Geopolitical Tensions Limiting the Auto Sector’s Recovery

The complex scenario that the Mexican automotive sector has faced during 2020 and 2021 as a result of the pandemic and its harmful economic effects has not dissipated. It continues to face serious challenges to its recovery in the near term, with an aggravating factor being the economic impact of the conflict between Russia and Ukraine, the initial effects of which have already been revealed.

Against the background of the strong impact that the pandemic had on the sector, which meant a contraction of 20.8 percent in total vehicle production[1] and 28.1 percent in total domestic sales during 2020, it is possible to infer that the result obtained throughout 2021 was not enough to reach the path of recovery toward pre-pandemic levels, due to various limiting factors that moved the market away from original forecasts.

Total production of vehicles ended 2021 with 3.1 million units, which is an annual reduction of -1.0 percent, partly due to the shortage of semiconductors for their integration into vehicles, among other elements that prevented the proper operation of the assemblers, such as the issue of energy supply (gas and electricity), as well as the performance of contagion with the appearance of the new variant of the Sars Cov 2 virus: omicron.

In this context, the sale of vehicles was also affected, feeling the effects of both the restriction in supply and the weakness in demand. Although the sale of light vehicles in the country closed 2021 in positive territory, with 1,014,375 units, an advance of 6.8 percent; this performance was just about half the projection at midyear that anticipated a possible advance of 12 percent. Something similar happened in the case of the heavy commercial vehicle market, although with a smaller gap. That segment registered a closing in 2021 of 31,970 units and an advance of 15.9 percent, in contrast to the 18 percent anticipated in the middle of the year.

From the supply side, the domestic market was affected by the shortage of both national and imported products, an impact that was reflected in the constant deterioration in average inventory levels, falling by up to 20 percent compared to 2020, and even 40 percent with respect to the optimal pre-pandemic inventory level (three months). Likewise, the balance against the estimates prior to the worsening of the inventory shortage, point to an affectation of 55,000 units in the total sale of vehicles.

As far as demand is concerned, there has been a significant weakening of consumer purchasing power. In 2021 alone, general inflation saw an annual increase of 7.36 percent, while automobile inflation reached 8.67 percent, closing with significant upward risks going forward, including the continuity of disruptions in international trade as well as the rise in the prices of commodities, highlighted in energy prices. In fact, data from the first half of February 2022 showed a persistent advance of general inflation in Mexico, standing at 7.22 percent after reaching 7.07 percent in January, while automobile inflation stood at 9.30 percent. Added to this restrictive landscape, which has an impact on consumption, are the forecasts for an increase in the reference interest rate, which on Feb. 10, increased 50 basis points to 6 percent.

In the performance of the labor market lies another factor of weakness for the internal market, where a significant reduction in the employed population in key income levels stands out.

According to the National Survey of Occupation and Employment, the percentage of the population employed at an income level greater than five minimum wages (MX$21,000 (US$1,000)) fell in 2021, from 5 percent of the total in 2018 to 2 percent. This implies that in this period, there were 1.1 million fewer people in this income range, which is a contraction of 47 percent. This data is relevant as it reflects the deterioration that the labor market has suffered in terms of a majority structure of occupation at low-paid levels and the collapse in the group of occupations with better incomes, which undermines the ability to directly spend on durable goods, specifically, vehicles.

Given this context, 2022 is anticipated to be a year in which the challenges and limiting factors imposed by the pandemic will persist. Such is the case regarding the uncertainty in the restoration of the supply of semiconductors to the industry, which has not dissipated; it will continue to be a restrictive element during the first half of the year. In addition, inflationary pressures will continue, with an emphasis on energy, this time exacerbated by the current conflict between Russia and Ukraine.

Regarding this last point, the increase observed in oil prices since the beginning of 2022 stands out. It is due in great part to the tensions between Russia and Ukraine that unfortunately led to Russia's invasion of Ukrainian territory on Feb. 23. Given these events, the price of West Texas Intermediate (WTI) stands at US$92.7 per barrel (dpb), while Brent is at $100.04 and the Mexican blend at $90.52[2] dpb, implying an average advance of 26 percent when compared to the levels registered at the end of 2021. These increases occur in a context that was already presenting upward pressure. According to the Commodity Markets Outlook of the World Bank, both energy and non-energy commodities had already registered in January 2022 an increase of 8.0 percent and 4.7 percent compared to December 2021 and an annual variation compared to January 2021 on the order of 73.6 percent and 20.5 percent, respectively.

With a weak performance, the domestic automotive market began 2022 with a drop in sales of light vehicles of 3.8 percent compared to January 2021 and a reduction of 9.1 percent in terms of production; this positioned the market at levels of a decade ago. The estimate for the internal automotive market in 2022 is for sales of 1,016,000 units, representing only a marginal advance of 0.21 percent against 2021.

The complex scenario described above suggests that the global and national economic situation may worsen in the coming months, which puts at risk the viability of reversing lagging demand, given the uncertainty in the arrival of the product, as well as the effect of an inflationary increase due to performance in oil prices and other commodities, which will undoubtedly affect both producers and final consumers.

Due to the foregoing, it is clear that the recovery of the automotive sector could be delayed. Such a delay in the reactivation of a sector that employs more than 2 million people and that contributes close to 4 percent of national GDP should be a factor of urgent attention in the face of attacks not only global in scope, but also internal ones that keep the market from reaching its potential.

[1] Including light and heavy vehicles

[2] Banco de México