By Naomi Waistell, manager of the Polar Capital Emerging Market Stars Fund
We have heard the phrase ‘a Mexican moment’ plenty of times before. The Mexican equity market experienced a similar period of strength between 2013 and 2015 as former President Enrique Peña Nieto swept to victory on a tide of optimism and enthusiasm. His administration was pro-business, pro-growth and based on an extensive agenda of constitutional reforms deemed vital for economic health. Chief among these was energy reform which offered a new vision for the sector, including the possibility of private sector investment to boost growth.
However, all this ended in disappointment. Energy partnership investments and growth did not come and the consequences of high inflation from liberalised energy prices caused economic damage. Enter President Andrés Manuel López Obrador (AMLO) in 2018, who won the election on a platform of reversing many of these reforms and promising to renationalise the energy industry. Of all leaders, AMLO seems an unlikely figurehead for another Mexican moment and there are signs he is not comfortable with the role. However, there are also increasingly clear signs that he understands this opportunity is one not to be wasted.
The landmark 1994 North American Free Trade Agreement (NAFTA) helped Mexico deepen its trade relations with the US and make its manufacturing sector, as far as the US was concerned, one of the most important. This flourished until China’s accession to the World Trade Organisation in 2001 reduced the pace of Mexico’s growth with the US market. More recently we have seen a reversal of that trend, with Mexico benefitting from caution regarding China, both in terms of a China Plus One strategy for companies’ FDI (foreign direct investment) and from capital market investment flows. We believe the new United States/Mexico/Canada Agreement (USMCA) which succeeded NAFTA in 2020, should continue to boost this vital trade partnership.
The world changed decisively in 2022. Russia’s invasion of Ukraine cemented the shift in supply chains that was already underway. The creeping compounding of factors such as President Trump’s tariffs, the pandemic and USMCA, together with other geopolitical tensions, particularly between the US and China, were made irreversible by the outbreak of war. The market disruption caused by these layering trade barriers highlighted the level of dependence on certain strategic regions for supply-chain stability and threw into question the viability of current trade systems. The benefits of bringing production back closer to the point of consumption have started up again for the first time in decades.
Mexico has all the ingredients to be ‘the factory of the Americas’ in the same way China was once dubbed ‘the factory of the world’ and in doing so take market share from China’s current share of exports to the US. While it is almost impossible to conceive of any location or hub replicating what China has built up, if the US is to be able to re-engineer its supply chain to incrementally reduce exposure to China, the most viable solution is most likely via Mexico. Importantly, recent major US policy including the CHIPS Act and the Inflation Reduction Act support nearshoring.
The opportunity appears vast. However, to maximise chances of success there are a number of bottlenecks Mexico needs to address first. It is likely that the initial growth will come from familiar areas in which Mexico has developed experience and sound markets, such as autos and consumer electronics. Announcements of investments into auto facilities are currently leading the charge, accounting for some 50% of FDI and it is expected that production of electric vehicles in Mexico could at least double this year.
There is criticism that the pace of progress is being held back by the astonishing lack of drive from government to stop this opportunity and grease its wheels. There is a myriad of policies the government could use to help growth from nearshoring, yet they have been reticent to do so. The political decision not to go ‘all in’ to maximise their moment is not easily understood.
There has also been a great deal of concern as to whether Mexico, and specifically the northern states most exposed to nearshoring, will have access to adequate supplies of quality labour and consistent, reliable electricity to meet the level of anticipated demand. The country is also experiencing material internal economic migration from the south to the north, as well as immigration from other South American countries. The labour participation rate dropped slightly during Covid but it is coming back again, so while the market is tight and wages are increasing to support that (minimum wages have risen 100% under AMLO), there are no reports of labour shortages for the types of task that will be required.
If Mexico is able to perform in the way it has done previously and achieve this much against the odds of decades-high interest rates and a President that curbs rather than courts investment, there should be excitement at the prospect of both of those factors being removed relatively soon, just as the real nearshoring effects start to be more visible in data and a realisation emerges about how powerful those improvements could be in unleashing the full growth potential of this new Mexico moment.
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