Where there’s an abundance of will, there’s a narrowing of way to rouse the productivity potential of the United States’ largest trading partner into an economic reality on the world stage.
Long before a worldwide pandemic, Mexico was trending toward a period of deeper economic complexity in 2020. Political uncertainty on both sides of the border. A new trade agreement bringing labor reforms. Doubts about the financial recovery of state-owned oil and gas company Pemex. Inflationary pressures. Lingering safety concerns and challenging external factors meant limits on the country’s ability to stimulate the economy while also prioritizing its policy of monetary prudence.
Then came the widespread shutdown of consumer activity on a global scale at the end of Q1. But despite the country’s transitory fiscal, trade, and political indicators, its intrinsic geographic and economic strength as the United States’ southern neighbor and largest trading partner continues to drive positive business sentiment among foreign and domestic investors.
Economics Engine
With 126 million citizens, Mexico has the 15th largest economy in the world and the second largest in Latin America, in terms of Gross Domestic Product (GDP). Its population is young and productive, with 43 percent aged under 25 and a total average of 27, according to the latest Consejo Nacional de Población 2019. On balance, the number of workers adding to the economy is higher than the dependents straining it. That productivity nexus will strengthen as working-age citizens (15-64) increase to 60 percent of the population in the next 20 years. This relative stability as a U.S. trading partner should increase its attractiveness for international business expansion by U.S. companies in the coming months and years ahead, according to the 2020 International Trade and Trends in Mexico Survey Report.
“A large majority of executives are moving or have moved portions of their operations from another country to Mexico,” according to Christopher Swift, a partner and litigator at Foley & Lardner, which conducted the survey. “That can be traced to three things: Global trade tensions, particularly in Asia; Mexico’s geographic proximity to the United States; and NAFTA’s legacy, which all combine to make the country stable and a natural destination for international expansion,” he said.
The legacy of NAFTA is in the anticipation of the new U.S.-Mexico-Canada Agreement (USMCA) that replaces it. Surveyed in the weeks leading up to USMCA’s passage, the 160 U.S.-based executives polled by Foley & Lardner represent the manufacturing, automotive, retail/e-commerce, and technology sectors based on specified interest in doing business in Mexico.
More than half of respondents’ companies were already in Mexico with plans to expand either rapidly or the near term. A quarter of respondents said that they would operate in Mexico in the next year, and another quarter expected to in two to five years.
Realities on the Ground
As resilient as positive sentiment remains, the realities of doing business in Mexico have been characterized by uncertainty since Presidents Obama and Peña Nieto were replaced by Presidents Trump and AMLO in 2016 and 2018, a magnetic pole shift of left and right from north and south of the Rio Grande.
After coming to power, President Donald Trump executed his campaign promise to replace NAFTA, which he characterized as “perhaps the worst trade deal ever made.” The USMCA was passed in the U.S. House of Representatives in December after new Mexican president Andres Manuel Lopez Obrador, known popularly by his initials AMLO, agreed to include laws and $1 billion to his federal budget to improve labor conditions.
The deal, which replaces NAFTA after 25 years, implements several conditions covering labor, the automobile industry, the dairy market, intellectual property, and digital trade rights, among others. Before the passing of USMCA, AMLO was better known for starting his presidency with a series of policy decisions that senior economic analysts and data scientists warned would slow economic growth in the following year.
Among his first orders of business, AMLO cancelled infrastructure projects including the $13 billion New International Airport for Mexico City (NAIM), suspended energy contract auctions for three years, and cut public expenditure. The country’s growth forecast for 2019 went from 2.5 percent when he took power in December 2018 down to 1.4 percent and would remain low, according to Deloitte’s Mexico Insights research report.
“These policy decisions, along with uncertainty surrounding international trade and the world economy, have driven down the country’s growth,” the report stated. “However, Mexico has strong macroeconomic fundamentals and we expect growth to continue to be powered by consumer expenditure, albeit at a slower pace.”
The Slower They Are The Bigger They Fall
A slowing pace has since crawled to the brink of recession, with the International Monetary Fund forecasting a growth rate slower still at 0.4 percent for the year while Scotiabank’s Global Economic Outlook forecasts a “bleak” 2020. Mexico’s signs of weakness in 2019 included: Gross fixed investment falling 3.2 percent in the first semester, the weakest in a decade; industrial production falling 1.7 percent year over year in July; an 8.4 percent year over year drop in construction; a 10 percent year over year reduction in the oil industry; and job creation slowing in August to its lowest rates since 2009.
“Investment is plummeting, job creation is slowing rapidly, construction activity is failing, and private consumption runs at the weakest pace in a decade,” Scotiabank said in its global forecast in late 2019. “A loss of confidence from firms and households appears to be the main factor explaining recent economic performance, even though formal indicators of confidence are not that bad.”
Mexico’s economy would suffer profoundly if the U.S. were to fall into a severe recession and financial dislocation. Negative consequences will surpass in magnitude and duration those faced by the Mexican economy during the global recession in 2008-2009,” Moody’s Economic Analysis.
Responsible for keeping the country out of recession is Mexico’s independent Central Bank, which is mandated to maintain stability and inflation. Banco de Mexico Deputy Governor, Javier Guzman Calafell, said in September that economic activity had decelerated, and stagnation had been observed in recent quarters, with unease over the potential implications for public finances and the Mexican Peso. On March 16, the peso fell to an historic low of 25.42 per $1 U.S.D.
Low Growth But Stable Fundamentals
Mexico is ranked 60 out of 190 in the World Bank’s 2020 Doing Business ranking, losing six spots compared to the previous year. The report measures regulations in business regulatory areas to assess the business environment in each economy.
“Mexico remains the region’s top-ranked country, but for the second year in a row Mexico did not introduce any major Business climate improvements,” the report said.
In contrast to falling to the world’s 60th-ranked business environment, Mexico remains the 15th largest recipient of foreign direct investment, according to the United Nations Conference on Trade and Development, World Investment Report 2019.
Total foreign direct investment is estimated at $485.5 billion, or roughly 39.7 percent of Mexico’s GDP. Mostly from the U.S., Canada, and Spain, the investment is concentrated on automobile manufacturing, electricity, water and gas finance, retail and wholesale trade, and financial services. The opening of energy and telecommunications sectors attracted 13.5 percent of all foreign direct investment in 2018.
Domestically, the International Monetary Fund (IMF) sees increased private investment as key to stimulating Mexico’s economy. During a mission to Mexico late last year, IMF Mission Chief Costas Christou met with Bank of Mexico Governor Diaz de Leon, Secretary of Finance and Public Credit Arturo Herrera, and Energy Secretary Roció Nahle.
In its Concluding Statement, the IMF recommended Mexico reconsider limiting private companies’ cooperation with state owned oil company Pemex after AMLO’s administration favored tax breaks and injections of capital ahead of the previous government’s tenders seeking private partners. The fiscal stimulus has not stabilized Pemex’s finances or helped increase production, with downgrades of the company’s debt to junk status by Fitch last June threatening the credit ratings of Mexico.
“The mission recommends reconsidering these decisions as they place the onus of stabilizing Pemex squarely on the government,” the IMF statement said. “Most importantly, joint ventures with the private sector remain the most promising way to replace reserves and increase production given fiscal pressures.”
Kickstart The Heart
The IMF’s findings and projections of slow domestic and global growth, combined with the government’s new policies, budget cuts, and regulations, suggest the resilience of Mexico’s positive sentiment have been anchored in its strong fundamentals, according to Ernst & Young’s Global Capital Confidence Barometer.
“Given this backdrop, it is interesting to note that 75 percent of Mexican executives surveyed in the most recent EY Global Capital Confidence Barometer continue to see the Mexican economy growing, up from 62 percent a year ago,” explained Olivier Hache, EY Managing Partner, Transaction Advisory Services, Mexico.
“Domestic market indicators support executives’ optimism, with sentiment up markedly across corporate earnings, short-term market stability and credit availability, and modestly for equity valuations.” In December, AMLO announced a coming stimulus package reportedly worth more than $400 billion over six years that would consider 1,600 infrastructure projects to “reactivate” Latin America’s second-largest economy.
For Mexicans and businesses alike, the form and timing of the investment, and the scale and ambition of the projects, could be the difference between waking up from a dream or a nightmare.
