**Policy, Planning, anci Research**

# **Macroeconomic Adjustment and Growth**

Can external restraint and internal balance in Mexico be reconciled at savings and investment levels that allow satisfactory output growth? What role do fiscal policy, interest rates, oil prices, and exchange rates play? How would a cutoff from external capital markets affect output growth? This paper develops and uses an econometric model for Mexico to discuss these questions.

What would be the macroeconomic effects of debt-equity swaps? Swapping public debt for private cquity, says van Wijnbergen, would raise the, equilibrium inflation rate substantially if Lley were implemented on a scale large enough to be interesting from a macroeconomic point of view. But without access to foreign capital markets in one form or another, output growth would be compromis_d.

A period of rapid growth and heavy external borrowing cnded for Mexico with the debt crisis of mid-1982. This episode taught certain lessons, according to van Wijnbergen: Growth acro b, **_Rit-_ uinsustainable- tor.rnvng** .. produce later losses that more than offset earlier gains. Mexico's agenda should therefore be renewed growth within the limits of creditworthiness. Fiscal constraint is equally necessary, to kcep inflation low and predictable.

As long as internal interest rates remain as high as they are, Mexico's fiscal problems are intractable without renewed access to foreign capital markets. But rollover of half or twothirds of foreign interest payments, in addition to principal payments, would bring a solution within reach. However, service of the face value of the current debt - without substantial - amounts of new money is incompatible with renewed output growth and thus not really in anyone's interests.

Renewed access to foreign capital markets is imperative both for restoring medium-term growth and for success of the current short-term stabilization effort. But not all forms of access are equally beneficial.

The increase in external debt implied by renewed access to international capital markets does not really threaten Mexico's creditworthiness. Lending to Mexico would probably increase the cxpcctLL rct repaIyILrit, **in iLeitls** of discounted value, rather than decrease itincreased upfront borrowing notwilltstanding.

But much depends on developments **in** world commodity and capital markets. A 2 percent increase in world interest rates would slow down Mexico's growth an estimated I percent.

Therefore, extemal debt arrangements should include contingency clauses conditional on developments in oil prices and interest ratec.

Van Wijnbergen concludes that with foreign financing in place, and Mexico's internal reform program continued and deepened, a cautiously optimistic prognosis seems justified. Growth is likely to begin recovering by the end of 1989, with positive per capita growth thereafter. Although this will require additional funding from abroad, Mexico's debt indicators should decline substantially. If Mexico continues its reform program, investing in Mexico should pay off handsomely.

This paper is a product of the Country Operations Division, Latin America and the Caribbean Country Department 11. Copies are available free from the World Bank, 1818 H Stree; NW, Washington DC 20433. Please contact Myriam Bailey, room 18169, extension 31854 (30 pages with charts).

PPR Working Paper Series disseminates thc findings of work under way in thc Bank's Policy, Planning, and Research Complex. An objective of the series is to get these findings out quickly, even if presentations are less than fully polished. T'he findings, interpretations, and conclusions in thcse papers do not necessarily represent official policy of the Bank.

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