As reported by the last one Atradius study, Mexico's economy was already performing weakly before the US presidential election in November 2016: GDP grew by only 2,3% last year mainly due to lower oil prices and production, tighter fiscal policies and low productivity growth. In this sense, the current internal political problems, in particular the instability in terms of security and widespread corruption, continue to have a negative impact on the level of business and consumer confidence, not to mention the uncertainty regarding future US policies.
Here then is that Mexican GDP growth expected to slow further this year to 1,5%. Remittances from Mexican workers to the US amount to about 25 billion dollars a year, the highest amount in the world: in this context, any obstacles to these transfers, such as a potential US tax, could reduce the net value of remittances, with an impact on consumer confidence and private consumption. However, the effect on the total economy would be limited as remittances represent only 2,2% of Mexican GDP. Furthermore, the weakening of the Peso significantly increased the value of remittances, on dollar wages, in local currency terms.
Mexico's economy is heavily dependent on the USA: the direct channels through which US policies could affect the Mexican economy are trade, investment and, to a lesser extent, remittances and immigration. Furthermore, Mexico is indirectly exposed to the broader global effects of President Trump's policies: this vulnerability is reflected in the higher swings in the Peso and the loss of confidence since the November election. Washington's protectionist rhetoric has been specifically aimed at Mexico and diplomatic relations have become rather turbulent; it is above all the uncertainty related to trade policies (what will be achieved and what would be feasible outside the WTO dispute settlement system) that has become a crucial issue with regard to Mexico's prospects. However, since January the situation has definitely improved as the US administration seems to want to adopt a more traditional and pragmatic approach in its trade policy. The level of business and consumer confidence has improved since February and March respectively, even if the outlook for Mexico remains uncertain. In 2015 direct exports to the USA accounted for over 80% of Mexican exports and 26% of GDP. The peso underwent a 15% devaluation against the US dollar in the period between the election of Donald Trump and his inauguration last January. However, after the inauguration of the new US President the Peso recovered and is currently the strongest currency in the world. Furthermore, the strong integration of supply chains between the US and Mexico could also have a negative impact on some large US companies and this could curb the imposition of penalizing tariffs by the US administration.
Despite the recent reassessment, inflation is expected to remain above the 4% target this year due to higher oil prices and base effects. In an effort to protect the currency and prevent further inflationary pressures, la Bank of Mexico increased the benchmark interest rate several times (from 4,25% in July 2016 to 6,50% at the end of March 2017), with a negative impact on domestic demand. At the same time, thanks to the depreciation of the exchange, Mexican exports have become cheaper in terms of dollars: last March, exports grew by 14,1% compared to the same period of the previous year. However, the positive effect has not affected all Mexican firms as a large share of the manufacturing sector's exports contain relatively more expensive US imports. Furthermore, firms that are dependent on imported goods and/or have unhedged dollar-denominated debt are pricing in a negative impact on their cash flows, with an impact on late payments. Difficulties in accessing credit limit the ability to repay interest and principal and/or roll over lines of credit and this could lead to a breach of financial obligations and even bankruptcy, especially in the case of companies that are already in crisis from the point of financial view. The situation could worsen in 2017 due to the increase in US interest rates, which will further increase external financing costs. In particular, companies active in the public construction segment are in crisis due to budget austerity, which began well before the Trump presidency: public spending cuts have led to the postponement of many infrastructure projects, including power plants and airports, and to reduce investments in the energy sector despite the recent reform. This trend could accelerate in the event of a further slowdown in the economy, driving up the number of defaults.
Mexico benefits from high foreign direct investments representing 44,3% of GDP and of which over 40% comes from the USA. Over the past decade, nearly half of these investments have been in the manufacturing sector, which is most dependent on NAFTA's integrated supply chains. And, according to analysts, the uncertainty related to the renegotiation and the feared abolition of NAFTA will cause a drastic reduction in investment in the manufacturing sector. Portfolio investment is equally high, accounting for well over 268% of the country's international reserves last year. Mexico is, therefore, vulnerable to swings in market confidence due to the short-term nature of this type of investment which could be reversed if the level of confidence falls, unlike long-term direct investment in assets. However, this high inflow of portfolio investment also reflects the level of development of the Mexican financial market. Here then is that Atradius expects foreign direct investment flows to remain robust over the medium term, including in the manufacturing sector. Furthermore, many US companies that produce in Mexico export to other non-US markets and should therefore not be affected by the imposition of customs duties by the US administration. In this sense, despite the structural problems, the competitive advantage of localization of production in Mexico could be preserved, to the benefit of medium/long-term investments.
