Will Mexico seize the moment and capitalize on nearshoring?

343

This year has not been good for most emerging economies that have felt the impact of rising interest rates, a slowdown in the global economy and a firm U.S. dollar. Amid this, Mexico is an outlier: Its economy has fared better than expected and its stock market has outperformed other emerging economies. 

The Mexican peso has also been one of the world’s strongest currencies, appreciating by 15 percent versus the dollar over the past 12 months. The peso has been supported by the Bank of Mexico maintaining a policy rate of 11.25 percent, which is well above the country’s inflation rate of 5 percent.  Increased remittances from the U.S. have also tipped Mexico’s current account into surplus providing added support for the currency. 

Mexico’s strong showing has coincided with heightened tensions between the U.S. and China, as well as supply chain disruptions associated with the COVID-19 pandemic. In the process, Mexico recently has overtaken China as the largest trading partner of the U.S.: Its share of U.S. imports now stands at 15 percent while China’s share has fallen to 14.6 percent as of July, down from a high of 20 percent in 2018. 

Foreign direct investment into Mexico is also on the rise: Greenfield foreign direct investment reached a record $40 billion in 2022, and it has increased by 40 percent in the first half of this year over a year ago.  According to FDI Intelligence, manufacturing projects accounted for more than half of last year’s tally, with automotive companies leading the way. U.S.-based companies accounted for 41 percent of the inflows, followed by 28 percent for Asian companies, many of which are seeking to circumvent tariffs and become more integrated into the North American market. 

One of the most heralded developments this year is Tesla’s announcement of plans to build a gigafactory in Monterrey, Mexico with the aim of producing an electronic vehicle for the masses that will cost $25,000. The latest plans call for a plant to be running by the first quarter of 2025 that will have an annual production capacity of 2 million vehicles and employ about 7,000 workers. The total investment is estimated at $10 billion dollars, which is twice the original estimate.   

Tesla’s plan is being hailed by the corporate media as a way of modernizing Mexican industry, and it has attracted other businesses to the country. The “multiplier effect” is apparent as companies that produce components such as electric parts, brakes and windshields are setting up or expanding operations in nearby areas. This has increased the need to expand infrastructure to alleviate strains as plants are being hit by power blackouts. 

Meanwhile, other carmakers including General Motors, Kia Motors and BMW have announced EV investments in Mexico since the start of 2021. In the process, industrial parks are filling up quickly not only in Monterrey, but also in other areas such as Mexico City and Baja, Calif. This shows up in a decline in nationwide vacancies to 2.1 percent last year, according to the Mexican Association of Private Industrial Parks. 

The big question is whether the surge in industrial activity will mark a turning point for Mexico’s economy, or whether Mexico will be unable to fulfill high expectations as it did in the early 1990s. Foreign investors were attracted to Mexico then, as the country’s finances improved and it was able to tap international capital markets after being shut out for a decade. However, the government was forced to devalue the peso in 1994-95 and Mexican banks incurred substantial loan losses. While the U.S. government came to Mexico’s rescue by providing assistance totaling close to $50 billion, foreign investors looked elsewhere for opportunities.  

The main allure for investors today is that Mexico has become a destination of choice for foreign companies looking to export products to the U.S. — commonly known as “nearshoring.” However, the federal government has been criticized for not being proactive in taking action to encourage foreign investment.  

Ryan Berg, director of the Americas Program at the Center for Strategic and International Studies, is one of the most outspoken critics of Mexican President Andres Manuel Lopez Obrador. Berg sees Obrador as an erratic populist who demonstrates little interest in promoting Mexico’s status as a manufacturing hub.  In assessing the Outlook for Mexico in 2024, Berg states: “In short, Mexico in 2024 looks economically stagnant despite the once-in-a-generation opportunity presented by nearshoring.” 

A related concern is that U.S.-Mexican relations have deteriorated during Obrador’s presidency, and there is a risk they could worsen over the next year and beyond with pivotal elections in both countries.  Mexico’s ruling party has selected Claudia Sheinbaum, former Mexico City mayor, to be its 2024 presidential candidate. She is a close ally of Obrador and recent voter surveys have her as the favorite to succeed him. 

Accordingly, while Mexico now is reaping the benefits from geopolitical developments, foreign investors must assess an array of risks within Mexico. One is the likelihood of policies being reversed such as has happened in Mexico’s energy sector or recent legislation that guts Mexico’s independent electoral institution. Another is the lack of physical security for goods that pass along the network of roads and highways going to the United States. One study contends that Mexican cartels rank as the nation’s fifth-largest industry. 

The bottom line is that views on Mexico’s prospects are split. Many economists and analysts see Mexico as poised for success because of its proximity to the U.S. As Ian Bremmer of the Eurasia Group observes, “Mexico is the country that stands to benefit the most from nearshoring.”  

Others, however, see significant problems. They include Sen Lindsay Graham (R-S.C.) who has stated, “The Mexican government is no longer in charge of most of their country. It’s a narco-terrorist state.” 

For the time being, an increasing number of companies are deciding that the opportunities outweigh the risks. The Mexican government, however, must address the country’s challenges to capitalize on the opportunities. 

Nicholas Sargen, Ph.D. is an economic consultant for Fort Washington Investment Advisors and is affiliated with the University of Virginia’s Darden School of Business. He has authored three books including “Global Shocks: An Investment Guide for Turbulent Markets.” 

Source: The Hill