3 some. Third and **most** importantly, on the available evidence this package<sup>seems</sup> sufficient to **establish a basis** for ustainable<sup>growth in Mexico.</sup> II ECONOMIC BACKGROUND In the years preceding the 1989/1990 debt negotiations, Mexico has gone through a rather tumultuous series<sup>of macroeco,.omic</sup> developments, and, towards the end, through an increasingly rapid process of structural reform.<sup>A better</sup> understanding of what happened in the years<sup>leading up to the negotiations</sup> explains much of the various parties<sup>negotiating positions, and of the urgency</sup> 2 1 behind the proceedings. We therefore provide a brief survey<sup>of this period.</sup>

# II.1 Macroeconomic Developments

# A. The Period Leading Up to the Stabilization Program 88/89

Between 1950 and 1974, Mexico enjoyed<sup>a remarkable period of high</sup> growth, low inflation and moderate<sup>external debt accumulation. Real growth</sup> averaged 6.4%, and inflation was<sup>in single digits throughout the period, in</sup> line with the prudent fiscal policies<sup>followed. This era of fiscal</sup> conservatism came to an abrupt end in the early<sup>seventies. Government</sup> involvement in the economy expanded<sup>rapidly, and increased public expenditure</sup> pushed up aggregate demand and the<sup>rate of economic growth. However, the</sup> higher government expenditure was not matched by rising public sector revenues. As a result, the inflation<sup>tax and external debt became</sup> increasingly important sources of<sup>public finance. At the same time, a decline</sup> in private savings incentives (real<sup>interest rates turned sharply downward)</sup> prevented a matching increase in private<sup>savings; external debt thun</sup> increased, increased oil revenues notwithstanding.<sup>The period of single digit</sup> inflation ended in 1973, the real exchange<sup>rate2l started to appreciate and</sup> the accumulation of external debt accelerated above the<sup>GNP growth rate. A</sup> serious, but comparatively brief, financial and economic crisis in<sup>1976</sup> terminated following major oil discoveries<sup>in 1977. The ensuing prosperity</sup> lasted until 1982, when soaring domestic<sup>inflation, falling international</sup> oil prices, rising world interest rates, and<sup>massive capitalflight</sup> led to a refusal bv external creditors to roll<sup>over Mexico's short-term debt and a</sup> subsequent suspension of Mexican payments<sup>of interest on its external debt.</sup> Over the 1982-88 period, economic growth<sup>ground to a virtual halt. This</sup> was accompanied by charply falling living<sup>standards, a deteriorating</sup> infrastructure, high inflation, and a loss of investor<sup>confidence. Towards</sup> the second half of **t.his** period, a series of measures was taken<sup>to reverse</sup> Mexico's declining fortunes. Among the<sup>most important goals were:</sup> (a) macroeconomic **stability;** (b) a rationalized set of incentives for private sector investment; (c) reallocation of public spending to support private sector-led growth, improved social<sup>services and the environment;</sup> and (d) a J/ A more detailed treatment can<sup>be found in Dornbusch (1988), Ortiz (1990)</sup> and van Wijnbergen (1989).

2/. The real exchange rate is defined as<sup>the price of foreign goods relative</sup> to domestic goods. Appreciation means a decline in this relative price.