IMF's Flexible Credit Line for Mexico

As the G20 Summit developed, mexican authorities announced the agreement on a 47 thousand million dollars as a Flexible Credit Line (FCL) from the IMF. This is the first time the found offers financial help to Mexico and not the other way around. It is important to acknowledge that Mexico has a good record in macroeconomic achievements, at least for the last 15 years, and this credit line should be seen as a prize rather than a negative sign.

As it is defined contingent it will only be used in case of need, furthermore, it is available in a time when internacional financial flows are drying, not only for Mexico but for all emerging markets as the rich economies are deleveraging. The agreement looks like pure gold in moment of historic financial stress.

Still, there are many voices, mostly from left-wing politicians, arguing that this credit line is more public debt, or worse, that this violates the constitutional arrangement that Congress must aprove the level of indebtness every year. Both are political fallacies.

First, this FCL would not be public debt as it is not a security Mexican government must honor with future tax revenues. The credit would be paid only with international reserves generated by exports or direct foreign investment.

Second this credit would not be honored with future tax revenues. If this were to be the case, government would buy dollars from the central bank in order to re-pay the credit. This is a contradiction since the credit is already in the obligations side of the central bank's balance sheet.

Understandingly Mexican politicians are averse to sign any contract with the IMF provided such horror stories as Argentina's following found's guidelines. Let us not forget that argentinians failed in two basics of modern macroeconomics -controlled budget deficits and flexible exchange rate- anyway, even if the found drove Argentina to it's last crisis, the credit line has no conditions of use at all.

Assume Mexican central bank were to use the credit this would reveal that the demand for dollars is bigger than some international reserve level decided by the central banker. Thus, borrowed dollars will be bought in exchange of Mexican pesos, reducing money supply. Now how will the bank pay those dollars? With a healthier economy, foreign direct investment should increase causing a rise on international reserves. Oil sales should also provide a source of dollars. A natural question is: what happens if the latter two mechanisms do not work?

In this polar scenario Mexican government should have to issue dollar debt to be paid with future tax revenues. How can the last posibility be ruled out? Simply put, it can not be dismissed. Is true though that is far less likely to occur.

The right approach to the credit of the example can be reduced to a simple one: Mexico is bringing "future international reserves" to present. It is also true that the credit line will disuade present speculation from Mexican currency.

It may be possible that the credit turn in to public debt, however it is far less likely and advantages outweight risks from using it -if needed.

G20 Summit Comuniqué

Resolutions of the Summit at London are available now. Shall be analysed carefully.

IMF Note for G20 Summit

It is available now, with date and forecasts relevant for the Summit.

Addressing Global Imbalances

As today's Martin Wolf column on the London Summit stress, there are roughly two approaches to solve the current global crisis. The first focuses in healing financial markets and pulling aggregate demand in advanced countries such as the US, the UK and Spain. The second focuses on re-balance the humongous savings surplus of fast-growing economies created over the last 18 years -Germany, China, India, Brazil, Japan are in this set of economies- is only resembled by the excess of consumption of some advanced economies -US, UK, Spain.

Wolf describes on depth the latter two approaches. A comprehensive solution should include at least three features: One, healing advanced economies financial systems. Two, de-leveraging financial balances of advanced economies -this opposes the spirit of taking US out of recession by increasing public spending and deficit. Three, a restructure of the global monetary system.

Of course there are several ways to deal with either of these three features. Addressing the first, healing the financial system, the recent plan labeled as the PPIP, unveiled by Secretary Geithner will re-start a market for toxic assets with no demand, however, it is difficult to anticipate whether or not this plan will re-start lending to the private sector.

About the second feature, de-leveraging advanced economies, aggregate demand in these countries should be increased, but not in an endogenously fashion but in the external sector one. There is one straight way to re-balance global economy, current debtors should increase exports to finish the umbalance. This exports should be targetted to creditor countries. The latter will address the excess of debt of the creditors, at the same time it should decrease the unemployment rate.

The third feature, is probably more complicated, what we do know is that in times where the IMF was trying to define its role in the present, it should absorb the explicit target of being the financial world's police, and probably help in the second feature, encouraging an increase in savings -increase in net exports- for the troubled economies and a decrease in the positive trade balance of theose with surpluses.

Department of Economics' Ranking

This is the latest Department of Economics Ranking.

Endorsed by REPEC, and cited by Mankiw in his Blog.

Informal economy

There is this book written by Mario Vargas Llosa -El pez en el agua- where he describes the approach of his presidential campaign for Peru in the late 80's.

His was a liberal approach to economic policy and civil rights, among several interesting ideas contained on the book, he points out how the so called informal economy -those economic agents performing activities out of the tax system, not necessarily in black markets- is a direct result of the gross bureaucracy and the inability of the State to provide legal certainty at zero costs.

The reading provides a new approach that fits with precision all conditions Mexicans face. It is straightforward to observe that, as Vargas Llosa says, law is a privilege for those go have a high income or political influence.

Can there be a case for defend all Mexicans involved in an informal activity in Mexico? Not for all of them maybe, but certainly for those who make a cost-benefit assessment and conclude that it is not worth it to be fully registered.

Take the following example. It is rather common that an employer offers to a worker a "word" contract instead of a signed one. The incentive for the worker to accept the offer consist of the advantage of not paying taxes, though not having social security, in exchange of a higher monetary wage.

Since public health services are of low quality, the worker of above can easily prefer to buy private insurance with the money he is not paying in taxes or social security.

There are no incentives for an agent to be part of the formal economy, he is not receiving quality services at all, on the contrary he must go through an awful bureaucratic system to get health services.

Welfare states are easily corrupted and transformed to under attain their objectives. It has been seen that Latin American state structures favor only those with political connections. This is, services assumed as public are in practice privatized, just as Hayek suggested in his Road to Serfdom.

The latter is an explanation for the existence of the informal economy. Moreover it attach full responsibility to the state structure for it's existence.

Mexican banking and upper bound rates

In recent weeks a debate developed at congress. Mexican banks have a foreign nature since most of them are owned by transnational corporations.

Attention to their policies about active rates was drawn when it came to light that these institutions are still profitable. Official agencies such as the National Banking Comission (CNBV) declared that profits were to be explained by charges on depositors, other than interest rates, for example, those made cause of transactions, commonly known as commissions.

Furthermore, it was made public that rates are considerably higher in Mexico than in banks' home- countries.

These facts caused outrage in a number of political sectors. Even though banks argue that high rates can be supported on an income and risk assessment, comissions can not.

There is one more argument that add weakness to the risk argument of above, Mexican bank market is an oligopoly.

This is why Congressmen are inolved in a series of reforms addressing high rates and comissions. However popular, the first problem -interest rates- is far more complicated to solve. It involves a series of reforms of the market structure since an apparent colusion is taking place.

Comissions on the other hand, are only an instrument for voracious rent-seeking. It is common knowlege, for example that if one holds 1k pesos in a bank account for a year, the balance will end up well below 1k pesos, since a comission of no use would have charged.

The latter is a clear example of a pervasive rent-seeking scheme, which in turn provides with no incentives to lend to a risky project. Moreover, high interest rates with long terms became an appealing mechanism to dilute consumption credit risk.

Put together all these features and you will have a poor banking system. Possible solutions rely on legislation, certainly not for high interest rates, but for the high level and number of comissions. A fix yearly schedule for these charges should be decided by either the Central Bank or the CNBV. In order to address the number and level of comissions a feasible solution should be to increase savings mobility across banks. This only measure will end up reducing both the number and the level of comissions -I. Llamosas thought this too.

Another possible measure can force the recipient bank to pay for the comission charged for changing one's savings account from a bank to another. An optimal rule would include a zero comission in changing banks for a depositor.

The case for an upper bound in interest rates is more complicated. Assume there is a maximum rate i*. Every economist knows that the interest rate is composed by at least three parts. First, it must measure the risk of re-payment. Second, it must provide inflation insurance. Third, it includes an extra positive profit for the bank.

Assume this third part is zero -like a competitive market should observe. Now, there are at least two kinds of agents with high inherent risk, the lower income citizens and the risky projects undertaken. Both would need to pay an interest that would probably be higher than i*. So, none of this agents will be a subject with credit worthiness. The latter may force this agents on to the black market of credit, known for it's ruthlessness.

Assume that i* is set too low, then this latter case holds. Assume i* is set too high, then we have the current situation, and there are no incentives for banks to lend at a competitive rate since a possible solution (a collusive one) is to set rates at i*.

Although profitable in terms of votes for this summer's election, imposing an upper bound to interest rates charged on banking loans is not an option. Congress should focus on comissions and improving market mechanisms in order to guarantee competition.