Overview of the Economic and Political Climate in Mexico Between 1970-1991

Summary

The central issue addressed in this case is deciding on the appropriate financing alternative for a Procter and Gamble subsidiary located in Mexico given the economic condition and risks involved at that point in time. Each alternative has a different tax implication and risk profile, depending on the exchange rate and economic performance. A comparative analysis is performed and the historical background is studied in order to determine the best alternative to raise capital for the Mexican subsidiary. The risk-cost analysis is carried out under the assumption of an expected devaluation of the peso compared to the US dollar. Furthermore, a risk assessment is performed in order to develop a better understanding of the various risks involved. The conclusion that can be drawn from this analysis is that the peso denominated loan in the most appropriate option.

1. OVERVIEW OF THE ECONOMIC AND POLITICAL CLIMATE IN MEXICO BETWEEN 1970-1991

• Between 1970 and 1980, the country had to deal with a number of significant challenges: the discovery of the Chaipases oil field in the late 1970s lead to a substantial increase in inflation ($32 per barrel of oil), which was expected to increase in the following period.

• In 1982, as a consequence of the major fluctuations in the price of oil, the economy collapsed which lead to a debt crisis (the measures taken by the government were to convert the debt into peso and defer the principal repayments for 5 years).

• President Miguel de la Madrid imposed austerity measures of fiscal restraint and structural economic reform. These measures were effective in reducing inflation and avoiding a recession.

• In 1988, president Carlos Salinas De Gortartis implemented offensive economic reforms and modernization which lead to substantial capital inflows from foreign investors.

• Between 1989 and 1991, the external debt (as a ratio of GDP) decreased from 47% to 36%.

• Between 1982 and 1991, the dependency on oil exports decreased from 77% to 29% in 1991.

• Although the government had set very ambitious goals like decreased inflation, improvement in the standard of living, the Key Mexican Economic Indicators showed a completely different picture. The general population wealth had decreased and there was a trade balance deficit.

• Trade liberalization due to the NAFTA agreement, fixed exchange rates and weak oil administration had a significant impact on the depreciation of the peso.

• A change in the political administration is expected at the next election in 1994

One of the most relevant indicators is the increase in money supply from 62.6% in 1990 to 122.2% in 1991 which cannot be explained by