Bank. It was felt that it wouldcompromise the national sovereignty to do othervise.4 7

5.15 Thus the fact that there was no recent tradition of linking lend-ing decisions and macroeconomic performance must be taken into account whenassessing the Export Development Loan experience. And the inclusion in theloan documentation of a document on the Government's Export Strategy was ata minimum a major modification in the style of the Bank's lending relationswith Mexico.

471 At an earlier time--the late fifties and the sixties--a somewhatdifferent modality had prevailed in Mexico-Bank relations. The Bankwould give the Government its macro-economic diagnosis and let it knowthat it would be willing to finance sizeable programs--e.g. power androad--once certain major macro-economical obstacles--e.g. publicsavings--had been overcome by measures to be chosen by Government. Theapproach was considered legitimate by the Government because it wasanalytically linked explicitly by Mexico's debt servicing capacity andcreditworthiness, which were accepted as being a proper concern for acreditor. This practice was abandoned when the Bank spread its areasof interest to so many issues--rural development, income distribution,basic needs, demography, poverty, environment, that it was unable tocontinue to devote the requisite manpower to the required intensivemacro-economic and fiscal analysis. It may well be that this was thechief reason why the Bank was not very successful to either diagnosethe impending crisis before it occurred or to engage the Government inserious discussions about preventing it. This is made quite clear bythe discussion of the economy and of Bank strategy that accompanied thepresentation of the Loan to the Board. (See IBRD Report P-3601-ME ofMay 31, 1983.)

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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 supportthe efforts of the Government to expand rapidly non-oilexports 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) thevarying perceptions of the numerous people who participated in it, (c) theshift and blurring in perceptions that time inevitably produces, (d) thefragmentary nature of the documentary record, this evaluation can onlyprovide a tentative and impressionistic answer. It is that the dialogue atthe technical level with Government officials, which took place when Super-vision Missions collected the material that they needed to report to theBank on trade policy developments, was of use to Mexican officials in clar-ifying inconsistencies and problems and transmitting some of the Bank'sthinking.

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. Iteven 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 undoubtedlegitimate interest and standing. Throughout the period preceding July1985, when the Bank staff saw fairly clearly that the "ExportStrategy,--which itself was not very ambitious--and other Governmentpolicies were being implemented in a hesitant and half-hearted manner,there was no suggestion that this was inconsistent with obligations assumedunder the Loan and Guarantee Agreements. And when after the above-mentioned date the Government became far more vigorous in pursuing theNopening of the economy' objectives, it was quite clearly an internal,domestic decision. In any event, the Trade Policy Loan discussions andnegotiations, from 1985 onward, tended to be the forum in which tradepolicy issues were discussed between the Government and the Bank.

5.19 In conclusion, the direct impact of the operation on policy seemsto have been small. But as a basis for establishing a dialogue at thetechnical level, which made the work on the Trade Policy Loans, initiatedin 1985, possible, it may well have been very important.

- 8? -

Table 1: NOMNAL AND EFFECTIVE PROTECTION /a OF SELECTED INDUSTRIES, 1979

Implicit Implicit piCit ImplicitNominal Effective Nominal Effective

Alcoholic beverages 48 612 Plastic products 40 481Nals and beers -28 -89 Glss and products 3 9Colas and mineral waters -60 -77 Cement 0 21Tobacco -27 -27 Non-etallic mineral producte 1 8Soft fibers and cloth 1 0 Iron and steel, beic 1 12Nand fibers and cloth 10 18 Non-ferrous metals, basie 11 78Other textiles 0 -8 Metal furniture 14 87Clothing 24 6 Metallic structural products 0 -2Shoes and leather 7 8 Other metal products, except machinery 7 18Sawail products 0 40 Machinery and non-*Iectric equipment 20 8Other wood and cork products 0 -8 Electric machinery and equipment 17 84Cardboard and paper 20 57 Domestic electric appliances 86 94Printed matter 0 07 Electronic equipment so 220Petrochemicals -42 *85 Automobiles 42 192Chemicals, basic 12 -15 Chassis, motors, parts 1 36Fortilizers -18 -15 Transport equipment and material 17 21Synthetic Resins and fibers -10 -16 Other manufacturing Industry 21 52Pharmaceuticals 9 18Soaps, detergents, cosmetics 4 11Other chemical products 18 sOil cloth products 10 22

/a The method used Is to calculate Iglicit protection, i.e. to base the calculations on differences betweendomestic and foreign prices, rather than on tariff schedules. Thus the figures reflect the results ofquantitative restrictions and of subsidies as well as of tariffs; given the Importance of non-tariffprotection 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 MateoVenturial, Comerlto Extorior, April 1989.

- 38 -

Table 2: Export Development Loans 2331-HE and 2777-MEDisbursements by Quarters (US$ million)

Ln 2331 Ln 27771984 Disb. Cum. Disb. Cum.

I -* *II 0.9 0.9III 27.8 28.7IV 17.4 46.1

1985

I 9.4 55.511 28.6 84.1III 22.7 106.8IV 8.7 115.5

1986

I 16.4 131.9II 42.7 174.6III 6.7 181.3IV 45.1 226.4

1987

I 35.3 261.7 **

II 23.4 285.1III - 285.1IV - 285.1

1988

I 39.1 324.2 118.1 116.1II 7.1 331.3 9.2 127.3III 2.9 334.2 43.4 170.7IV 1.7 335.9 7.5 178.2

1989

I 9.9 345.8 33.6 211.8II 345.8 6.8 218.6III 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 IIIUSW100 allion, effec6lve U88 275 million, øffective US* 176 milliln, effectivefr 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. 228.0 190.70Nov. 81, 1987 226.0 199.80May 15, 1988 225.0Dec. 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 Commitmentsand of the Growth of Manufactured Exports, 1983-1989

(US$ million and 2)

Z of PROFIDE1983 1989 a Lending 1983-89

Automobiles & Parts 341.3Motors, 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 ofJan.-June 1989 over Jan.-June 1988.

Source: BNCE (for Exports) Comercio Exterior and (for PROFIDE), directcommunication and IBRD Trade Policy Reform and EconomicAdjustment, Rep. 7114-ME which cite Banco de Mexico sources.

- 41 -

Table: DiMICD: DMSTIC RESURCE COST (DC) a~VELS, 1982AlS AINDA. RATE OF CANGE (N), 1970-1982

1982 1970-S2 1982 1970-82DRC 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 -0.74Condensed Milk 1.28 6.66 FertllIsere 0.27 0.69Vegetable 01l* 0.68 5.11 Synthelc Fibers 1.00 -0.08

~6her Food 0.81 1.60 Pharmaceuticals 0.48 -2.78Bevere@s 0.7 -1.72 øher Industrial CheIal*as 1.16 8.87Seer ørewing 0.69 6.70 Coke 0.97 1.94Tobacco 0.51 2.1 Non-etallic Mineral 0.87 -1.16Text1 le Produchs 0.82 1.44 Ref ractor* 0.80 3.41Soaps and Deterg~n6s 0.60 8.99 Cement 0.71 2.68atch.. 0.0 -1.10 Primary Iron and St..l 1.12 -2.87

Secondary Iron and Steel 1.15 -1.27Ligh Intermediate Iron and Steel Pipes 0.99 -8.24

M.t.I Product 1.06 0.67Animal Fede 2.78 2.78 Copper and Producte 1.00 0.61Cotton Tex61es 0.80 2.74 Aluminum and Product 0.94 0.74Spinning and Waving 0.82 -0.67 Automobile odIes 0.14 -2.89orsted Text1 e 0.82 1.78

~ Synhec Texhl l*e 0.84 4.69 Capital oods and Consuner DurablesHennequen 0.69 -0.64Paper 0.76 -0.29 Metl Castings 1.02 8.26Cardboard 0.77 0.04 on-lechrlcal Mchinery 1.16 -4.07

~ood and Products 0.91 1.80 Fare Machinery 0.68 -0.46Rubber and Plastice 1.46 1.62 Electrical Machinery 1.10 0.85Tires and Tubes 1.84 -8.61 Transport Equ~pment 0.96 4.25Painte 1.19 4.04 Metal Furniture 1.08 0.26Glass Containere 0.67 1.68 Consumer Elechronics 1.14 4.270her Glas 0.71 -0.68 Automobils 1.61 4.18Batteries 1.12 6.45

Souroe: Mexico: Trade Policy Industrlal Performance and Adjustments, IIRD ReportNo. 82.169-ME, june 24, 1986.

42*

Table 6s Interest Rates Charged on 90 Day PROFIDX Dollar Loans1983-1988

(I per annum)Quarter

1 II III IV

1983 - - 12.20 12.701984 12.95 14.20 12.18 8.601985 9.10 6.42 6.85 6.651986 6.15 6.00 5.25 5.001987 5.00 6.70 6.85 6.651988 6.20 7.20

Sources Banco Nacional de Comercio Exterior, Special Tabulation

- 43 - ATTACHMENTPage 1 of 2

BAmCO mCIO DE COTIERGO EXTERIOR. S nc.94no DE DESARROtto

June 18, 1998

REF: INTL. FINANCIALORGANIZATIONSIFO-292

COSIENTS RECEIVED FROM THE BORROWER

THE WORLD BANKINTERNATIONAL BANK FOR RECONSTRUCTIONAND DEVELOPMENT698-19th Street, N.W.20433 Washington, D. C.

ATT'N: MR. ALEXANDER NOWICKIDIVISION CHIEFEVALUATION DEPARTMENT

Dear Mr. Nowicki:

In reference to your letter dated May 7, 1998 whereby youenclosed the *Program Performance Audit Report* (Loans 2331-MEand 2777-ME), we would like to make the following comments:

1. It may be suitable to begin the PPAR with the positiveaspects of EDP-I and EDP-II, and then to present theanalysis of those issues that hamper the operations.

2. The 1982 economic crisis of Mexico was accompanied by manyadministrative and institutional changes. The PPARdocuments make an extensive assessment of the "crisiscondition" but it is brief on the substantial changes undertaken by the Mexican Government in 1983 in order toreestablish, as fast as possible, adequate condition forMexico's development.

3. One aspect that it is completely forgotten in the PPAR .isthe fact that the loan 2331-ME was the first operationbetween World Bank and BANCONEXT. As such, neither IRD norBANCOMEXT were keen on the way the other institutionoperated.

4. The PPAR document mentions that it is not clear why it tookso long to declare effective the 2331-NE loan. We wouldlike to remind you that there were certain condition foreffectiveness which had a slow legal and administrativeprocedures, such as the transfer of FOMEX from Banco deMexico 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 ATTACHMENTPage 2 of 2

SIANC AI OVtItSAaRLVI

O"comm

5. Many of the discussions regarding policy issues were basedon a document prepared by IMCE "Instituto Mexicano doComercio 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 inmatter 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-


MEXICO

FIRST AND SECOND EXPORT DEVELOPMENT PROJECTS

(LOANS 2331-ME and 2777-ME)

June 23, 1989

Trade Finance & Industry Operations DivisionLatin Amer4ca and the Caribbean Country Operations

Department II

- 47 -


MEXICO


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 setsof factors, one internal and the other external. The internal factorsderive from the necessity to formulate an economic development strategyappropriate for Mexico which had pursued through the beginning of the 1970san inward-oriented industrialization approach which had largely exhaustedfurther growth possibilities. The external factor was the highly unstableworld market for petroleum. Thus, the negative impact of inadequate domes-tic fiscal and monetary policies in the early 1970s led to serious economicdifficulties in 1976 and some attempts at policy reform provided the basisfor partial recovery in 1977. However, the opening up of new oil fields,in part responding to the higher prices stemming from the first oil pricerise in 1973, combined with the added stimulus of the second oil price risein 1979, gave rise in both domestic and external circles to euphoricexpectations over Mexico's economic growth potential. The incentive forfurther reform was lost and the country embarked on a highly expansionisttrajectory which, in spite of the growth in oil revenue, required asubstantial level of foreign borrowing.

2. The boom quickly turned to bust, however, when oil prices began todecline in 1981. In early 1982, the Government was forced to withdraw fromthe exchange market, resulting in a devaluation of the peso, and announcedits intention to curtail the fiscal deficit. At the same time, privateinternational banks began to curtail their lending. In the face of rapidlydisappearing exchange reserves, the authorities in August 1982 unilaterallysuspended amortization of most of the external debt. On September 1, 1982,President Lopez Portillo nationalized the domestic banking system, furthershaking the confidence of the private sector.

3. Thus, by the end of 1982, external and internal imbalances withinthe Mexican economy had created a crisis of proportions never previouslyexperienced by the country. Capital flight, accelerating inflation, highnominal (as well as real) interest rates on a massive external debt andfurther declines in the prices for petroleum exports threatened economicviability and put severe strains on both the political and social fabrics.The new administration which took office on December 1, 1982, immediatelybegan to formulate comprehensive measures to deal with the most pressingissues. These were also designed to restore the confidence of both thedomestic private sector and the international financial community.

- 48 -

4. A medium term stabilization program was submitted to the IMF asthe basis for an Extended Fund Facility and was approved on December 23,1982. In addition to the measures required to bring about an improvedinternal balance, the program indicated the general direction of structuralreforms which would be necessary to-integrate Mexico into the world economyand 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 actionswhich 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, increaseddisbursement ratios and the modification of existing loans to meet thechanged 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 stabilizationpolicies which included restraints on domestic credit, exchange controlsand controls over both imports and exports, the Mexican authorities soughtto design special facilities which would nevertheless encourage an externalorientation within the productive sectors. Moreover, as the short-termmeasures gave way to structural adjustment programs, those efforts wouldserve as essential ingredients in the future opening of the economy.

6. A project to provide investment financing to export-orientedindustries had been under discussion between the Mexican authorities andthe Bank beginning in late 1981. Identification and preparation missionswhich were in the field in the course of 1982 were able to design in quickfashion project features capturing the new needs of the export sector as aresult of the events of that year. Moreover, the opportunity was providedfor intensive dialogue between Bank staff and the Mexican authorities inthe formulation of specific details of the export strategy spelled out inthe Export Policy Letter submitted by the Government which appeared as anannex to the President's Report recommending the approval of the project.The loan (2331-ME), for the equivalent of $350 million, was approved by theBoard in June 1983.

7. Objectives and Scope of the Project. The principal objective ofthe project was to support the efforts of the Government to expand rapidlynon-oil exports by (i) assisting in the formulation and implementation ofan export development strategy and (ii) providing exporters ready access toforeign exchange, on terms comparable to those prevailing in internationalmarkets, for imports of production inputs and equipment during a period ofcritical foreign exchange scarcity. A Bank credit line for the latterpurpose was justified at the time due to the inability of Mexico to obtainnormal international commercial credit. Given the magnitude of theexchange shortage and the expected demand for foreign currencies fromexporters to purchase necessary imported inputs, it was considered that theloan would disburse quickly and would therefore contribute to a rapidtransfer 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 majorpurposes. The principal component, $275 million, was initially allocatedto be used to establish a revolving fund in foreign exchange (the ExportDevelopment Fund or PROFIDE)1 through which working capital subloans wouldbe made to exporters to finance the costs of imported raw materials, compo-nents, spare parts or other production inputs. Since this was designed tobe a revolving fund, subloans were to be made in foreign exchange and wereto be repaid from the proceeds of the export transactions. A second compo-nent, amounting to $71 million (Programa de Financiamiento de Inversionespara las Exportaciones or FIFE), was allocated to provide medium and long-term subloans for financing fixed investments by industries to help themmaintain, expand or generate export capacity, and by hotels to helpincrease revenues from foreign tourism. In addition, some $3 million wasset aside for technical assistance subloans to exporters, for studies tohelp improve Mexican export development strategy and to strengthen theagencies related to the export sector.

B. EDP II

9. Backaround. During 1983 and through most of 1984, substantialprogress was made in achieving the stabilization goals of the Government.The fiscal deficit was sharply reduced. Unprecedented trade surplusesresulted from a sharp fall in imports (from $24.0 billion in 1981 to $14.4billion in 1982 to $7.7 billion in 1983), combined with a continued highlevel of export earnings (of the order of $25 billion), including a recov-ery in non-traditional non-oil exports which had been stagnant since thelate 1970s. A major foreign de*t restructuring was accomplished, includingnew 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 slightlynegative 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, publicsector borrowing increased substantially and monetary policy becameaccommodating. GDP growth rates became positive once more.

10. As a coasequence, 1985 witnessed the re-emergence of the basicimbalances and the full recognition of the need to match stabilizationefforts with long overdue structural reforms. In the middle of the year,major new initiatives were undertaken, including broad measures for importliberalization, reduction in public sector expenditure, rationalization ofparastatal operations including the sale of some enterprises to the private

1/ A pilot PROFIDE had been established in April 1983 under the SAP bytemporarily transferring $100 million from the existing Capital GoodsIndustries Development Project (Loan 2142-ME) but these funds, to belent on short-term, were to be transferred back to the original projectas soon as the subloans were repaid.

- 50 -

sector, and the adoption of an appropriate exchange rate policy. At theend of the year, the Government announced its intention to join the GATT,signifying the fundamental change in its development strategy from aninward orientation behind protective walls to an outward orientationcapable of becoming more effectively integrated with the world economy.2

The need for far reaching structural adjustment became even more pressingwhen oil prices weakened further in late 1985 and 1986 while the earthquakein September 1985 exacerbated the deteriorating situation, resulting inadditional expenditures for rehabilitation.

11. Policy dialogue between the Bank and the Mexican authorities whichaccompanied the implementation of EDPI was intensified and broadened sub-stantially. Following the decision of Bank management to link increasedleading to that country with central policy reforms, agreement was reachedwith the Mexican authorities on the preparation of a package of policy-based loans. The multiyear trade adjustment program elaborated by theGovernment was supported by a Trade Policy Loan (2745-ME) while the indus-trial adjustments which were expected to be the consequences of the openingof the economy were supported by Industrial Recovery and Industrial Tech-nology Loans (2746-ME and 2747-ME). The three operations were presentedsimultaneously to the Board and approved on July 29, 1986.

12. Preparation of EDPII was initiated in 1985 to continue the Bank'ssupport to export development efforts under EDPI, to provide additionalfinancial assistance as the funds under the first operation were nearingfull commitment and there was need to build up the revolving fund to meetincreasing 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 TradePolicy Loan, given the specific focus of the former on export policies,export finance and improvements in the institutional framework underlyingexport development. The loan (2777-ME) was approved by the Board inJanuary 1987.

13. Objectives and Scope of the Project. As with EDPI, the essentialobjective 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 exportersthrough comprehensive financial services for imported inputs and equipment;and (b) strengthening, streamlining and expanding the non-financialincentive 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 wasset aside for indirect exporters (i.e., enterprises supply-ing inputs to final ex1orters);

21 A number of the measures which Mexico subsequently undertook, forexample reducing the maximum tariff to 20Z, went beyond its commitmentto GATT as outlined in the formal accession document.

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(b) provision of $74.5 million for long-term finance (FIFE) forfixed Investments by exporters for the establishment,expansion or improvement of export capacity, and for con-struction, rehabilitation or expansion of hotels generatingpredominantly foreign exchange revenuest and

(c) a techaical assistance component of $0.5 million for stud-ies designed to improve the financial and administrativesupport system to exporters and the productivity andefficiency of selected product groups and for supportingindirect exporters.

II. THE EXPORT SECTOR

15. Export Performance. The measures introduced by the Government atthe end of 1982 were, in part, designed to reverse the unfavorable trendsin non-petroleum exports which had developed at the end of the 1970s. Fotthe 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, theshare of manufactured exports declined to around 14% in 1981 and 1982 (seeAnnex I). In 1983, the value of manufactured exports rose by more than 30%as compared to the previous year. This improvement reflected not only thesubstantial real devaluation included in the Government's stabilizationprogram 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 thepeso (see Annex IV) ane the resumption of growth in domestic markets led toa slowing down of export expansion. In 1985, there was actually a declinein the value of these external sales.

16. The macro policies adopted during 1985, liberalizing the traderegime and substantially reversing the incentive structure combined withanother substantial devaluation of the peso, were quickly reflected in therenewed dynamism shown by manufactured exports which in 1986 rose onceagain in value by almost 40Z. Moreover, as a result of the decline in oilprices experienced in that year, the value of manufactured exports exceededthat 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, withfurther increases of the order of 40% and 15? respectively. The slowdownin 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 1987indicate that exports of manufactures represented some 12? of the grossvalue of non-oil industrial output, compared to 4Z in 1980.

17. Transport equipment and components, basic steel products andpetrochemicals currently represent some 60Z of manufactured exports andabout three-fourths of the expansion experienced in the current decade (see

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Annex II). Nevertheless, external sales are highly diversified involving abroad range of products among the different industrial subsectors. Thisreflects 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 proximityof sizeable markets in western and southwestern United States also offersimportant advantages to Mexican producers.

18. Analysis of the performance of Mexican exports must also take intoaccount developments affecting the assembly or Imaquila" industries, basedon imports of parts and components from the United States with re-export offinal goods to that country under special customs tariff arrangements. TheMexican regime controlling this trade was established at the end of the1960s. In contrast to most other countries, Mexican trade statistics forthese items are separately reported, reflecting basically the value addedin the country. Preliminary data indicate that these exports exceeded $2billion in 1988, some 302 higher than in the previous year and more thanthree 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 industrialsector.

19. The bulk of the maquila plants are located along the border withthe United States, although the Mexican regulations are not restrictive.This trend has reflected internal transport difficulties, as well as theadvantages of "twin-cities" relations developed between neighboring citieson both sides of the border. In recent years, however, there has been somegrowth of these facilities within the country, due to labor shortages inthe border areas combined with high turnover. Moreover, as a result of thegrowing 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 attractiveexchange rate to provide incentive for export activity. It was recognizedthat the eventual reversal of the anti-export bias arising from commercialpolicy prevailing under the stabilization program would require eliminationof quantitative restrictions on imports and the reduction of tariffs. Inthe 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 sothat exporters could obtain the foreign exchange required for theirimports. A timetable indicating the expected dates of key policy actionswas attached to the letter. The basic objective was to create a de factofree 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

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and assist enterprises on meeting administrative requirements for theirexports was included. Responsibility for this service was to be given tothe Instituto Mexicano de Comercio Exterior (IMCE), the basic public sectorexport promotion agency attached to the Secretario de Comercio y FomentoIndustrial (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 Governmenttook numerous steps consistent with the program outlined in its ExportPolicy Letter. For example, the 'single-window* facility was establishedin IKCE,3 import duties were reduced on a broad list of products, priorlicenses for temporary imports for export production were no longerrequired, coverage of quantitative import restrictions was reduced, andregulations for an expanded and simplified temporary admissions system wereestablished. Many of these measures were outlined in a national program ofindustrial 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 theGovernment announced a series of measures to achieve fundamental structuralchange in the Mexican economy.

24. On the trade policy side, restrictions on exports for all but asmall number of products were removed, the coverage of quantitativerestrictions on imports was sharply reduced, a schedule of tariff reduc-tions was established which would eventually result in a maxim tariff of20Z, and the system of official reference prices (arbitrary prices on whichtariff levels were imposed) was scheduled to be phased out. The basicelements for the establishment of the free trade status for exporters werespelled 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 temporaryadmission system, 4 and a modification of the duty-drawback scheme.

25. In connection with EDPII, the Government submitted a statement onExport Development Policy summarizing the main elements of the measuresaffecting macro policies which had been taken in the context of the earlier

3/ In practice, however, this facility did not prove effective as thevarious agencies with responsibilities for administering prevailingexport controls were not willing to delegate that responsibility toIMCE. Thus, the essential function which the single-window served wasto assist in familiarizing exporters with administrative requirementsand in identifying the relevant institutions.

4l Mexico has had for many years a temporary admission system under whichlarge enterprises with substantial import requirements could make useof bonded warehouses under Customs supervision.

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Trade Policy Loan and the specific measures for export development taken inlate 1985 and 1986 to implement PROFIEX. These included a wide range ofmatters including improving access of exporters to the full value of theirexchange 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 finalexporters to their domestic suppliers, which would be used by the bankingsystem as the basis for providing the latter with working capital credits.

26. At the present time, the principal policy objective of the twooperations, the establishment of free trade status for exporters, has beenvirtually completely achieved. Export controls remain on a small number ofproducts, amounting to about 252 of non-oil exports. These are primarilyin the agricultural sector where domestic sector policy considerations areparamount, or in those instances where there exist external trade restric-tions (e.g. textile exports to the US which are subject to quotas). In thecase of imports, existing controls affect products which account for about25% of total domestic production but they are similarly concentrated in theagricultural (or agro-industrial) sector and are closely linked with domes-tic sector policy. While in the macro sense the remaining restrictions onimports and exports cover items representing a substantial portion of totaloutput of tradeables, further liberalization is not possible without con-fronting domestic agricultural sector policy.

27. Experienced exporters report little difficulty in coping with thevestigial controls.5 But it must be noted that there remains a learningprocess for new exporters, albeit at a small cost. Within the privatesector, it is felt that, as confidence grows in the Government's intentionto 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 tocope with remaining administrative requirements, as well as to develop anexport marketing capability, either individually or in some cooperativeform with other firms.

28. The major current administrative procedure which appears to pre-sent difficulties, again particularly to new exporters, relates to exchangecontrol which is regulated through the commitment to surrender foreignexchange (CVD) to the Banco de Mexico. Obviously, once full convertibilityhas been achieved, this barrier will disappear. It should also be notedthat the system of temporary admissions which was designed for generallymedium-sized enterprises (PITEX) has been generally well received and,through 1987, there were sharp increases in its utilization However, at theend of 1987, tariffs on a number of inputs were reduced to zero whichobviated the need for many firms to use PITEX, resulting in a decline in

5/ Aside from the quantitative restrictions noted in the previousparagraph, there are some prior export and import license requirementsstemming from health and sanitary regulations.

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those operations in 1988. The decision to raise once more tariff levels ona number of these items, taken in early 1989, may result in an increase inutilization of the system during the current year.

29. Recent surveys of the private sector, some of which were conductedin connection with monitoring the impact of the Trade Policy Loans of theBank, indicate general acceptance and support of the basic liberalizationpolicies of the Government but, at the same time, point up the need forstability in those policies. Interviews undertaken in connection with thiscompletion report suggest that the main problems in the further expansionof exports, particularly promoting the emergence of new exporters amongsmall 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 administrationand in the utilization of transportation facilities. Measures to deregu-late truck transportation and to reduce the restrictions on the number ofcustoms brokers have been cited as steps which could be effective in theseparticular areas and would further advance the objective of the presentadministration to open up the economy.

III. IMPLEMENTATION OF THE PROJECTS

30. PROFIDE. The borrower, under both projects, was the BancoNacional de Comercio Exterior (BANCOMEXT), a bank created by the Governmentin 1937 which had acted, and continues to act, as its financial agent, andhad assisted in the financing of official imports as well as in financingprimary product exports in the difficult periods before and during WorldWar 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 andadministering foreign lines of (suppliers') credits. The new administra-tion indicated at the end of 1982 its intention to reinforce the activitiesof 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 deProductos Manufacturados (FOMEX). This second-tier trust fund was createdby the Banco de Mexico in 1962 at a time when there was little interestwithin the financial system to meet the financing needs of manufacturedexports. FOMEX provided, through the existing banking system, both pre-and post-export financing for manufactured products. As a condition ofeffectiveness 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

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Annex III).6 Among the factors were the need to integrate FOMEX intoBANCOMEXT and to introduce the procedures for the new financing program.While FOMEX, as well as the first-tier banks, had had experience in tradefinancing, the criteria which had been established for eligibility forPROFIDE involved additional paper work and adjustments had also to be madeto existing operational procedures to conform with Bank disbursement regu-lations. Supervision missions undertaken by Bank staff in the early stagesof project implementation reported that both the intermediary banks andpotential 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 requirementto submit detailed export marketing plans which they considered as confi-dential commercial information.

33. At the same time, however, these missions found that existingFOMEX local currency financing for working capital for exporting enter-prises continued to be available at subsidized rates, highly negative inreal terms. The substantial decline in imports in 1983 had reduced thedemand for foreign exchange while exchange control implementation wasdirected at assuring that exporters would have acce.a to required foreignexchange for their imports. In these circumstances, '-Iorters were able toborrow in local currency to meet working capital requirements and had noneed to use the PROFIDE line. Moreover, in spite of the nature of thePROFIDE loans, which linked exchange requirements for imports with exportearnings, there was some reluctance by exporters to incur foreign,exchangeliabilities.

34. While the Bank was prepared to agree to the simplification ofeligibility criteria, it found itself in a difficult position regarding theFOMEX interest rate on domestic currency loans. During appraisal, theMexican authorities had indicated that one of their policy objectives wasreform of the entire interest rate system in order to eliminate implicitsubsidization and to achieve positive real lending rates. It became clearduring supervision that interest rate issues, in particular the FOMEX rate,were being discussed by the Mexican authorities with the United StatesGovernment 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 appropriateaction on the interest rate for the competing local currency credit lineonly after those negotiations were completed, although some increases inthe 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 wasachieved.

61 Utilization of the pilot PROFIDE project (see para. 8 above), createdby temporarily transferring funds from an on-going project, was alsoslow. Of the $100 million made available, only about $30 million wasactually used.

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35. Commitment of PROFIDE funds accelerated in the second half of 1984(see Annex V) and was attributed to% (i) the simplification of applicationprocedures and the growing familiarization of BANCOMEXT-FOMEX personnel, aswell as the first-tier bank personnel, with the program (ii) the impact ofpromotional efforts in making exporters more aware of the facility and ofthe absence of foreign exchange risks; (iii) and the reduction in theinterest rate differential between the FONEX local currency credit line andPROFIDE. In addition, PROFIDE clients have noted several characteristicsof these credits which make them attractive. Given credit scarcity, FOMEXlocal currency credits usually do not cover the full amount of the loanrequest and banks generally require compensating balances, as compared tofull 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 twoyears but the balance of uncommitted funds continued to present a problemto the Bank which had anticipated a much faster pace of disbursement (Seethe table comparing estimated disbursement with actual, appearing in AnnexIII). Discussions were pursued with the Mexican authorities on severaloccasions concerning a possible cancellation of uncommitted balances and/ortransfer of some PROFIDE funds to FIFE. The subsequent full utilization ofthe project funds followed upon the extraordinary measures taken to meetemergency needs after the earthquake in September 1985 when $52 million ofPROFIDE funds were shifted to FIFE to finance reconstruction needs.

A. EDP II

37. The more rapid utilization of the Bank's funds for PROFIDE underEDPII as compared to EDPI reflected the decision made by BANCOMEXT-FOMEXmanagement to obtain quick disbursement by making several large subloansabove the maximum of $10 million permitted under the agreement with theBank; in these cases, the Bank agreed to waive the limit but did not agreeto the $20 million requested by BANCOMEXT, approving instead the amounts of$15 million. As a consequence, the rate of disbursement was considerablyfaster than anticipated in the appraisal (see Annex IV). The loan becameeffective in March 1987 and the original allocation of $100 million wasfully committed by September of that year. In August 1988, the Bank agreedto transfer to PROFIDE $35 million from the unutilized component forindirect exporters. This additional amount was also rapidly used and afurther $20 million was transferred in December 1988 and just as quicklycommitted. The balance from this component was transferred to the mainPROFIDE account in June 1989.

7/ For example, an importer of crude hides noted that the form of hisforeign exchange drawing under PROFIDE permits him to buy directly frommeat-packing plants avoiding wholesalers and resulting in considerablesavings.

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38. At the same time, the increased promotional activities undertakenby BANCOMEXT and the growing familiarity within the financial system withthe facility have led to a substantial growth of operations under therevolving fund. In 1988, total use of PROFIDE funds amounted to some $1.3billion, representing a turnover-ratio of over 3 for the year. By the endof 1988, 332 enterprises had made use, or were making use, of the facilityand the number of operations exceeded 2000 (see Annex VIII), with anaverage 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 moreimportantly at the levels of the fi-st-tier intermediaries, is longer thanexpected and the effort required to develop an adequately experienced staffat the various operational levels is substantial. The growing importanceof foreign trade transactions, particularly exports, has imposed upon thecommercial banking system the need to train a large staff in the mechanicsof 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 institutionsoutside the federal capital and with the further exception of the Monterreyarea which has developed more expertise in this field.

40. To illustrate this point, second-tier operations under FOMEX whichoriginate 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, thethird most important industrial center in Mexico, PROFIDE second-tieroperations in 1987 were less than $2 million but in 1988 the figure rose toalmost $40 million and is expected to exceed $100 million in 1989. To agreat extent, this expansion is due to active intervention of BANCOMEXT;the first-tier intermediaries in most regional centers are still largelypassive and further effort is required to build up and strengthen the staffof those banks who deal with export financing.

41. As a result of the changes in the components which were introducedduring the implementation of the two projects, the total amount of fundscommitted under EDPI for PROFIDE amounted to $225 million (compared to theoriginal $275 million); these were fully committed by February 1987. UnderEDPII, 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 (seeStatistical Annex Table 7) corresponds generally to the pattern of Mexico'sindustrial exports. The main branches of activity among PROFIDE borrowersinclude transport equipment, basic metal and manufactures, machinery andelectrical equipment, and chemical and plastics. However, little use hasbeen made of this funding by the food, beverage and tobacco industrieswhich represent the third largest grouping among exports, reflecting the

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low import content of those activities, not only for direct productioninputs 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 FIFEwas designed to assist such units to upgrade, or to expand, their produc-tive capacity to meet export standards, to eliminate bottlenecks or toadapt products to export markets. It was considered at the time that suchinvestment could provide rapid expansion of industrial exports. Given theexisting situation, there was not expected to be much demand for finance ofnew export-oriented projects. As a consequence, limits were put on thesize of subloans to be provided under this component to ensure wide cover-age among potential exporting enterprises. At the request of the MexicanGovernment, it was also agreed to extend eligibility to urgently neededexpansions of hotel facilities primarily attracting foreign tourists. 9

44. In order to ensure rapid implementation of this component, giventhe limited experience at the time of BANCOMEXT in industrial finance,itwas decided to obtain the participation of the Fondo de EquipamientoIndustrial (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 ofMexican industry. For tourism projects, it was also decided to obtain theparticipation of FONATUR, a trust fund established in 1974 which wasdevoted to both infrastructure and direct investment in this particularsector. It was expected that FONEI would be able to on-lend some $35million, FONATUR $25 million and the balance of $11 million would bedirectly lent by BANCOMEXT.

45. Commitments under FIFE were also slow in developing due to thedelays in designing and approving operating regulations for the participat-ing institutions and establishing appropriate working relationships. Inaddition, the overall low level of demand in the economy resulted in lowdemand for investment. By the end of 1984, one year after effectiveness,only $13.2 million had been committed (see Statistical Annex Table 5). Inthe first half of 1985, however, commitments accelerated with FONEIaccounting for about half of the loan approvals at the time.

81 At appraisal of EDPI, there was the expectation that agro-industrieswould have substantial need for imported packaging materials but thedevelopment of secondary petro-chemicals in Mexico has led to expansionof domestic production of plastics, meeting a considerable proportionof local needs for those items.

9/ Foreign tourism has been considered a priority activity by Mexicanauthorities because of its employment-generating capability, bothdirect and indirect, in addition to the foreign exchange it generates.

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46. Following the September 1985 earthquake, the Government requested,and the Bank approved, a transfer of $50 million from the PROFIDE componentto the FIFE component to meet emergency needs.10 A loan of $30 millionfrom 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 forother FIFE operations.

47. By September 1987, the revised FIFE component amounting to $121million was fully committed. Loans had been approved to 89 enterpriseswith 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 ($25million) largely due to the decline at the time in demand for constructionof new hotels; a large share of the actual lending was devoted to othertypes of tourist accommodations with smaller investment requirements.

C. EDP II

48. Under EDPII, FIFE was allocated $74.5 million with the expectationof continued participation of FONEI and FONATUR. This participation,however, did not take place as agreements between both institutions withBANCOMEXT were never finalized. In the case of FONEI, the conditions oflending under FIFE were not as favorable as was the case with its otheroperations receiving support from the Bank. In those instances, FONEI wasable to capitalize the repayments it receives on its subloans since theGovernment is responsible for repaying the Bank. This procedure, moreover,was being followed for BANCOMEXT under EDPII but had not been the case forEDPI. FONEI requested the extension of that procedure to its participationin 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 toconclude the necessary agreement. FONATUR itself was going through adifficult period with a major reorganization and change in its managementwhich led to a long delay in dealing with the issue. At the same time, theagency was delinquent in meeting certain requirements under covenants withthe Bank, in particular, failing to provide an external auditor's reportwhich would have led the Bank to refuse to disburse against any of its

10/ An additional $2 million was transferred from the component fortechnical assistance to exporting enterprises which was never used;subsequently, this was transferred to the studies component forsectoral analyses (see below, para. 73).

11) Under a recently adopted decision of the Government, financialinstitutions receiving Bank loans will no longer be permitted to usethe proceeds for capitalization.

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commitments. As a consequence of these problems with the two priorcooperating institutions, the Bank did not object to the full utilizationof FIFEII by BANCOMEXT.

50. By the end of 1987, some nine months after effectiveness,BANCOMEXT through direct lending had committed about $16 million under thiscomponent. By June 30, 1988, commitments amounted to $47 million andalmost all of the full amount of the component had been committed by March1989. The rapid rise in commitments was largely due to approval of twolarge loans, one for $14 million and the other for $20 million; althoughthe latter exceeded the maximum size provided in the agreement, the Bankagreed to waive the limit in this case. A total of 13 loans have beenapproved with an average size of $5.7 million, four times the average underFIFE I.

51. In October 1987, BANCOMEXT signed a cofinancing agreement with theExport-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 forfixed asset financing (FIFE) and the conditions of lending are similar tothose applied to Bank funds. BANCOMEXT expects to use the bulk of thesefunds 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 tosome extent the limited experience at the time of both Mexican authoritiesand the Bank in dealing with this type of commercial transaction. Inaddition, it is important to note that the intent of the Bank staff indesigning these procedures was to promote export-strategy planning amongthe productive sectors. This experience confirms that such a mentalityderives essentially from the economic policy and regulatory environment andcannot be promoted by "administrative" measures which, in fact, may becounterproductive.

53. Under the first loan, Bank supervision missions were staffed witha broad range of expertise which permitted them to actively pursue a numberof 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 exportdevelopment programs, Bank staff examined, among other matters, programsdesigned to help finance domestic enterprises supplying inputs to exportingfirms which themselves might have import needs (the so-called *indirectexporters"), reviewed the promotional activities of IMCE, at the time theprincipal export promotion agency, and, at the request of BANCOMEXT,analyzed the existing system for export insurance and guarantees, as wellas the experience of export consortia. Recommendations on the creditinsurance and guarantee systems were incorporated by BANCOMEXT in itsoperational activities while suggestions on IMCE activities were incorpo-rated into the terms of reference of studies financed under the project.

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54. The issue of the needs of 'indirect exporters' occupied a criticalposition i the preparation of EDPII and led to the establishment of a newfinancial document for commercial transactions, the domestic letter ofcredit. In 1986, BANCOMEXT initiated a program to rediscount these docu-ments in pesos, using its own funds. In that first year, funds providedunder 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 totalof 269 enterprises had been supported through these operations.

55. Under EDPII approved in 1987, a component amounting to $75 millionwas set aside for financing the foreign exchange requirements of indirectexporters. Demand for such financing did not materialize and these fundshave been transferred to the PROFIDE component.

56. The evidence in this instance, as well as in other countries wherethis practice has been established, suggests that the use of the domesticletter of credit to permit indirect exporters to obtain their foreignexchange requirements may be an important issue in those instances whereexchange controls are particularly rigid. This appears to have been thecase when EDPII was being prepared and was among the main justificationsfor the inclusion of the component. The situation, however, rapidlychanged in Mexico and these suppliers apparently now have few difficultiesin obtaining the small amounts of exchange which they may need.12

57. Nevertheless, the establishment of the domestic letter of credithas proven to be a useful instrument for promoting exports in the currentconditions of Mexico where there continues to be credit constraint,facilitating access to peso financing for smaller enterprises supplyingexporters. There are, however, indications that both financial intermedi-aries and final exporters still do not fully understand either the domesticletter of credit or the procedures for its use. There is therefore needfor strengthening educational and promotional programs to permit a widerand more efficient use of the document. This is becoming even more urgentas Mexico's industrial structure is becoming more complex and the chain ofproduction relationships is growing.

58. In recent years, Bank supervision inputs (for both field missionsand subproject reviews at Headquarters) for the two projects combined havebeen at about the same levels as the ones earlier prevailing for EDPI,although some key elements are now being dealt with in the context ofsupervision of Trade Policy operations.

121 There is some evidence suggesting that, in the case of Mexico,exporting enterprises are highly vertically integrated, if one excludesthe imported components, reflecting in great part the prior policyframework. Thus, where consideration is being given in other countriesto the use of domestic letters of credit, an effort should be made toexamine more 'carefully the extent of intra-industry dependence toprovide some quantitive measure of demand for that instrument.

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V. GENERAL CONCLUSIONS

59. The design and implementation of these two projects have takenplace in the context of an important evolution in the Bank's operationalstrategy for lending to Mexico. In designing EDPI, it was recognized thatthe dimensions of the crisis which the Government was then facing requiredan 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 Mexicanauthorities provide a policy framework for the longer-term which wouldindicate the nature of the structural reforms required to restore thecountry to a growth path. It was not considered possible at the time toelaborate on the measures to achieve that objective but the Export PolicyLetter submitted by the Government and the draft export policy paper whichaccompanied it (which was later replaced by a more comprehensive exportstrategy document) represented significant advances in the desireddirection.

60. Moreover, the agreement of the Mexican authorities to engage withthe Bank in a periodic review of progress under the prograln and of theimplementation of the loan permitted the development of an intensivedialogue on trade and related policy matters involving key decision makerswithin the Government structure. Given the limited and less structureddialogue which had characterized previous periods, this represented animportant milestone in the relationship between the Bank and theGovernment, marking the beginning of the period of fruitful economicdialogue which pervades in the present relationship between the Bank andthe Mexican authorities.

61. With the re-emergence of the basic imbalances in 1985 and the newinitiatives for opening the economy, the Bank decided to link increasedlending to those central policy reforms (see above, para. 11). The policydialogue which had been initiated under EDPI was intensified and providedthe basis for the design of the two Trade Policy Loans in 1986 and 1988, aswell as the second EDP in 1987.13

62. While the policy content of both EDPI and EDPII was limited, theydid focus on support for means to stimulate exports. In the case of EDPI,in the context of stabilization measures including exchange, import andexport controls, the principal goal was to provide a free trade-status forexporters. EDPII, complementing the earlier Trade Policy Loan, continuedthe effort. That objective has essentially been met (see above, para. 28).It is difficult to quantify the precise impact on exports of the measuresundertaken to implement the policy but the expansion in the level ofexports and the increase in the openness of the industrial sector (seeabove, 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.

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them.14 At the same time, the implementation process and the continuingdialogue with the Bank have had a substantial impact in providing to theMexican authorities important guidelines in formulating the broader liber-alization actions undertaken in mid-1985. The setback in export growthpreceding those actions was convincing evidence of the need for morefundamental reform.15

63. On the operational side, considerable success has also beenachieved in establishing a mechanism for channelling foreign exchange andproviding credit to exporters. on terms comparable to those prevailing ininternational markets, to permit them to import inputs, particularly in theearly periods of foreign exchange constraints, as well as under prevailingcredit constraints including high real interest rates on domestic borrow-ing. This achievement, however, occurred at a much slower pace thanoriginally anticipated and the expectation that EDPI could also be fast-disbursing was overly optimistic in view of the institutional changesrequired. In addition, at the outset inexperience in dealing with thiskind of commercial activity led to the imposition of lending conditionswhich were not suitable but this was subsequently corrected. The recentimproved performance of PROFIDE reflects the fact that the banking systemis becoming more familiar with the problems connected with the financialneeds of exporters. Nevertheless, further efforts are required to build upthe necessary expertise, particularly in financial institutions outsideMexico City and Monterrey.

64. Having concluded that the projects have been successful, is itpossible to measure the role of PROFIDE in the expansion of exports? Thereare a number of considerations which limit the estimation of any directcorrelation, including the differences in import content among firms andthe availability in some cases of suppliers' or other credits to supplementthe exchange made available under PROFIDE. What emerges from interviewswith clients who have recently entered into export marketing is theiropinion that the availability of this credit in foreign exchange, and atreasonable cost, played an important role in that decision.

65. Moreover, the trend of FOMEX lending activities relative to theperformance of manufactured exports indicate a growing importance ofPROFIDE. In the early 1980s, FOMEX financing of export sales was equiva-lent to about 40? of the value of manufactured exports while its pre-exportfinancing was equivalent to 20% of that trade. In 1988, the importance of

14/ It is obvious that these developments have complex roots, involving theentire macro economic context, trade and exchange rate policies, aswell as external demand.

15/ This experience may be relevant to other countries which may beconsidering export development programs in the absence of basic macroeconomic reforms to reverse production incentives.

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sales financing had marginally decreased (38?) but pre-export financing hadrisen to the equivalent of 292 of industrial exports of which PROFIDErepresented some 112. This confirms the view that the prevailing domesticcredit constraints and limitations on exchange convertibility haveencouraged exporters to make extensive use of the PROFIDE facility.

66. The rapid commitment and disbursement of PROFIDE funds under EDPIIis associated with the decision of BANCOMEXT to extend lines of credit,each of $15 million, to four multinational vehicle and parts manufacturersoperating under the special regimen for the automobile industry and to twopetrochemical firms. As a consequence, there was not only a quick transferof resources and a rapid build-up of the revolving fund, but BANCOMEXT wasable to avoid a lengthy period of commitment fees which had proven to be aburden under the first operation. Large credit lines with other multi-national -ito companies have also been provided through revolving PROFIDEfunds so that the overall weight of these transactions in the total ofPROFIDE 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 iscomplex 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 isno basis for rejecting applications for loans from such enterprises; infact, one of the achievements of EDPI was to reform the regulations ofFOMEX which previously could only lend to Mexican-owned operations. Tohave refused the applications would therefore have represented re-introduc-tion of undesirable discrimination. At the same time, it should beacknowledged that the Bank was correct in not agreeing to the limits asrequested 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 haveaccess to funding from their "casas matrices', it is often the case thatthe optimum allocation of total resources from the point of view of eachcorporation, which must operate within the constraints imposed by itsoverall market and financial situation, may not represent the optimum fromthe point of view of the individual subsidiary and the country where it islocated. BANCOMEXT officials stress that the enterprises, even if they aresubsidiaries, should be able to have recourse to local resources so as tohave flexibility in their decision-making. Given the size of both importneeds and the actual value of exports, PROFIDE funds represent a smallproportion of requirements of these firms but they have provided animportant "seeding, function in the mobilization of domestic resources toachieve 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 fromobtaining credits. Further growth of exports is likely to require addi-tional finance from PROFIDE. To meet those needs, it may well be necessaryto expand its available resources rather than to reduce its existing creditlines.

- 66-

70. Both loans contained relatively large components for technicalassistance and studies. Under EDPI, some of the $3 million set aside forthese purposes was expected to be used to provide technical assistancethrough IMCE to exporting firms. For various reasons, no programs of thistype 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 experienceconfirms the lessons emerging from similar attempts, largely unsuccessful,in other countries with relatively advanced industrial sectors to involvepublic sector institutions in what are essentially commercial and confiden-tial transactions. It must be noted that, from the outset, INCE officialswere not enthusiastic about the activity.

71. A substantial portion of the studies components was devoted tofinancing a major research project dealing with the measurement of effec-tive protection. Originally based in INCE, the project was transferred toSECOFI when the former was dismantled in 1985. In recent years, it hasbeen able to generate a mass of information which has been extremely usefulin policy formulation, shedding light on the expected impact of the tradeliberalization measures, as well as in the monitoring of the Bank's twotrade policy loans. The essential point emerging from this experience isthat these kinds of policy-oriented studies require a sustained effort andappropriate institutionalization in order to be able to contribute topolicy formulation; these are not 'one-shot' ventures. The Bank shouldactively promote, indeed should insist upon, the continuation of this work.

72. Several subsector studies have also been financed under these twoloans, including auto parts, agro-industries, textiles (clothing), shoesand furniture. While BANCOMEXT is the sponsor and provides general super-vision, the studies have been carried out by different consulting groupswith somewhat varying terms of reference. As one would expect, the recep-tion of the industrial sectors to these studies has been mixed,16 rangingfrom criticisms concerning the generality of findings to expressions ofappreciation for the specificity of recommendations. Some concern has beenexpressed over the slowness of BANCOMEXT in dissemination of the documentsand particularly over the need for brief action-oriented summaries whichcould be more widely circulated and could be sold at prices well belowthose being charged for the full studies.

73. Given the substantial amount of funds for studies which havealready been set aside in on-going loans and are planned for new loansunder negotiation, there is clearly need for the Mexican authorities toreview its policies on issues such as the selection of topics, methodology,qualifications of consultants and selection of audience to be served. Inthe case of sectoral studies to identify export-oriented activities, earlyparticipation of the concerned private groups in product identification andstudy design would be essential and the approach in each case shouldreflect the specific characteristics of the subsector being analyzed.

161 The studies have also been used by the Bank in designing the IndustrialRestructuring Loan (Loan -ME) which was presented to the Board inApril 1989.

- 67 -

Moreover, consideration should be given to providing some funds within theoverall allocation to assist in dissemination of the recommendationsarising from this work. Decisions on the use of funds within the studycomponent 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 staffresources to that task.

74. The contribution of the projects to the development of the insti-tutional infrastructure supporting exports must also be noted, particularlythe role in helping BANCOMEXT emerge as a major participant in formulatingexport strategy. At the end of 1985, BANCOMEXT's status was confirmed inits new organic law and important tasks were assigned to it as a member andsecretariat for an inter-agency trade promotion and development committee. 1 7

The expansion of BANCOMEXT's activities, however, raises some questions asto principal orientation and appropriateness. There may arise the possi-bility of conflict of interest as regards the institution's responsibilityfor broad promotional activities, particularly its responsibility for man-aging external delegations or what are essentially commercial attaches. Inreviewing the question of responsibility for promotional efforts, attentionshould be given to a better definition of the relative roles of the privateand public sectors in these activities.

75. Considerable emphasis is now being put on further expansion ofBANCOMEXT investment operations under FIFE. Given the present macro-economic policy environment, it is not hard to imagine that, for the nextfew years at least, much of new private sector investment will have a heavyexport-orientation. In this sense, therefore, the mandate for FIFE opera-tions by BANCOMEXT, to expand productive capacity for export (or, in thecase of tourist projects, for foreign exchange generation), can provide itwith substantial financing opportunities. At present, limitations on thesize 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 beenplaying (no doubt due in large part to its access to Bank funds), absorbsthe time of a substantial portion of the human resources of the institu-tion. Given the relatively advanced nature of the financial system inMexico, is this an area of comparative advantage for BANCOMEXT?

76. It is likely that, in the very near future, the growing diversityof Mexico's exports will require not only an increase in funds for financ-iLg those sales, but also a search for additional instruments. BANCOMEXThas already been involved in export financing, including high-technologycapital goods and engineering services. It can be expected that the demandfor this type of financial activity will increase. As demonstrated inother newly industrializing countries, a sophisticated financial institu-tion with appropriate promotional activities can play 'a major role inexpanding those sales through the use of innovative financial packagesencompassing other elements of the banking system. Under the present work

171 It was not possible to review any of the work which may have stemmedfrom the activities of this committee but this matter could be followedup in a future operation in the trade policy area.

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program of BANCOMEX?, little attention is being given to preparing itselffor this function. Within the recently approved Financial Sector Adjust-ment Loan, a review will be undertaken of the functions and organization ofBANCOMEXT as part of a study of the public sector banking institutions.

77. Finally, there is need to expand efforts at reaching small andmedium enterprises to increase their utilization of PROFIDE funds. Forthis purpose, it may be useful to undertake studies of the characteristicsof exporting firms to deepen existing knowledge of the export sector. Mostof the reports already completed have focussed on subsectoral problems.The results of the work could provide the basis for strengthening promo-tional activities at the level of the first-tier banks, particularly inregional centers which have until now made limited use of the PROFIDEfacility.

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7o -

ANNEX 11

PROJECT COMPLETION REPORT

MEXICO

INDEX OF THE REAL EXCHANGE RIATE(1980 - 100)

1980 1 103.5 1985 1 85.911 101.2 11 88.2

111 99.4 111 103.9IV 96.0 IV 116.3

1981 1 90.0 1986 1 128.111 84.6 11 139.4

111 80.9 111 152.8IV 81.6 IV 160.5

1982 1 95.4 1987 1 162.411 112.7 11 163.0111 135.8 111 152.9IV 117.5 IV 152.8

1983 1 131.5 1988 1 143.311 125.1 11 132.2

111 120.7 111 120.7IV 117.6 IV 121.6

1984 1 109.711 105.7

111 99.9IV 95.0

Sourcet Banco de Mexico

71-

ANNEX III


MEXICO

FIRST EXPORT DEVELOPMENT PROJECT(Loan 2331-ME)

Estimated and Actual Disbursement Schedule(in US$ million)

Estimated CumulativeDisbursements /a Actual

FY84Dec. 31, 1983 60.0 -Mar. 31, 1984 120.0 0.9Jun. 30, 1984 180.0 0.9

FY85Sep. 30, 1984 250.0 28.7Dec. 31, 1984 290.0 46.1Mar. 31, 1985 310.0 55.5Jun. 30, 1985 320.0 84.1

FY86Sep. 30, 1985 330.0 106.8Dec. 31, 1985 340.0 115.5Mar. 31, 1986 345.0 131.9Jun. 30, 1986 350.0 174.6

FY87Sep. 30, 1986 181.3Dec. 31, 1986 226.4Mar. 31, 1987 261.7Jun. 30, 1987 285.1

FY88Sep. 30, 1987Dec. 31, 1987Mar. 31, 1988 324.2Jun. 30, 1988 331.3

FY89S4p. 30, 1988 334.2Dec. 31, 1988 335.9Mar. 1989 345.8

a At appraisal.

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ANNEX IV


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 0Jun. 30, 1987 15.0 0

FY88

Sep. 30, 1987 32.5Dec. 31, 1987 63.0Mar. 31, 1988 100.5 118.1Jun. 30, 1988 131.5 127.3

FY69

Sep. 30, 1988 160.0 170.7Dec. 31, 1988 184.5 178.2Mar. 31, 1989 203.5 211.8Jun. 30, 1989 218.0

FY90

Sep. 30, 1988 229.0Dec. 31, 1988 236.5Mar. 31, 1989 242.0Jun. 30, 1989 246.5

FY91

Sep. 30, 1988 250.0

L At appraisal.

73 -

ANNEX V


MEXICO

FIRST EXPORT DEVELOPMENT PROJECT(Loan 2331-MB)

Cumulative Commitments (Net) By Principal Components la(in US$ million)

PROPIDE FIFE

September 1984 30.4 5.9December 1984 38.1 13.2June 1985 120.6 44.0December 1985 187.3 80.0June 1986 207.6 105.2December 1986 223.9 108.5June 1987 225.0 115.3December 1987 225.0 121.0

/a As amended.

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ANNEX VI


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 6.9December 31, 1987 99.9 16.3March 31, 1988 99.9 35.7June 30, 1988 99.0 47.0September 30, 1988 122.6 47.0December 31, 1988 122.6 53.9March 31, 1989 122.6 73.9

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ANNEX VII


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 2.48Vegetable Products 0.00 1.43 0.00 1.04 18.20Fats and Oils 0.00 0.01 0.00 1.94 0.26Manufactured Food Products 0.00 0.00 0.82 0.00 5.47Mineral Products 0.00 1,45 0.46 1.98 76.88Chemical Products 3.88 15.11 41.67 122.62 280.68Plastic Materials 0.62 0.18 2.34 13.43 54.70Hides and Leather Products 0.09 0.24 0.84 1.98 2.99Wood and Wood Products 0.44 0.83 2.44 11.14 39.18Paper and Paper Products 0.00 0.05 0.46 4.07 16.98Textile and Products 1.00 1.68 3.71 7.76 17.62Shoes, Hats, Umbrellas

and Artificial Flowers 0.00 0.14 0.11 0.18 0.09Stone, Limestone and Glass Products 0.02 0.93 1 19 1.99 3.41Precious Stones and Pearls 0.00 0.00 0.00 0.06 0.30Basic Metal and Manufactures 19.12 9.09 65.96 82.00 193.90Machinery and Electrical Equipment 0.11 2.61 17.68 36.78 118.36Transport Equipment and Components 14.28 36.30 88.46 289.90 471.74Medical and Precision Instruments,

including Music and Sound 0.00 0.00 0.00 0.55 1.78Miscellaneous Merchandise 0.00 0.00 0.17 0.31 1.02Services 0.00 0.00 0.21 0.12 0.00

TOTAL 39.56 70.13 226.55 577.85 1306.06

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ANNEX VIII


MEXICO

FIRST AND SECOND EXPORT DEVELOPMENT PROJECTS(Loan 2331-ME and Loan 2777-ME)

PROFIDE

Average Size of Loan Operations

Total Numberof of Average

Operations Operations Size(in million US$) (in thousand US$)

1984 39.6 91 435.21985 70.1 177 396.01986 226.9 359 631.21987 577.9 1070 540.21988 1306.1 2076 629.1

Source: BANCOMEXT

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