Private Equity in Latin America:

The Mexican Case

FOCUS OF PRIVATE EQUITY

IN THE REGION

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Most of the Latin American funds raised

to date have had a late-stage focus, and typical
areas of investment have been company buyouts or majority equity stakes in established
companies.2 Venture capital funds were virtually
absent from the region until 1999 (see Exhibit 1).3
The chief reasons for the low proportion of venture capital investment are the lack
of interesting investing opportunities, the
excessive risk associated with investing in earlystage ventures in economically unstable
economies, the relative paucity of high-tech
companies, and the lack of a strong regulatory
framework protecting intellectual property

WINTER 2002

rights. However, in 2000and thanks in part

to the Internet boommore than US$1.1 billion was raised for venture capital, or more
than four times the total amount raised
between 1992 and 1999.4

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is an investment banker
with the JPMorgan
Mergers & Acquisitions
team covering Latin
America.
jdeyeregui@mba2001.hbs.edu

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JUAN CARLOS
DE YEREGUI

rivate equity investing first took off in

Latin America in the wake of the debt
crisis of the eighties, when global
banks that had been active in the
region found themselves holding a significant
amount of non-performing loans and had to
accept equity stakes in local companies in
exchange for their loans.1
Private equity investing in Latin America
grew exponentially, fueled by the new
investing opportunities created by the extensive macroeconomic and regulatory reforms
introduced in the early nineties. Latin American private equity funds raised almost US$15
billion between 1992 and 2000, mainly from
institutional investors in the U.S.

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is involved with Private

Equity and Real Estate for
emerging markets.
rcharvel@mba2001.hbs.edu

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ROBERTO CHARVEL

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ROBERTO CHARVEL AND JUAN CARLOS DE YEREGUI

GEOGRAPHIC CONCENTRATION
OF THE INVESTMENTS:
THE CASE OF MEXICO

Despite their broad regional scope, most

funds have focused their activities in three
countries: Brazil, Argentina, and Mexico,
which together account for more than 95% of
the investment in the region since 1992.5
Although Mexico has been one of the
main recipients of private equity investment in
Latin America, it has traditionally lagged behind
Brazil and Argentina. Industry analysts seem to
agree that Mexico has received less investment
than what the size of its economy might suggest relative to the other economies in the
region.
Sources estimate total investment in the
country to be around 20% of total private
equity investment in Latin America. Based on
its share of regional GDP, however, Mexico
would be expected to attract around 37% of
such investment.6 Investment has lagged even
when Mexicos macroeconomic prospects have
been the best in the region, due to its extensive and comprehensive set of liberal reforms,
the healthier fundamentals of its economy, and
the trade benefits that derived from NAFTA.7
THE JOURNAL OF PRIVATE EQUITY

EXHIBIT 1
Fund Raising in Latin America (U.S. Millions)
1994
$847
$847

1995
$827
$827

1997
$3,317
39
$3,356

1998
$3,664
$3,664

1999
$1,556
194
$1,750

2000
$1,536
1,101
$2,637

Total
$13,470
1,356
$14,826

THE MEXICAN MARKET

Recent Economic History

The economic history of modern Mexico (beginning in 1917) can be divided into two periods: first, the
formation of the new group in power following the Revolution and the import-substitution industrialization
model which evolved into desarrollo estabilizador or stabilized development; second, the exhaustion of the stabilized development model and the shift to a market
economy. Even where these two economic models are
substantially opposed, many of the institutions on which
the economy now relies have witnessed little or no
change.11 This is one of the challenges in developing a
private equity market in Mexico.
It is important to understand that the national government played a central role in creating and developing
the Mexican economy. For almost 40 years the Mexican
economy was closed to competition, and for many years
the government also provided financial resources to Mexican firms, particularly the big industrial groups; this created inefficient companies, stifled the growth of a business
and entrepreneurial culture,12 and strengthened groups
that starved entrepreneurs who were in need of capital
by monopolizing the available financial resources. For the
past 20 years Mexico has been trying to open its economy
and to shift to a market economy with GATT, NAFTA,
and privatizations. (For a detailed analysis of Mexicos
recent economic history, see the appendix.)

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A number of explanations have been floated as to

why Mexico has played a relatively minor role in the
resource allocation of the industry. The first posits the
lack of investment in an underdeveloped financial infrastructure and the lack of a sophisticated financial community. For example, the investment-banking sector came
late to Mexico: JP Morgan, probably the investment bank
with the greatest commitment in Latin America, has had
a presence in Argentina and Brazil since 1968 but only
opened its offices in Mexico in 1981.
The second explanation points to the influence of
industrial groups or grupos as an obstacle and direct competitor to private equity investors in Mexico. During the
last decade grupos have been very active in investing in
distressed or high-growth companies, the traditional field
of private equity funds. Moreover, due to their preferential access to credit they enjoy an unfair advantage when
competing with private equity funds for new deals.8
The third explanation is based on the economic literature on foreign investment. From this perspective, trade
agreements such as NAFTA which reduce or eliminate
tariff and non-tariff barriers are expected to increase trade
and reduce FDI.9 Since most of the private equity funds
that are active in the region are American, the theory would
suggest that a reduction in private equity investment, which
is just another form of FDI, is simply a consequence of
Mexicos accession to NAFTA. However, the strong FDI
inflows enjoyed by Mexico in recent years seem to cast
doubt on the validity of the last explanation, as evidenced
by a policy research paper of the World Bank.10 Moreover,
it fails to account for why pre-NAFTA Mexico had been
no more successful in attracting investment.
Other considerations might have an impact on
attracting private equity into the country. These variables
range from local business practices (family ownership concentration) to lack of entrepreneurship (which would
specifically impact venture capital) and professional and
middle management. These variables are difficult to estimate, but a good way to measure them is by reference to
Internet start-ups during the Internet bubble of the late
nineties: Argentina and Brazil far surpassed Mexico in
the creation of new ventures.

1996
$1,516
$1,516

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1993
$100
22
$122

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1992
$107
$107

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Private Equity
VC
Total

PRIVATE EQUITY IN LATIN AMERICA: THE MEXICAN CASE

Institutional Framework

The Mexican legal system, which is based on civil law,

is characterized by a relatively weak judiciary and offers
relatively little protection to minority shareholders. This has
had a negative impact on the overall performance of the
economy.13 Moreover, investors rights are far from guaranteed in a system which functions inefficiently at best (see
Exhibit 2).14 A pervasive lack of human infrastructure
competent lawyers, accountants, and judges15further
complicates mattters.
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ability to generate cash flows, so it is less risky to give

loans and easier to forecast the performance and valuation
of the borrower. Second, private financing involves greater
monitoring by lenders, which could serve to reduce
agency conflicts and transaction costs by generating information about the borrower.21 Because of the lack of a
professional financial intermediary community including
financial analysts, investment bankers, venture capitalists,
private equity, LBO shops, qualified accountants, independent auditors, financial press, and institutional investors,
the information generated by banks is one of the only
sources of information for firms in Mexico that reduces
transaction costs.22 Finally, bank loans contain more comprehensive and restrictive covenants than public debt
contracts and are typically secured with collateral.23 Collateralized debt is especially relevant because of the underdevelopment of the legal system, including the areas of
bankruptcy law and creditors rights protection.
On the downside, bank-based systems face two significant problems: First, the possibility of inefficient
lending by banks to business groups supported by relationship-driven decisions. Second, businesses with intangible assets and without positive cash flows cannot raise
bank debt,24 which depresses entrepreneurial activities.
During the period when banks were owned by the
Mexican government (1982-1991), credit decisions were
based not on future cash flows and the ability to repay, but
on credit history or collateral value. Banks used these criteria because they lacked reliable financial information. In
the nationalized years, banks used to roll over a loan when
payments were missed rather than declare the borrower
in default. Banks during this period of flawed credit-risk
analysis had inadequate loan structuring and insufficient
monitoring of their investments.25 Mexico had a bankcentered financial system that had historically26 channeled
resources to the conglomerates or business groups. This
was very similar to Japan and significantly different from
the U.S., which relied heavily on the public markets.
When banks were privatized in 1991 and 1992, the
financial institutions didnt have a banking culture or adequate experience. This shortcoming, together with cheap
access to foreign fundsas U.S. interest rates declined
and the expectations of growth in Mexico increased
created a situation where banks were lending too much
and without the correct risk analysis.27 This nearly
destroyed the banking industry in Mexico after the Tequila
crisis where interest rates increased significantly and people
couldnt repay their loans (see Exhibit 3). Mindful of their
own lack of professional management, Mexican banks

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Tradition and execution, then, conspire to ensure

that shareholders rights are inadequately protected.16 The
problem is particularly acute for minority shareholders
whose interests are overlooked by managers or dominant
shareholders. On the other hand, Mexico exhibits one
of the highest ownership concentrations in the world (see
Exhibit 3). The major problem associated with ownership concentration is the expropriation of minority shareholders stakes by large-scale shareholders.17
Following the introduction of reforms in the transition to a market economy, in 1993 Mexico passed a new
Foreign Investment Law that considerably opened the
economy to foreign ownership. Successive amendments
in 1996 and 1998 improved the investment climate by
eliminating all performance requirements and liberalizing
criteria for automatic approval of foreign investment projects.18 However, some limitations remain in effect: certain economic sectors are reserved to the State or Mexican
nationals,19 while foreign ownership is limited to less than
49% or subject to the approval of the Foreign Investment
Commission in other sectors. In addition to these regulations, FIC approval is mandatory with respect to the
acquisition by foreign firms of more than 49% of the capital stock of a Mexican company with more than Ps85
million (approx. US$8-$9 million) in assets.20
Financial Sector

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Mexicos financial sector is supported by three main

sources of funding: banks, the Mexican Stock Exchange
(BMV), and business groups. These groups, like similar
ones in Korea or Japan, play a leading role in the economy
and participate in lending activities by extending credits
through accounts receivable.
Because of the underdeveloped state of the financial sector, and thanks to the fact that this is a commercial banking-centered system, M&A activity is less
common than it is in developed economies. This further
limits opportunities for private equity investors targeting
M&A transactions. Moreover, the illiquid Mexican market
doesnt provide the best possible environment for exiting
investments through IPOs.
Mexico: A case of a financial sector supported by
commercial banking. Commercial banks in Mexico play
a key role in the economic cycle, as this is a bank-based
system. Countries with bank-based systems such as Japan
do their financing in the form of private debt. Bank-based
systems have some advantages over capital markets systems. First, private lending is more sensitive to the firms
WINTER 2002

THE JOURNAL OF PRIVATE EQUITY

EXHIBIT 2
Institutional Grading
Enforcement
Efficiency of the judicial
system

Rule of law

Corruption

Accounting
Accounting standards

Ownership
Concentration*

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English Origin
Australia
10.00
10.00
8.52
75
0.28
Canada
9.25
10.00
10.00
74
0.40
Hong Kong
10.00
8.22
8.52
69
0.54
India
8.00
4.17
4.58
57
0.43
Ireland
8.75
7.80
8.52
na
0.36
Israel
10.00
4.82
8.33
64
0.55
Kenya
5.75
5.42
4.82
na
Na
Malaysia
9.00
6.78
7.38
76
0.54
New Zealand
10.00
10.00
10.00
70
0.48
7.25
Nigeria
2.73
3.03
59
0.40
5.00
Pakistan
3.03
2.98
na
0.37
Singapore
10.00
8.57
8.22
78
0.49
South Africa
6.00
4.42
8.92
70
0.52
Sri Lanka
7.00
1.90
5.00
na
0.60
Thailand
3.25
6.25
5.18
64
0.47
UK
10.00
8.57
9.10
78
0.19
US
10.00
10.00
8.63
71
0.20
Zimbabwe
7.50
3.68
5.42
na
0.55
Average
8.15
6.46
7.06
69.62
0.43
French Origin
5.35
Argentina
6.00
6.02
45
0.53
Belgium
9.50
10.00
8.82
61
0.54
6.32
Brazil
5.75
6.32
54
0.57
7.02
Chile
7.25
5.30
52
0.45
2.08
Colombia
7.25
5.00
50
0.63
6.67
Ecuador
6.25
5.18
na
na
4.17
Egypt
6.50
3.87
24
0.62
8.98
France
8.00
9.05
69
0.34
6.18
Greece
7.00
7.27
55
0.67
3.98
Indonesia
2.50
2.15
na
0.58
8.33
Italy
6.75
6.13
62
0.58
4.35
Jordan
8.66
5.48
na
na
Mexico
6.00
5.35
4.77
60
0.64
Netherlands
10.00
10.00
10.00
64
0.39
Peru
6.75
2.50
4.70
38
0.56
Philippines
4.75
2.73
2.92
65
0.57
Portugal
5.50
8.68
7.38
36
0.52
Spain
6.25
7.80
7.38
64
0.51
Turkey
4.00
5.18
5.18
51
0.59
Uruguay
6.50
5.00
5.00
31
na
Venezuela
6.50
6.37
4.70
40
0.51
Average
6.56
6.05
5.84
51.17
0.54
German Origin
Austria
9.50
10.00
8.57
54
0.58
Germany
9.00
9.23
8.93
62
0.48
Japan
10.00
8.98
8.52
65
0.18
South Korea
6.00
5.35
5.30
62
0.23
Switzerland
10.00
10.00
10.00
68
0.41
Taiwan
6.75
8.52
6.85
65
0.18
Average
8.54
8.68
8.03
62.67
0.34
Scandinavian Origin
Denmark
10.00
10.00
10.00
62
0.45
Finland
10.00
10.00
10.00
77
0.37
10.00
Norway
10.00
10.00
74
0.36
Sweden
10.00
10.00
10.00
83
0.28
Average
10.00
10.00
10.00
74.00
0.37
Sample Average
8.31
7.80
7.73
64.36
0.42
*Means of ownership the three largest shareholders in the 10 largest non-financial domestic firms
(not including companies where the State owns a share)
Source: International Country Risk Guide;
International Accounting and Auditing Trends, Center for International Financial Analysis & Research Inc.; Moodys International;
Price Waterhouse; and country sources.
In La Porta et al. [1999].

PRIVATE EQUITY IN LATIN AMERICA: THE MEXICAN CASE

WINTER 2002

EXHIBIT 3
Nonperforming Loans as Share of Total Loans
1989
1994
1995

30%
Source: Banco de Mxico.

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EXHIBIT 4

Bank Loans 1997-2000

100

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105

90
85
80

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EXHIBIT 5

1%
9%
12%

1997

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have been reducing their participation in the funding

activities of the country (see Exhibit 4).
Mexicos stock exchange. Mexicos stock exchange
or Bolsa Mexicana de Valores (BMV) is a private limitedliability institution owned by brokerage houses. Each
house owns a single share. BMV had historically played
a small role in the financial activities in Mexico, as there
existed many problems and limitationsfor example,
unrestricted insider trading that caused prices to fully
incorporate the information before its public release.28
BMV is a relatively small financial intermediary (see
Exhibit 5). There were few public offers (only five in 1999
even when the market capitalization that year increased
66.87% and the index increased 86.70% in real terms),29
which has a negative impact on exit strategies for private
equity or venture capital. One of the structural problems
of BMV is that it is not very liquid; investors are usually
individuals not institutions and the companies list on
average 7% of their stock in the public markets.30 This last
point is important considering that minority shareholders
rights are not efficiently protected. Finally, public companies have been repurchasing their shares in recent years
(see Exhibit 6).
The role of business groups. Business groups are integrated into corporate groupings thanks to cross-shareholdings, close and long-term business relationships with
banks, and strong ties among the management teams of
the various companies. Another important characteristic
of Mexican firms in general and groups in particular is that

IV I
II III IV I
II III IV I
II III
97 98 98 98 98 99 99 99 99 00 00 00

CNBVhttp://www.cnbv.gob.mx/boletines/INE/BMT/DSS/IFC/CCS/BLC/CNT/
200009BCR.XLS

BMV and Other Stock Exchanges Around the World (U.S. Billions)

Dec. 1998 Low

92.0
89.0

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Mexico
Developed Markets
Germany
1,094.3
1,082.2
USA
10,271.9 10,425.5
France
985.2
956.7
Japan
2,439.6
2,398.9
United Kingdom 2,297.7
2,284.1
Canada
543.4
543.2
Italy
569.7
517.4
Emerging Markets
Argentina
45.3
41.3
Brazil
160.9
102.9
Chile
51.9
48.4
Korea
114.6
109.9
Philippines
35.3
35.7
Greece
80.0
93.4
Taiwan
260.0
251.6

1999
Dec. 99/
High
Dec.
Dec. 98
153.5
153.5
66.9%
1,432.2
11,919.5
1,503.0
4,455.4
2,954.8
789.2
728.2

1,432.2
11,440.8
1,503.0
4,455.4
2,954.8
789.2
728.2

30.9%
11.4%
52.5%
82.6%
28.6%
45.2%
27.8%

83.9
228.0
68.2
308.5
48.2
218.4
376.0

83.9
228.0
68.2
308.5
48.1
204.2
376.0

85.1%
41.7%
31.5%
169.2%
36.3%
155.3%
44.6%

Source: BMV 1999 Annual Report.

WINTER 2002

THE JOURNAL OF PRIVATE EQUITY

EXHIBIT 6
Public Companies in BMV (U.S. Millions)
Listed
Year Companies
1995
185
1996
193
1997
198
1998
195
1999
190

Listed Series
346
345
326
316
338

Capitalization Value % Change

90,939
-29.97
106,780
17.42
156,182
46.27
91,978
-41.11
153,489
66.87

Source: BMV 1999 Annual Report.

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In comparison with other types of foreign investments, investing through private equity is a significantly
long-term position as this activity is done in illiquid equity
positions with possible future benefits..Private equity funds
have a long-term investment horizon, ranging from 3 to
10 years, after which the investments are exited.32
Long-term vision is not the only benefit that private equity might bring to the region. As described earlier, there is a lack of business culture and professional
management in these countries. Private equity investors
add value to their stakes by playing an active role on the
boards of directors of the companies in their portfolio.
Through their participation in the corporate governance
of the firm, they contribute efficient managerial skills,
experience, and access to a powerful network of relevant
contacts in the business.
Because Mexico has a financial system that is supported by commercial banks, firms without cash flow will
not have access to credit; entrepreneurs will thus find an
additional barrier in developing their projects. Along the
same lines, SMEs have been effectively cut off from bank
credit. Private equity funds benefit the countries in which
they invest by providing funding to entrepreneurs and
innovators, thus enabling new ventures, including startups. This has societal implications insofar as entrepreneurship becomes a viable alternative for greater numbers of
people, in contrast to the current situation where
entrepreneurial activities are supported by seed capital

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BENEFITS OF CREATING AND SUPPORTING

THE PRIVATE EQUITY INDUSTRY IN MEXICO

granted by high-net-worth individuals. A larger pool of

new entrepreneurs will contribute to the development of
other intermediaries, such as lawyers, accountants, and
recruiting firms, by presenting new deals and opportunities in a dynamic environment instead of a stagnant business world. Neither commercial banks nor local capital
markets have been willing to finance local SMEs or startups. As a result, these companies have faced considerable
hardship, irrespective of their relative profitability or financial condition.33
Probably the most important effect of private equity
in Mexico is the potential to close the gap between the
Mexican financial markets and those of developed nations.
By following an intensive and strict due diligence process, as well as by exercising considerable control over the
companies in which they invest, private equity funds can
reduce the risk associated with this type of investment. By
doing so, they may generate much-needed information
on Mexican firms.
Another major benefit of private equity investing is
that it tends to foster liquidity in the capital markets. Private equity funds seek to exit their investments. Studies
of the U.S. market suggest that the most profitable private equity investments have been exited by way of an
IPO.34 In doing so, the private equity funds would benefit local capital markets by increasing the volume of
trading and the number of issuers on a local capital
market.35 Therefore, by attracting more private equity
investments, Mexico would be indirectly fostering the
development of its thinly capitalized public markets.

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they are usually family-owned businesses. This causes high

ownership concentration. In many cases companies are not
professionally managed as family members who are not
necessarily the most qualified managers run them. Finally,
groups benefit from the lack of competition in the public
markets, as new firms do not look to sell part of their
equity.31

PRIVATE EQUITY IN LATIN AMERICA: THE MEXICAN CASE

FORECAST OF THE PRIVATE EQUITY MARKET

IN MEXICO

As the Mexican government continues to adjust to

a market-driven economy, privatizations in the power,
petroleum, and natural gas industries may be on the way.
This may be a chance to attract new foreign equity investments. Privatizations are not the only way that the govWINTER 2002

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exchange of the Frankfurt Stock Exchange created especially for new firms looking for IPOs.
Companies that wish to list in the Neuer Markt
have to comply with international accounting
standards (U.S. GAAP), which include strict disclosure requirements.38
3. Trying to integrate its financial system into that
of the U.S. Under this scheme BMV would cease
to exist and Mexican companies would list only
in U.S. public markets.
4. Keeping BMV as an intermediate stock exchange
for smaller companies, creating local exit strategies for investors and entrepreneurs who ultimately have access to U.S. stock exchanges.
5. Extensively reforming BMV.

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In any case, for the stock exchange to gain liquidity

and credibility, the first and most important reform should
be geared toward regulating disclosure rules and listing
and accounting standards. It is also important that the
congress approve the ability of individual social security
accounts to invest in the stock exchange. This, together
with the presumed influx of institutional investors
attracted by the reform of disclosure and accounting standards, would enable the stock exchange to achieve more
liquidity.
With more effective protection and enforcement of
investor rights, companies may be willing to list a higher
percentage of their equity on the stock exchange. This
would serve to reduce ownership concentrations as well
as create a healthier investment environment for institutional investors, further deepening the Mexican equity
capital markets.
On the legal side, the regulatory framework must
encompass the problem of investors rights thereby creating a less risky investment environment. Other potentially positive effects of reform include: First, share
ownership may help spread wealth. Second, it may align
workers interests with those of companies. Third, it may
decrease the principal-agent problem (i.e., shareholders
putting pressure on managers to improve performance).
Finally, a more flexible financial culture may expand productivity and economic growth by making it easier for
entrepreneurial firms to raise money.39
There are no guarantees, however, that regulatory
reform will bring substantive change to the system. First
and foremost, it is far from clear whether companiesbe
it because of long-standing traditions of family ownership
or deep-seated mistrust of the law enforcement and justice

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ernment could impact the performance of the industry.

The new administration should try to increase the performance of the financial system by creating a new institutional infrastructure (see following section). This strategy
should include a fiscal reform that might decrease corporate taxes, to further modifications to the protection
of property rights and the ownership of foreigners.
On the other hand, industrial groups that meet a
more competitive environment based on the decreasing
relationships between them and the government, as well
as an increase in competition as some of the covenants
of NAFTA and the application of a free-trade agreement
with the EU are introduced, may be willing to sell part
of their non-core assets in order to become more efficient.
This may push M&A activity in the next few years, creating opportunities for further private equity investments.
Finally, it is probable that private equity funds will
continue to target mature investments in basic industries
such as real estate. Among the benefits of investing in this
particular industry is that companies need not reach IPOs
for investors to make a profit as every project is usually
sold separately, creating liquidity for the investment.

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ALTERNATIVES FOR DEVELOPING

FINANCIAL MARKETS IN ORDER TO CREATE
THE INFRASTRUCTURE REQUIRED FOR
PRIVATE EQUITY INVESTMENTS

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To develop the private equity industry, Mexico needs

to develop its equity and debt public markets. In order to
do this, the legal system, including the efficiency of the
judicial system as well as the protection of investor rights,
must improve significantly. The success of these sets of
ideas is contingent upon healthy public finance and a
favorable macroeconomic environment that relies on the
approval of the proposed tax reform (with this reform,
the government would be more independent from foreign investment and revenues generated by petroleum).
Mexico must choose between developing and
reforming its existing financial institutions or exploring
other options for developing the public markets, such as:

1. Developing a pan-Latin American public market

like the Easdaq in order to have more liquidity
in the capital markets.36
2. Creating a second Mexican exchange similar to
the Neuer Markt, which has strict disclosure and
listing standards similar to and sometimes exceeding those of Nasdaq.37 The Neuer Markt is a subWINTER 2002

THE JOURNAL OF PRIVATE EQUITY

systemswould be willing to let go of equity under any

circumstances. Another major obstacle may be the firmly
entrenched business culture of the grupos. These concerns
notwithstanding, regulatory bodies should consider
exploring one or more of the options described herein.
APPENDIX

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The basic and most important legal document in Mexico

was the constitution that was written after the revolution of
1917. This document laid down many doctrines regulating and
protecting various industries and the economy as a whole.
Among the most important were: ownership of all subsurface
mineral deposits was granted to the state; foreign ownership of
land was heavily restricted; the government had the right of
expropriation; and, by law, the government had a monopoly on
certain industries such as petroleum or electricity.40 The 1917
Constitution was amended many times, but the State maintained its grip on the economic development of the country.
The prime example of the leading role of the State was
the economic model adopted by Mexico in the 1940s: importsubstitution industrialization. This system protected Mexicos
firms and companies from foreign competition by implementing
tariffs and quantitative restrictions on imports. From this period
until the 1980s, the government provided low-interest, longterm loans to major industries through financial institutions
developed by and run from the government.41
Import-substitution strategies led to an increase in foreign direct investment that was reflected in stable and constant
economic growth from 1954 to 1970. This was the era of desarrollo estabilizador or stabilized development. The almost two
decades were characterized by low inflation based on tight fiscal
and monetary policies, a fixed exchange rate, and a consistently
higher growth rate than in earlier decades.
It was period of urbanization as well. There were signs
that the strategy was becoming inefficient: growth slowed in
later years, agricultural production declined, the economy
became more dependent on foreign capital goods, and income
distribution became more unequal.42

op
y

Mexicos Recent Economic History

The Four Economic Crises (1976-1994)

1976: the exhaustion of an economic model. As Mexico
changed in the sixties, political unrest developed in
universities and the southwest mountains. In response
to this situation, the next years were characterized by
repression, violence, and an aggressive expansionary
fiscal policy. President Lus Echeverra (1970-1976)
increased investments and encouraged import substitutions in intermediate and capital goods. Soon fiscal
and current accounts began to appear to push up infla-

PRIVATE EQUITY IN LATIN AMERICA: THE MEXICAN CASE

tion. The government had to start borrowing from

abroad to cover these deficits. Ultimately, in 1976,
the increase in the inflation rate led Mexico to its first
devaluation since 1954.43
1982: the mirage crisis. In 1978 a mirage appeared in
the eyes of the government: oil discoveries, which
established Mexico as the country with the fifth-largest
oil reserves in the world. This made things easy for the
already-established strategy based on government
spending financed from abroad. The increasing dependence of the government on money from abroad, the
constant fiscal and current deficits, the fixed exchange
rate, and the increase in inflation together with the
decrease of the price of oil in 1982 led to an economic
crisis in which President Jos Lpez Portillo (19761982) announced that it could not even meet interest
payments on foreign debt. Among other measures
taken by the government, banks were nationalized
and exchange rate controls were implemented to try
to stop capital flight, but these measures only increased
this tendency. The 1982 crisis had a negative impact
on the capital accounts of Mexico until 1985. Some
of the positive impacts of desarrollo estabilizador were
reversed.44
1987: the lost decade and another oil crisis. The newly
elected President Miguel de la Madrid (1982-1989)
decreased government expenditures, reduced subsidies, and increased taxes. He also tightened the monetary policy, an approach that led to a significant
increase of interest rates which created a no-investment
environment and inaugurated a period of economic
stagnation known as the lost decade. Oil prices collapsed again in 1985, creating further constraints in
an unstable macroeconomic environment that was
rocked by an earthquake that same year that killed
thousands and caused billions of dollars in material
damages. This, together with the fact that fiscal tightening eased in response to midterm elections, the fiscal
deficit increased, inflation increased, and the exchange
rate was fixed, created an environment in which capital flight reappeared. Even under these extreme circumstances, President de la Madrid decided not to
suspend interest payments on foreign debt. All of these
problems led to the 1987 crisis.45
1994: the Tequila crisis. Not everything went wrong
with de la Madrid. The reforms started by de la Madrid
and continued by President Carlos Salinas (1989-1994)
led to economic revitalization. Banks were privatized
in 1991 and 1992. The recently privatized banks, good
expectations on the part of an international investment
community willing to lend to and invest in Mexico, and
a decrease in interest rates in the U.S. caused Mexicos
consumption and investment to rise. Mexico relied on
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EXHIBIT A
GDP Annual Growth Rate 1950-2000
GDP growth
15
10

-5

1940-2000
Source: INEGI.

00

20

96

19

92

19

88

va

Robert Kossick, Recent Trends in Foreign Investment in

Latin America, http://natlaw.com/pubs/spmxfi6.htm, 2001.
Bill Shepherd, Latin Equity Funds Are a Hot Idea, Global
Finance, March 1997. Craig Torres, Latin America Warms to
Private Equity, The Wall Street Journal, September 2000.
4
Robert Kossick, Recent Trends in Foreign Investment in
Latin America, 2001.
5
H. Werner, A New Year, a New Latin American
Strategy, Venture Capital Journal, March 2001.
6
Economist Intelligence Unit.
7
JPMorgan Research, Emerging Markets Today.
8
H. Werner, A New Year, New Latin American
Strategy, Venture Capital Journal, March 2001.
9
Magnus Blomstrom and Ari Kokko, Regional Integration
and Foreign Direct Investment, The World Bank, 1997.
10
Ibid.
11
One part of this article describes and evaluates the institutional framework.
12
Including the development of professional management.
13
R. La Porta, F. Lpez de Silanes, A. Shleifer, and R.W.
Vishny, Law and Finance, Journal of Political Economy, 106
(1999), pp. 1113-1155.
14
Ibid.
15
Aghion, Hart, and Moore, The Economics of Bankruptcy
Reform, NBER Inc. 4097, Cambridge, 1992.
16
This part is based on: R. La Porta et al., 1997; R. La
Porta et al., unpublished manuscript; R. La Porta et al., 1999;
and F. Lpez de Silanes, 2000.
17
F. Lpez de Silanes, Reforming and Deepening Mexicos
Financial Markets. Council on Foreign Relations. A paper from
the Project on Development, Trade and International Finance,
2000.
18
U.S. Department of State, FY2001 Country Commercial Guide: Mexico, July 2000.

Fi

na
lA

pp

ro

foreign financial resources to fund its investment needs.

This made this country extremely vulnerable to the
international financial markets, a situation that blew up
in 1994 with the rise in U.S. interest rates. This,
together with internal political distress reflected in the
uprise of the guerrilla campaign in Chiapas, the assassination of the leading presidential candidate, and the
assassination of PRIs president, created an unfavorable
environment, and capital flight reappeared. The foreign reserves of the central bank decreased and the government started relying on short- term debt to prevent
the central banks reserves from declining. There was
an implicit risk: the inability to roll over the short-term
debt. In December 1994, in the first month of his
administration, President Ernesto Zedillo (1994-2000)
was unable to stop the reserves of the central bank from
decreasing, a situation which led to Mexicos fourth
economic crisis in 18 years. As part of the solution,
Zedillo introduced for the first time a floating exchange
rate as well as other important changes in the institutional framework such as the independence of the central bank from the Mexican government and the reform
of the pension fund system.46

lC

-10

19

19

84

80
19

76
19

72

68

19

19

64
19

56

60
19

19

52
19

48
19

44
19

19

40

op
y

ENDNOTES
1
Alex Hoye and Josh Lerner, The Exxel Group:
September 1995, Harvard Business School, 1997.
2
In this category we find the biggest funds such as the
Argentinean Exxel, the Brazilian GP Investimentos, and the
Americans Hicks, Muse & Tate, J.P. Morgan Capital, Darby,
and Newbridge, all of which have raised funds ranging from
US$500 million to US$1 billion.

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THE JOURNAL OF PRIVATE EQUITY

35

lC

op
y

R. Kossick, Recent Trends in Foreign Investment in Latin

America, 2001.
36
Since its foundation in 1996, Easdaq has had limited
success, with only a few firms listed, which usually cross-listed
on Nasdaq.
37
J. Lerner, A Note on Private Equity on Developing
Nations, Harvard Business School, 1996.
38
Lpez de Silanes, op cit.
39
Waking Up to Equity Risk, The Economist, March 10,
2001.
40
H. Pill, HBS case no. 9-797-096.
41
Op cit.
42
E. Krauze, 1997.
43
H. Pill, op cit.
44
H. Pill, HBS case no. 9-797-105.
45
Op cit.
46
H. Pill, HBS case no. 9-797-051.

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