Yesterday’s News: Contingency Plan

The future of United States-Mexico economic relations is up in the air after Donald Trump’s surprising victory in the United States presidential election.

As the Wall Street Journal reported, this uncertainty is reflected in the mood of businesspersons in Mexico. Some, like the former head of the Banco de Mexico Guillermo Ortiz, believe that “as a businessman, Trump will listen to [the business community].” However, others are less certain.

“All long term investment will be put on hold until Trump’s protectionist policies are unveiled, and their impact clearly understood,” said Armando Santacruz, a Mexican businessman.

The uncertainty in the business sector is reflected in Mexican monetary policy as well.

Exchange Rate

The Mexican peso has fluctuated throughout this election. As it had done in the past, the peso fell last night by 13 percent to more than 20 pesos per US dollar.

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The peso has fallen in value since last year; typically falling as Trump surged – the spikes in the graph above – and gaining, especially in the last month, when it appeared that Hillary Clinton had a clear path to the presidency.

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About a week before the US election, the peso started to lose ground against other major currencies. This loss was initiated by a tightening in the polls between Donald Trump and Hillary Clinton and the United State Federal Bureau of Investigation’s announcement that it was looking into a new cache of emails relating to their closed investigation into Clinton’s use of a private email server as Secretary of State.

The day after the election, as Reuters reports, Mexican officials did not announce a plan to support the peso.

Interest Rate

Economists are consistently predicting that the Mexican Central Bank will raise interest rates in the coming months. The contention lies in the question: By how much?

Just after midnight, Reuters reported speculation by three economists that the Banco de Mexico would raise rates between 75 and 150 basis points. However, any rate hike seems to have been postponed until the previously scheduled November 17 meeting.

Contingency Plan

Agustin Carstens, the Governor of the Banco de Mexico, said before the election that he was working with the Finance Minister on a “contingency plan” in the event of a Trump victory.

However, after Trump’s victory the contingency plan appears to be a “wait and see” strategy.

After an initial dive in after-hours trading, the US stock market has recovered as investors come to terms with the electoral upset.

Although there is past precedent to suggest that the plan may include strong interventionist policies, such as the interest rates swaps used in 2008.

Given the uncertainty in the United States and abroad regarding what comes next, the relative calm among Mexican monetary authorities may be the best plan of action for the next week.

Inflation vs. Growth: Colombia’s Inaction

The Central Bank of Colombia (el Banco de la Republica) announced that “after assessing the risk balance for inflation and growth, the Board of Directors deemed appropriate to maintain the benchmark interest rate unaltered.”

This decision contrasts Brazil’s recent decision to lower the benchmark interest rate in an effort to improve economic growth (see “Yesterday’s News: Brazil’s Dilemma“). However, these two opposite decisions make perfect sense when you look at economic growth in Colombia and Brazil.

Inflation

As reported by Reuters, data from the Central Bank on inflation show a large drop in September compared to July: 7.27 percent and 8.97 percent, respectively. However, inflation remained higher than 3 percent higher than the Central Bank’s target of 2 to 4 percent.

Data from the Central Bank of Colombia show how inflation has risen in the past two years. Colombia has seen inflation rise and fall several percent every few years over the last two decades. The latest spike in inflation began in late-2014 and has been attributed to the fall in oil prices and rise in food prices. Bloomberg reports that “Colombia’s annual inflation rate continued its sharp drop toward the central bank’s target as food supplies improve following a drought, and a stronger peso cools the rise in import costs.”

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In order to combat inflation, the Central Bank slowly raised the benchmark interest rate from September 2015 through July 2016. At its last meeting in September, the Central Bank left the benchmark interest rate unchanged at 7.75 percent.

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Brazil has struggled in recent years to control inflation, which remains above 8 percent. However, Brazil’s Central Bank (Banco Central do Brazil) predicts a steady fall in inflation for the next 10 quarters and falling within its target by 2018.

Economic Growth

In its World Economic Outlook for October 2016, the International Monetary Fund predicts that Colombia’s economy will expand in 2016 and 2017, while it predicts the Brazilian economy to contract in 2016 and grow slightly in 2017.

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Colombia’s modest growth means that it can afford to prioritize inflation reduction over economic growth, unlike Brazil. However, if Colombia’s modest growth falls in the near future, it may pressure the Central Bank to interest rates.

Indeed, one member of the Central Bank’s board of directors (Junta Directiva) has said as much. El Portfolio reports that the board member “noted that data for the last month show that the balance of risks is tilted towards slower growth than to inflation.”

The recent (in)action by the El Banco de la Republica to maintain interest rates shows its prioritization of inflation control over economic growth. However, its decision was a cautious one and one that, as the board member points out, may need to be reaccessed if growth begins to slow.

Cruising Along: the Mexican automotive industry

Mexico is currently in the middle of a manufacturing boom and the automotive industry is leading the charge (for greater detail, check out Cruising Along: Mexico’s export sector).

The automotive industry is a powerhouse of the Mexican economy. In 2015, Mexico exported US$25.8 billion in vehicles with a gasoline powered engine capacity of fewer than 3 liters, which is 28% of its total exports within the HS-87 category.

In addition to proximity to and a favorable trade environment with the US, companies locate their factories south of the border for several other reasons.

First, the cost to manufacture vehicles in Mexico is much smaller due to lower wages. A 2014 estimate suggests that auto workers in Mexico make roughly US $5.25 an hour, which is about a third of their American counterparts. The lower labor costs allow car manufacturers – for example, the big three in the US – to make a profit their smaller vehicles while keeping production of their larger, more profitable SUVs and trucks in their home country.

Second, just like in the United States, the national and state governments of Mexico have offered foreign car companies generous incentives. However, there has been political pushback against such incentives. The most recent and well-known incident occurred in Nuevo Leon, where the newly elected governor complained loudly about a nearly $100 million incentive package agreed to by his predecessor.

Third, domestic consumption in Mexico has become a driver of growth. In 2015, 1.3 million new units were sold in Mexico, which was a 19% change from the previous year. Furthermore, as reported by the Wall Street Journal, the recent uptick in production in June was due partly to “strong domestic demand for new cars.”

A rising standard of living – US$5,750 GNI per capita in 2000 to nearly US$10,000 in 2015 – has contributed to an increased demand for vehicles in Mexico. A strong domestic market for domestically manufactured vehicles small vehicles protects the auto industry foreign market volatility. This has taken greater significance due to the recent shift in consumer preference in the United States from small cars to large vehicles.

For these reasons, it is unsurprising that several car companies and their subsidiaries announced their intention to heavily invest in Mexico. For example, Kia recently opened a US$1 billion new plant near Monterrey, Nuevo Leon approximately 120 miles from the US border. Their new factory will eventually build 300,000 vehicles per year, primarily for export.

Another recent announcement came from Audi. The subsidiary of Volkswagen will invest €1 billion (US$1.1 billion) to expand its production capacity in the state of Puebla. In addition to traditional gasoline vehicles, Audi plans to eventually build an electric version of the Audi Q5.

Production was low in the first four months of 2016 and production is expected to remain flat relative to last year’s numbers.

However, the next few years look promising. Production capacity will reach new heights as the Kia, Audi, and other companies’ factories fully come online around and after 2020.

Although there have been instances of labor issues in the automotive sector, the benefits from investment in automobile manufacturing in Mexico have been tremendous. A 2015 estimate suggest that auto workers in Mexico earn approximately US$8 and US$10 per hour with benefits; roughly three times the national minimum wage of 73.04 pesos per hour (US$3.84 at the current exchange rate).

As this article and the data in Cruising Along: Mexico’s export sector show vehicle manufacturing has been and will continue to grow in Mexico. Along with this growth will be an expansion of the middle class built upon manufacturing in several industries. Much like in the United States in the mid-20th century, vehicle manufacturing will be at the center of this economic boom and will provide benefits across the economy.

The middle-class dream is within grasp for many Mexicans in no small part due to the growth of manufacturing, especially for the men and women on making cars on the assembly line.

Cruising Along: Mexico’s export sector

During the presidential election in the United States, the US’s trade deficit with Mexico has been cited as a major concern. Unfortunately, political stump speeches are often bereft of the nuance necessary to adequately address international trade issues. The purpose of this article is to provide data and analysis to help readers better understand some of the nuances of the Mexican economy and export sector.

This article begins with background information on the Mexican economy. Next, it digs deeper into the most recent data on Mexican exports. Finally, it ends with a brief analysis.

Background

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Mexico straddles several geographic areas: North America, Latin America, Central America, the Caribbean, and the Pacific. The Mexican economy is bolstered by this geographic diversity in terms market access – the United States via land, Asia via the Pacific, and the European Union via the Atlantic.

In terms of gross domestic product and population, Mexico is the second largest country in Latin America. The capital of Mexico – Mexico City – is the second largest metropolitan zone in Latin America with more than 20.6 million residents – or 18.6% of the country’s total population – in the metropolitan area. The Mexico City metropolitan area – primarily the Federal District and the state of Mexico – is the most economically important region in Mexico. The area constitutes roughly a quarter of Mexico’s total GDP (Brookings).

The second most economically important metropolitan area in Mexico is Monterrey, Nuevo Leon. Nuevo Leon is a northern state with a small border with the United States at Colombia, Texas just west of much larger border cities of Nuevo Laredo, Tamaulipas and Laredo, Texas.

Monterrey’s economic success is due in large part to its proximity to the United States and the economic relationship between the US and Mexico. These factors and state support have encouraged the massive, export-oriented industrial development in the border state.

Numerous trade agreements have encouraged companies to located facilities within Mexico in order to take advantage of geography, low wages, and a technically skilled labor market.

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Mexico has signed a number of free trade agreements and preferential trade agreements (OAS). The earliest and most important FTA is the North American Free Trade Agreement between Mexico, the United States, and Canada. Mexico has FTAs with more than 40 countries and economic blocs, including the European Union, the European Free Trade Association, the Pacific Alliance, and Japan (map 1).

In February 2016, Mexico signed the Trans-Pacific Partnership. Although Mexico already has FTAs with four of the other countries involved, the TPP will give Mexico greater access to Australia, Brunei, Malaysia, New Zealand, Singapore, and Vietnam. The sum of these six countries GDP is $2.31 trillion (World Bank).

These trade agreements have contributed to the manufacturing boom in Mexico. Despite the significant number of FTAs, Mexico’s export sector is still heavily reliant on the US market and on just a few types of goods.

Export Sector

What and where are important questions to ask when examining international. This section uses five graphs to answer two questions: what is produced, and to where is it exported?

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Where The vast majority of Mexican exports go to the United States (graph 1). Geographic proximity, the size of the US economy, and a favorable trade environment explain the dominance of the US market vis-à-vis Mexican exports.

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Exports are highly concentrated in three HS-categories: vehicles, electronic equipment, and machinery (graph 2). Vehicles and electronic equipment have accounted for at least 40% of Mexican exports since 2013 (table 1). This heavy concentration can leave Mexico in a vulnerable situation if there is a dramatic shift in policy or consumer preference in the recipient country. However, as graph 3 shows, the Mexican export sector has handled dramatic trade shifts in the recent past.

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There have been several significant changes in Mexico’s main export commodities in recent years (graph 3). Mineral fuels, oil and electronic equipment exports as a share of total exports fell harshly since the start of the Great Recession. Since the same period, vehicle exports have grown as a share of total exports.

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Eighty-nine percent of vehicles exported in 2015 went to Mexico’s two other NAFTA partners with 84 percent going to the US and 5 percent to Canada. The United States and Canada have captured roughly 90 percent of vehicle exports from Mexico since at least the early-1990s.

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US domination in vehicle exports shown in graph 4 is not the end of the story. Graph 5 shows that growth in exports to other countries has outpaced growth in exports to the US since approximately 2004. However, while exports to the US have continued to grow, exports to the rest of the world have fallen since their peak in 2012.

Conclusion

Economic liberalization policies in the late-20th century contributed to the boom in manufacturing that is still going in Mexico. While the Mexican export sector is heavily dependent on the US market, it is fairly well diversified in three broad manufacturing categories.

This article has illuminated the “what” and “where” of Mexican exports. Turning to the “how” requires an in-depth look at the most important at the domestic policies and key businesses that affect the most important export category: vehicles.