Investment slowdown, peso weakening and higher interest rates
ROBBIE WHELAN
President Donald Trump's threats to rewrite the North American Free Trade Agreement and build a wall at the U.S. southern border are causing a reckoning for the Mexican economy before a single cinder block has been set or trade negotiation scheduled.
Mexican output growth is projected to slow to a near halt in 2017; inward investment has tumbled; the peso is down; interest rates and inflation are rising; and the nation's business and political leaders are asking whether they need a new economic model less dependent upon their northern neighbor.
Before the U.S. presidential election in November, Citibanamex forecast that Mexico's gross domestic product would grow by 2.3% in 2017. Since then the bank has twice lowered growth expectations, first to 1.8% and more recently to a paltry 1.2%, in part because of uncertainty over trade and investment relations with the U.S.
Surveys show rising pessimism among businesses. Citibanamex predicts gross fixed investment in Mexico will contract by 0.8% this year, after rising 4.6% in 2015. In the first nine months of 2016, foreign direct investment fell by 24% compared with a year earlier, according to the Bank of Mexico, as businesses that rely on cross-border commerce grew spooked by campaign criticism of free-trade deals even before the U.S. election. Since 1999, the U.S. has accounted for 46% of all foreign direct investment in Mexico, with Spain as the next largest single country investor at 3%, according to Mexico's Economy Ministry.
"The key word for 2017 is uncertainty," said Sergio Luna, chief economist for Citibanamex. "Manufacturers are going to prefer to have more clarity before they make any investments."
Another drag on growth has been higher interest rates: Mexico's central bank has raised interest rates six times over the last year in response to a weakening peso and concerns that the currency's decline is pushing inflation higher. Economists at PNC Financial Services Group warn that recession is likely in 2017.
Angst over the longer-term is tied to Mexico's dependence on exports, which account for a third of its economic activity. Some 80% of those exports go to the U.S.
"Any economy, in order to be healthy, has to be based on two engines of growth: the domestic market and the external market," said Economy Minister Ildefonso Guajardo in an interview in his Mexico City office Tuesday. "What do you do to strengthen the external engine? You have to diversify trade."
To that end, Mexico's leaders have recently sped up negotiations to secure expanded trade deals with the European Union and opened talks with Argentina and Brazil about the possibility of buying corn, wheat and soybeans from South American producers. That would ease their dependence on U.S. grain—especially advantageous in case of a trade war.
Some in Mexico's export industries see a silver lining in the decline of the peso, which has lost 16% of its value against the dollar since the beginning of May. Any border tax imposed by the U.S., the thinking goes, will be met with a devaluation that will be more than enough to keep Mexican goods competitive.
"Whatever tariff Trump puts on Mexican products, the peso is going to devalue enough to accommodate it," says Doug Donahue, who runs Entrada Group, a San Antonio-based company that offers business services and rents industrial parks to Mexican exporters, 40% of whom are automotive suppliers.
But the weak currency has a downside: Annual inflation jumped to 4.72% last month, the highest level in more than four years. Rising inflation is likely to prompt the central bank to keep raising interest rates, which crimps domestic demand.
One school of thought holds that Mr. Trump's protectionist stance might be the reality check Mexico needs to turn inward and invest in bolstering the domestic economy.
Nafta's critics south of the border point to the fact that Mexico's annual GDP growth since the deal took effect has averaged 2.6%, compared with 4.2% during the previous two decades. Poverty levels have remained roughly the same as before the free-trade era.
And despite recent reforms that opened up the energy and telecommunications industry and successfully attracted billions in foreign investment, Mexico faces significant barriers and risks associated with relying more on its domestic market, including high rates of organized crime, weak rule of law, a lackluster education system and political corruption.
In order to focus on internal growth, "there's a stronger need than ever for Mexico to keep at it with domestic reforms," says Christopher Wilson, a Mexico expert at the Wilson Center, a policy think tank in Washington.
Monica DeBolle of the Peterson Institute for International Economics points out that 60% of Mexican workers still work in the underground economy—where workers avoid taxes—despite government programs aimed at helping them access banking services and the social safety net.
"Mexico's consumers are very hand-to-mouth," Ms. DeBolle said. "Going from an economy that is export-led to a domestic-led economy would be really hard."
Others, including many of Mexico's top industrialists, believe the country's best chance is to divert Mr. Trump's attention to China, with which the U.S. ran a trade deficit of $347 billion in goods alone last year.
Eduardo Garza T. Fernández, president of Grupo Frisa Industrias, a steel manufacturer that exported roughly half of its $500 million in sales last year to the U.S., says Mexican producers should buy more of their supplies from within North America, rather than Asia, to reduce the deficit and sidestep Mr. Trump's ire. The idea is central to Mexico's approach to renegotiating Nafta.
"Things are going to be more expensive for Mexican companies," Mr. Garza said, "but there has to be more integration."
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