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Analysis

Plateful Of Uncertainty, Optimism

Wed, 02/21/2018 - 09:12

The implementation of structural reforms early in the administration of President Enrique Peña Nieto opened the door to new investment possibilities, allowing the revamping of strategic sectors that had been neglected, such as energy and oil and gas. This continued in 2017 but external politicking, including the renegotiation of NAFTA, ensured an unsteady ride throughout the year.

According to the World Bank, Mexico ranks 15th among the world’s economies, with a US$1.04 trillion GDP at end of 2016. The International Monetary Fund (IMF) estimates Mexico's 2017 GDP will rise 2.1 percent, pumping up its April forecast by 0.4 percent. Mexico’s expected growth is well above the average for Latin America, which is forecast to advance at a 1.2 percent clip. Among the reasons for upward expectations, the IMF notes that despite the uncertainty generated by NAFTA’s renegotiation and a downward revision for US economic activity, Mexico’s economic performance for 1Q17 was better than expected. 

In the 1990s, exchange rates between the peso and the US dollar were the main thermometer of the economy. Sudden devaluations meant that an economic crisis was down the road. Such was the case in 1982 and 1994, when accumulated devaluation of the peso hit 470 percent and 44 percent respectively. These devaluations were followed by an economic crisis in both instances. While it cannot be said that the 21st century has been without upheaval, the US-peso exchange rate prior to the 2008-09 financial crisis averaged MX$10.41. Global economic dynamics and the policies implemented by the US Federal Reserve had led to a gradual increase in dollar strength against its Mexican counterpart but the pre-election protectionist rhetoric and subsequent election of real-estate billionaire Donald Trump to the White House threw a wrench in the system. Starting in 2016, the peso slid from MX$17.35 to MX$20.71, peaking in Jan. 2017 after Trump’s inauguration at MX$21.9. 

But whereas in the past crisis would follow the peso’s slide, this time around has been much different. Despite some nervousness about the direction of US policy and its impact on Mexico and the peso, Carlos Rojo, CEO of Grupo Financiero Interacciones, says the latest exchange rate ride has become an opportunity. “All the movements we have seen in the exchange rate have translated into competitiveness,” he says.

DOUBLE-EDGED SWORD

While a weaker peso has favored exports, Banxico has warned that it has also impacted inflation. 2015 ended with recordlow inflation of 2.13 percent but in 2017 alone it has shot up to 6.66 percent. Higher fuel prices have had a significant impact, but the increase in prices associated with an expensive dollar have taken its toll in inflation. Still, the fact that 2017 has been a complicated year does not mean that 2018 is bound to repeat the same story. Banxico’s September 2017 Expectations of Specialists in the Private Sector Economy Survey says that 2017 is expected to end with inflation values close to 6.30 percent. When asked about 2018, most experts believe inflation will fall by 3.79 percent, with an exchange rate of MX$18.15 by the end of 2018. Despite inflation and 

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a fluctuating exchange rate, most business leaders believe that the country’s macroeconomic foundations are among its best assets. “When it comes to managing the macroeconomic foundations of the country, authorities are doing a good job. Banxico is taking appropriate measures and public finances are under control,” says Reynaldo Vizcarra-Méndez, National Managing Partner of Baker McKenzie.

The country’s top business leaders believe that Mexico offers other advantages such as its demographic bonus. Nuno Matos, CEO of HSBC Mexico, says that having a large population allows Mexico to reduce its dependence on exports. “With a population of 125 million and a relevant demographic advantage, Mexico has the opportunity to develop its internal market.” Ernesto Torres, CEO of Citibanamex, says that in addition to its demographic bonus, it is important to consider the population’s purchasing power. “There are many elements that make Mexico one of the countries with the best growth prospectives among emerging markets, for example, a large and dynamic internal market. According to the World Bank, the average income of Mexico’s population is medium high, which creates great opportunities.”

A COUNTRY OF REFORMS

After President Peña Nieto took office in 2012, he quickly moved to introduce a package of reforms that would reshape much of the country’s industry. Under the Pacto por México (Pact for Mexico) moto, congressmen approved the series of reforms aimed at modernizing some of the country’s most strategic industries. The reforms were applauded by the private sector for their potential to modernize the country and change the prospects for sectors that had been neglected in terms of investment due to the lack of participation from the private sector. Vizcarra-Méndez says that the reforms might be “one of the greatest achievements of the present administration,” and believes they are among the reasons for the country’s economic prospects. “Without them we would not have such a positive growth outlook.” IMF expects that full implementation of structural reforms will lead to an increase in real GDP of 2.7 percent in the medium-term. 

In addition to providing a positive image of the country, Ildefonso Guajardo, Minister of Economy, says that the reforms are acting as a catalyst for new investments. “The set of structural reforms carried out by President Peña Nieto’s administration have paved the way to attract domestic and foreign investments in strategic sectors,” he says. Gerardo Familiar, President of the Chemours Company, believes the reforms offer particularly interesting opportunities in the oil and gas sector. “Thanks to the Energy Reform, the oil and gas industry will generate an economic boom in the country in the coming years.” Energy was not the only industry to benefit from the reforms. Legislative changes also touched the telecommunications segment. Pablo Coballasi, PC Capital 
Managing Director, says the Telecommunication Reform has allowed a more dynamic market. “It allowed competition and lower prices in the market,” he suggests. 

For all the good the reforms are doing in terms of investment, an improved regulatory framework is needed to ensure competitiveness and judicial certainty. “The Ministry of Economy has implemented several measures to ease doing business in Mexico,” says Guajardo. “For example, it has worked to reduce regulations and facilitate investment in sectors where FDI was previously restricted, such as telecommunications and energy; it has increased accessibility and transparency at the Public Registry of Commerce and Property and has promoted the use of electronic platforms to ease processes related to FDI registry.” 

DIVERSIFY, DIVERSIFY, DIVERSIFY

After NAFTA came into effect in 1994, Mexico became host to several companies eager to export production to the US, taking advantage of the one-of-a-kind agreement. Almost 24 years later, the country’s commercial relationship with the US is no longer the sole reason for attracting companies from across the world, which is why some suggests the potential changes in NAFTA, or even its demise, can be weathered. “The investments made in Mexico by the likes of Audi or BMW are not only aimed at the US market but worldwide. This shows that even though NAFTA is important, it is not everything,” says Edmund Duckwitz, President of the German-Mexican Chamber of Commerce and Industry (CAMEXA). 

Mexico has a network of 12 free-trade agreements with 46 countries, 32 agreements for the Promotion and Reciprocal Protection of Investments with 33 countries and nine agreements of limited scope. The prospect of losing the treaty with Mexico's largest trade partner is a headache but the business community agrees that changes will force the country to broaden its horizons. “The biggest issue in the market is uncertainty. Even though the scenery is very challenging, it will bring us a historic opportunity to move out of the comfort zone in which we settled years ago with the US,” says Roberto Cabrera, Managing Partner of Industries and Markets of KPMG. Among the factors that led to such comfort, Cabrera lists not only NAFTA but the large Mexican community that lives in the US. “That comfort zone has also made us tolerate situations like bad administrations and corruption, so the current scenario is full of opportunities.”

Breaking bad habits is not easy, and in the case of Mexico, weakening its relationship with the US might be easier said than done. Still, there are a number of markets where Mexico could turn its attention. “The first approach and simplest should be Latin America. A second target should be Europe because of its economic potential and size. Finally, a third target could be Asia. Countries like China are complicated to do business with but the current situation is making China look at us,” says Cabrera. 

The government also believes that the need exists to look elsewhere for partners. “President Peña Nieto’s administration expects to diversify Mexico’s trade agenda with potential markets,” explains Guajardo. To do this, a number of actions have been put in place, such as strengthening commercial ties with the European continent and Latin America. “We are modernizing our 15-year-old trade agreements with both the EU and the European Free Trade Association countries. In Latin America, we are deepening existing agreements with Brazil and Argentina and the Pacific Alliance,” says Guajardo.

While the NAFTA renegotiation has been marked by belligerent speech from President Trump, Duckwitz says that renegotiation with the European Union obeys simply to a matter of updating the conditions to present needs. “There will not be any major changes related to the economies of both regions. This treaty already encompasses several important sectors; however, there were many others that were left out of the original agreement, such as the agricultural sector, which will be included with this modernization.”

Although Europe and Latin America offer significant opportunities for the country, Guajardo says that the AsianPacific region stands out. “The Asia-Pacific region is a priority for Mexico. However, since TPP’s entry into force is uncertain, Mexico is exploring alternate paths.” To this end, the category of Associate State of the Pacific Alliance was added in March 2017 in an attempt to negotiate more trade agreements with countries in the Asia-Pacific region. “Australia, Canada, New Zealand and Singapore are the first four candidates to become Associate States of the Pacific Alliance,” says Guajardo.  

A WORLD WITHOUT NAFTA

Should NAFTA be terminated, what would happen to Mexico? The question has been going around ever since Trump said that “Mexico has taken advantage of the US for long enough” 
and announced his intention to renegotiate or even drop out NAFTA. The declarations raised a red flag among the business community, but after a storm, calm usually settles in. “For Mexico, the US market is important but Mexico is also very important for the US. It is completely inaccurate to say that NAFTA only benefits Mexico,” says Duckwitz. 

Few believe that an outright termination of NAFTA will occur. “Our view is clear: there will be a NAFTA 2.0. We believe there will be some changes in rules of origin and labor standards and we will see the incorporation of sectors such as energy and e-commerce,” says Matos. Still, the important thing is to remain calm. “We sometimes forget that we are dealing with a giant and that we need to be really smart about how we handle the renegotiation,” says Vizcarra-Méndez. Negotiations were expected to conclude before the end of 2017 but over the months it has become clear that they will carry into 2018. “The renegotiation will have to unfold at its own pace. It would be unfortunate if the timetable were affixed to the 2018 Mexican presidential elections but US and Mexican presidential elections are merely junctures and they should not distract from the agenda,” adds Vizcarra-Méndez. 

It is important to note that NAFTA’s third particpant, Canada, also plays a significant role in Mexico’s economy. “Mexico has achieved a lot thanks to NAFTA but also thanks to the bilateral and trilateral relationships of the North American bloc. NAFTA has been a keystone of the trilateral relationship but the economies are so close and complementary that the relationship will continue regardless of what happens with NAFTA,” says Raul Martínez-Ostos, Chairman of the Board and Director General of Grupo Financiero Barclays México. Regardless of the outcome, most business leaders agree that investments are here to stay. Grupo Financiero Interacciones’ Rojo says: “People investing know they are here for the long run and they understand that what the country is experiencing now is a volatile process, but structurally speaking, the country is in good shape and the reforms, will completely change the face of the country.”
 

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