Financial systems and development

t Box 5.6 Restructuring a large corporation: a Mexican example
The Valores Industriales S.A. (VISA) group, an inte- (including exchange of VISA debt for sovereign debt),
grated beverage and consumer goods conglomerate and debt-to-equity conversions. The array of options
r with more than 40,000 employees, is one of Mexico's made it easier for VISA to meet the needs of its sixtylargest
industrial concerns. During the late 1970s VISA seven creditors, who held varying views of VISA's fuborrowed
heavily to finance ambitious expansion and ture profitability, had different liquidity preferences,
diversification plans, but by 1987 it could no longer and faced different accounting and loss provision reservice
its debt. Like other Mexican companies that had gimes. Creditors were also permitted to trade claims
borrowed abroad, VISA was hurt by devaluation, high among themselves. Some creditors chose to receive
interest rates, and the recession that began in 1982. As cash for their claims, at a substantial discount from face
debt service began to consume most of its severely de- value. Others rescheduled $153 million at floating marpressed
cash flow, investment plans had to be post- ket rates and $75 million at lower fixed rates and also
poned and basic maintenance expenditure reduced to a received an equity stake in the restructured company.
minimum. The consequent decline in efficiency and To finance its restructuring and debt reduction proproductivity
made matters worse, and in early 1987 gram, VISA raised $334 million in cash from new and
VISA engaged the International Finance Corporation existing shareholders and investors. Of this, $135 mil-
(IFC) to help it formulate a restructuring proposal that lion came from new long-term loans, $36 million from
would restore the conglomerate's viability and reduce bond sales to the Mexican public, and $5 million from
its $1.7 billion debt to a sustainable level.
public share offerings in the Mexico City Stock Ex-
Eighteen months of negotiations among the existing change; the sale of assets (including automotive parts
shareholders and creditors, Mexican government agen- firms and hotels) brought $108 million, and a foreign
cies, and new investors and creditors produced a com- institutional investor bought a $50 million equity stake.
plex restructuring agreement. VISA was to merge two The restructuring restored VISA's competitiveness
large companies-fully integrating their manufacturing and reduced its debt from $1.7 billion to $0.4 billion,
facilities-redeploy some of its other installations, and leaving it a viable concern. The success of its negotiated
reorganize its administration. In addition, several non- debt reduction program was based on the sharing of
core businesses would be sold. Iosses between lenders and shareholders. Many more
VISA offered its creditors a variety of options, includ- firms in developing countries will have to go through
ing debt buybacks at a discount, debt-for-debt swaps similar reorganizations to become viable.
terprises and often were not permitted to foreclose Overly expansionary fiscal policies led governon
defaulting borrowers; occasionally the process ments to borrow heavily at home and abroad. Fiwas
more political than developmental, with loans nancial distress has been most serious in countries
being made to friends of the government. Many with large external debts. Domestic borrowing in
loans went to industries in which countries had no those same countries crowded out private sector
comparative advantage and which were profitable borrowing and produced inflation. In countries
only as long as they were protected. By the 1980s with greater macroeconomic stability, financial dismany
firms became unable to service their debts. tress tends to be chronic rather than acute.
This is not to suggest that all directed loans were Economic recovery requires the restructuring of
mistakes; many were successful. Financial institu- financial intermediaries and insolvent firms. It also
tions are highly leveraged, however, and so can be requires a policy environment in which finance can
bankrupted if even a small fraction of their loans become less a tool for implementing interventiongo
bad. The inadequacy of prudential regulation ist development strategies and more a voluntary
and supervision meant that most institutions were market process for mobilizing and allocating renot
made to take adequate provisions or write off sources. The success of that transition depends
bad loans, and their books gradually became a cat- partly on increasing lenders' confidence that fualogue
of past mistakes.
ture financial contracts will be honored, which in
Problems at the microeconomic level were exac- turn calls for an improvement in the ability of
erbated by macroeconomic policy in many coun- lenders to assess risk and to enforce contracts. This
tries. Interest rate ceilings hindered the growth of is the subject of the next chapter.
financial systems and encouraged capital flight.
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