May 2017

Mexican Eyes Look Anxiously Northward

President Trump’s election and possible changes in trade relations with the U.S. have dampened the prospects for Mexico’s economy

By Dan Markham, Senior Editor

Donald Trump’s surprise rise to the presidency, and the election’s ultimate effect on the manufacturing sector, is the subject of much debate in the United States, but it isn’t only the U.S. that is feeling the Trump tremors. Mexico’s economy, and its steel industry, are anxiously awaiting the policies of a new president whose electoral success was built, in part, on anti-Mexico rhetoric. With Trump’s stated desire to tear up the North American Free Trade Agreement and to impose tariffs as high as 35 percent on goods coming into the U.S. from Mexico, the Mexican industrial sector is in a state of considerable uncertainty.

GDP growth in Mexico, which ran near 2.5 percent in 2016, is expected to tumble because of that uncertainty. Earlier this year, Platts S&P forecast growth of 1.8 percent for Mexico in 2017. Banco de Mexico, in its recent survey of leading domestic businessmen, placed the country’s growth at just 1.5 percent. The story is the same for steel. Both analysts and industry participants expect modest growth in Mexican steel consumption in 2017, somewhere near 2 percent.

The fallout from anti-trade rhetoric in the U.S. election, delivered not just by Trump on the Republican side but also by Democratic runner-up Bernie Sanders, began in the second half of 2016. Foreign direct investment, especially in the automotive industry, declined by 20-25 percent in 2016, with much of the slowdown taking place in the second half.

“Several of our contacts in the manufacturing industry are concerned about what will happen and are postponing some of their investment projects,” says Jesus Canas, an economist in the research department at the Federal Reserve Bank of Dallas. “They need to know if the rules are going to change and how it will affect them.”

Most analysts believe the market’s nervousness is overblown and that any eventual action will fall well short of the political rhetoric.

“Anything that comes out of this will most likely just be an improvement on NAFTA, rather than a repeal,” says Elijah Oliveros, an economist specializing in Latin America for S&P Global Ratings. Adds Canas: “There is room for improvement, but all three countries have gained from this agreement.”

Some in the Mexican industrial sector are confident the basic foundation of NAFTA will remain in place. “We aren’t very worried. We are good business partners,” says Ubaldo Ortiz de Los Santos of steel distribution company Acerotek in Nuevo Leon. Alejandro Reyes Castrejon of Monterrey-based Villacero adds, “the industry understands that any action involves consideration of many factors likely to affect the U.S. market.”

Most business leaders in the United States also continue to support NAFTA. While many back Trump’s proposals to reform the tax code and take a hard line on China, they are less enthusiastic about tearing up the trade pact that has streamlined commerce between the U.S., Mexico and Canada for the past 23 years. At the recent Platts Steel Conference in Chicago, none of the speakers defended making wholesale changes to NAFTA.
The possibility of new tariffs is more likely, though how they’re enacted and at what rate remains a source of debate. Some experts say the market could adjust to a 20 percent tariff, but a 35 percent tax on Mexican goods entering the United States could be devastating.

Tariffs leveled at any rate will prompt Mexican manufacturers to look for alternative buyers for their goods. “If there’s a tax, it’s a natural strategy to go look for new partners where you don’t have that tax,” says Thais Terzian, a consultant for CRU on the steel industry in Latin America. “It’s difficult to see where they can develop better markets than the U.S., where they can sell that many cars, but they will look.”

Radically overhauling the U.S.-Mexico trade partnership would not just have negative effects on companies with operations in Mexico, but U.S. businesses, as well. Mexico is the export destination of choice for half the U.S. states. Texas has become the nation’s leading exporter, with its cities close to the Mexican border taking significant advantage of NAFTA. In 2015, Texas exports reached $247 billion, far outpacing the next-largest exporting state, California, with $163 billion.

Commenting on the steel industry, Terzian says changes in the trade relationship will have a greater effect on Mexican producers of sheet products rather than long products. Production and consumption of long products, including rebar, is more internal.

While Mexico’s construction industry has been mired by bankruptcies, and debt issues cloud the scale of government infrastructure investment, Terzian is optimistic about the long-term outlook for construction. “There is going to be private investment in Mexico, as they have a lot to develop and build. We expect long product demand to keep growing through 2021.”

Mexico’s infrastructure needs are significant, reports S&P Global Ratings, and must be addressed regardless of what happens with NAFTA. It ranks Mexico 57th out of 138 countries in terms of quality of infrastructure, well behind its North American peers. “In order to boost growth and improve competitiveness, Mexico must continue to invest in infrastructure,” reports S&P.
Independent of the effects of U.S. policy, the Mexican industrial economy is on track for slower growth in 2017. “In the first half, we’ll see slightly lower growth than last year. The second half should be about the same,” predicts Castrejon.

Automotive production remains at very high levels, though persistently low gas prices have nudged U.S. consumers toward trucks and SUVs and away from smaller vehicles. That hurts the Mexican auto industry, which holds a greater share of the small vehicle market compared with its U.S. counterparts.

Low oil prices hurt Mexico in another way. The economy in the south, concentrated in the states of Campeche and Tabasco, is heavily dependent on energy production. Oil drilling in the region has fallen by about 50 percent from its peak and is not expected to bounce back as quickly as in the United States. “The decline in oil production is going to weigh on the overall economy,” Oliveros says.

However, Mexico’s partially state-owned energy industry is undergoing significant reforms designed to spur greater private investment. Once fully implemented, the oil and gas market is expected to resume healthy growth. “Changes that allow more competition and foreign investment could spark regional growth in energy-dependent areas like that seen in recent years in Texas regions such as the Eagle Ford Shale,” Canas says. Until then, Mexico’s energy market promises to remain sluggish even with higher oil prices.

Mexico is undertaking other economic reforms, including changes to labor and fiscal policies, that are welcomed by the steel industry. “We believe there will be steady upward growth in steel consumption with the structural reforms that are under way,” Ortiz says.

This is consistent with a general optimism over the long-term outlook for Mexico’s steel sector. “The national steel industry has made significant investments in recent years to meet the requirements of different industries such as automotive, white goods, construction and other steel consumers. The supply of domestic steel products will continue to grow,” says Cesar Estrada Solis, director of Canadiac, the trade association representing the Mexican steel distribution industry. Oscar Reynoso of National Material of Mexico adds that distributors are seeing some supply hiccups this year with production constraints at the mills, but he believes the tightness will be short-lived.

While the election of President Trump raised eyebrows, Mexico’s state and national elections in 2017 and 2018 will have a more direct effect on the country. The upcoming vote in the state of Mexico is drawing considerable attention, as it’s expected to be a bellwether for the federal balloting the following year. Like in the U.S., there are some strong anti-globalization voices in the race. “The rhetoric is similar to what we have here in the U.S., with calls for protectionism instead of openness. It’s going to be interesting,” Canas says.

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