More than a year after NAFTA negotiations got underway, the only accomplishment was uncertainty. But when the Trump administration announced the US and Mexico had reached a preliminary bilateral deal without Canada it appeared to ease investor concerns in Mexico — at least for now.
“Investments into Mexico were suffering,” says Martin Castellano, head of Latin America Research at the Institute of International Finance. “Uncertainty took a toll on investment decisions.”
When Mexico’s economy contracted 0.2% in 2018’s second quarter, the central bank released its analysis that the weakness was worse than expected, but that a deal with the United States would help disperse the ambiguity.
A Bloomberg survey of CEOs and other decision makers underscored investor sentiment that not knowing what was going to happen to NAFTA was the biggest factor affecting Mexican investment portfolios. Nearly half (47%) of those polled cited the agreement as holding them back, more than any effects from the global economy (38%) or concerns with the new administration (14%).
Alvaro Araujo, a managing director at M&A consulting firm Alvarez & Marsal Global Transaction Advisory Group, points to car manufacturing as one area where the confusion was breeding indecision. “Some parts cross the border more than once during the assembly of a vehicle.” Without an agreement, he says, no one even knows what a car would cost.
A way out of the stand-off could help boost the political fortunes for two leaders: Mexico President Enrique Peña Nieto could use a win to bring a bright note to his last days in office, while Donald Trump might like to move the conversation to other topics that could show progress on the US Republican agenda.
Mexico and the US decided to leave Canada out of what became a bilateral negotiation, with the intention of presenting Canada with a mostly “take-it or leave-it” proposal.
Trying to strike a deal
As of presstime, US/Canada negotiations were ongoing, if somewhat contentious. But by August the US and Mexico seemed to have reached an understanding. “After a verbal announcement of an agreement, the importance of the NAFTA issue has declined among global financial investors,” says Marco Oviedo, head of Latin America economic research at Barclays.
Granted, the old version of NAFTA is still the law of the land, and a final version may even drop the name, which Trump says has “negative connotations.” Congressional approval is needed from all three countries before any change can be made to the 1992 accord.
But with or without the Canadians, and even without a final confirmation, the fact that Mexico and the US agreed to something is what matters to investors. “The details may change, but knowing that there is a will provides certainty,” says Castellano.
“It is a relief,” adds Araujo. “We are working on prospective transactions in the region and I do believe this message will help a lot.”
“Mexico deserves most of the credit for saving NAFTA,” says Peter Hakim, president emeritus and senior fellow at the Inter-American Dialogue. “Its government understood Mexico would have to make concessions to Trump’s demands—that accommodating Washington was better than losing NAFTA, which is too important to Mexico’s economy to put at risk.”
What the future holds
With 80% of its exports going to the US, and trade representing more than a third of GDP, Mexico can’t afford not to keep trade flowing north.
To be sure, the agreement tweaked some major details. But most observers felt the new pack simply revised the 24-year-old NAFTA. Luis Manuel Martínez, senior director at S&P Global, says that the announcement, although still lacking details, indicates that the virtual single North American supply-chain created by the three-way marriage will not be seriously disrupted.
The auto industry is a clear example of supply chain without borders, with assembly parts crisscrossing between countries multiple times until a vehicle becomes a single unit.
According to the Mexican auto association, the industry represents 16.9% of Mexico’s manufacturing sector. And 80% of the auto-sector production is for export, mainly to the US and Canada.
Martínez says changes to NAFTA could even bring more investment to the region, and to Mexico, thanks to a local content clause. The new agreement will require 75% of material used to make cars – steel, plastics, etc. – to come from North American suppliers, up from 62.5%.
Another section requires that 40% to 45% of a vehicle must be made by workers earning more than $16 an hour. Since Mexican hourly wages average below $3, the deal basically guarantees that, at least for the next few years, almost half of car assembly be done in the US or Canada.
“Most of the new agreement is already in place when you take into the account Detroit’s big three are already operating in Mexico,” says Martínez. “It doesn’t look like these requirements would bring disruption to the auto industry supply chain network.”
Diversifying trade
Of course, in an economy the size of Mexico’s, “the auto industry isn’t everything,” says Martínez, noting “the incoming government has talked about investment in agriculture and energy.”
And the United States (and Canada) isn’t the only viable trading partner. To Oviedo, although NAFTA does give Mexican goods access to the world’s largest market, “its relative importance has been decreasing with all other economies promoting free trade.”
Castellano says Mexican companies are working to diversify their portfolio of trade partners and indicates South America can offer growing demand for Mexico’s cars and agricultural products. “Argentina and Brazil are potential markets,” he says.
With neighbors to the south facing their own homegrown crises and some local economies still shaky, though, Mexico may have to rely a bit longer on US consumers. LF