June-July 2017

CEO Executive Summary: U.S. Trade Representative Robert Lighthizer formally notified Congress of the Trump administration’s intention to renegotiate NAFTA beginning Aug. 16. While he and his Mexican counterpart set Dec. 15 as a target completion date for the negotiations, the talks are likely to extend into 2018. This tight time frame suggests NAFTA will be updated rather than revamped, and the resolution of a bilateral sugar dispute bodes well for finding solutions to less contentious trade issues in the upcoming talks.

The performance of the Mexican economy continues to be mixed. The government revised upward expected growth for 2017, but the increase is forecast to be just 1.5% to 2.5% due to weak foreign and domestic investment and high interest rates to combat inflation. Despite this, the peso-dollar exchange rate fell to 18 largely due to declining political risk. And while the private energy sector continues to report exciting advances, Mexico’s petroleum reserves, production and exports all continue to fall.

The approach and aftermath of the June 4 state and local elections dominated Mexican politics in recent months. The elections covered four states, including the State of Mexico, the country’s second most populous state, which was too close to call just days before the election. The ruling PRI party squeaked out a victory in this race, but while the PRI survived, it did not thrive. Its vote total was half of what it had been just six years ago. Meanwhile, the Morena party of Andrés Manuel López Obrador doubled its vote tally in just two years, finishing just three points behind the PRI. This outcome reaffirms López Obrador’s front-runner status for the 2018 presidential election. Meanwhile, challenges to the election results forced the Mexican Congress to postpone until July a special summer session to address anticorruption and security legislation.

U.S.-Mexico Relations

On May 18, U.S. Trade Representative Robert Lighthizer informed Congress of the administration’s intention to renegotiate NAFTA, setting in motion the required 90-day consultation period prior to the start of negotiations. It also initiated the public comment period and set June 27-29 as the dates for a public hearing to help identify U.S. negotiating priorities.

Unlike an early draft of the letter, the contents of which was leaked to the press in late March, Lighthizer’s letter to the congressional leadership was thin on specifics. It pointed to support for “higher-paying jobs” and growing the U.S. economy as core objectives of the renegotiation. And it called for modernizing NAFTA by “including new provisions to address intellectual property rights, regulatory practices, state-owned enterprises, services, customs procedures, sanitary and phytosanitary measures, labor, environment, and small and medium enterprises” without providing any additional details. It instead promised to work closely with Congress to determine those details. According to the Trade Promotion Authority legislation, the administration must present to Congress its specific objectives for the trade talks at least 30 days before the start of negotiations, which are slated to begin on Aug. 16.

On May 31 and again on June 19, U.S. Commerce Secretary Wilbur Ross expressed optimism about the coming negotiations and suggested they could be finished by December or January. A late May meeting between Lighthizer and Mexican Economy Minister Ildelfonso Guajardo set Dec. 15 as the target date for completing the negotiations to give the Mexican Congress and the U.S. Congress sufficient time to approve the new agreement before Mexico’s next president takes office on Dec. 1, 2018. But in his June 21 Senate testimony, Lighthizer noted that while all parties want to complete these negotiations as quickly as possible, it was likely that they would extend into 2018.

Given this tight time frame, it seems unlikely that the negotiators will make substantial changes to the current text of the agreement. Such a short timetable instead suggests that NAFTA will largely be updated, with the text of the Trans-Pacific Partnership forming the basis for much of the revised agreement, as suggested by Secretary Ross. The talks will inevitably be complicated by March’s record U.S. trade deficit with Mexico, since the Trump administration believes all trade deficits are bad for the United States. The Mexicans, however, have expressed a willingness to accept some “rebalancing” of its trade surplus as long as it is done “through trade expansion, not through trade restriction” according to Guajardo.

On June 6, Mexico and the United States concluded negotiations to modify a 2014 sugar agreement that lowered quotas and raised the price floor on Mexican refined sugar exports to the United States. The U.S. sugar industry hesitated to accept the agreement, however, forcing a final tweak a week later. The agreement enabled the two countries to resolve one of the most contentious issues in the U.S.-Mexico trade relationship. In the process, it avoided sanctions that were threatened by the United States and the Mexican retaliation that would have resulted and would have complicated the upcoming NAFTA renegotiation. Meanwhile, Mexican efforts to find new sources for its agricultural imports led to large reductions in its U.S. imports of soy flour, corn and chicken during the first four months of 2017.

On June 20, Ford announced it would move small car production to China instead of Mexico. The firm argued that the decision was based exclusively on cost projections rather than on concerns the Trump administration would penalize the company for moving production to Mexico.

The eighth annual U.S.-Mexico CEO Dialogue in early June launched the U.S.-Mexico Economic Council to further enhance the bilateral economic and trade relationship.

Mexican Economy

On the heels of higher-than-average first-quarter growth, April retail sales in Mexico registered their fastest expansion since late 2016, reflecting consumer confidence that increased for the fourth straight month in May. This unexpected performance convinced the Mexican government and the Bank of Mexico (Banxico) to revise upward their growth estimates for 2017, from between 1.3% and 2.3% to between 1.5% and 2.5%. This economic activity drove up company earnings and helped push the Mexican stock market to record highs in May.

Other economic signals indicate that growth will remain muted this year. Growth has been driven by consumer spending, which is expected to wind down, rather than by investment. Indeed, Mexico’s leading companies plan to reduce their level of investment in 2017 due to uncertainty over the future of trade with the United States. And foreign direct investment fell to less than $8 billion in the first quarter of 2017, its lowest level in eight years, and public investment fell 9.1%. Still, foreign construction investment tripled in the first quarter as firms took advantage of public-private partnerships in the sector, while leading multinationals operating in Mexico say they no longer fear the collapse of NAFTA and plan to continue investing.

Growth will also be limited by high interest rates designed to keep inflation in check. Inflation reached an eight-year high in the first half of June, a 6.3% annualized rate, and is expected to stay above 6% throughout the summer. In this context, the Bank of Mexico twice increased its benchmark interest rate an additional quarter point, first on May 18 and again on June 22, to a current level of 7%. In support of the Banxico’s inflation-fighting efforts, the finance ministry announced that the government cut spending 2.3% in the first quarter and increased its primary surplus by 76%. Inflation is expected to begin to decline in the last four months of the year, and Banxico Governor Agustín Carstens insists that he will leave inflation on a clear trajectory to 3% before he steps down as head of the central bank on Nov. 30.

Despite a sharp drop in oil prices, rising U.S. interest rates, Brazilian-generated instability in Latin America money markets and Moody’s recent alert regarding precarious finances in nine Mexican states, Mexico is benefiting from an inflow of capital that has strengthened the peso. In part, the peso’s value reflects government efforts to ensure macroeconomic stability, the IMF’s reaffirmation of Mexico’s flexible $86 billion emergency credit line and Mexico’s healthy foreign exchange reserves, fed by continued growth in tourism and remittances. But the main driver of a peso-dollar exchange rate at its strongest level since the election of President Trump is reduced political risk. The defeat of the Morena candidate in the State of Mexico election and political problems that have weakened President Trump and limited the implementation of his trade agenda together pushed the peso-dollar exchange rate to a recent high of 17.9 on June 16 before settling in at 18.1, its strongest level in more than a year.

Finally, business, unions and the government are discussing a July 1 increase in the minimum wage to help recoup its purchasing power, degraded by inflation since the minimum wage was last raised on Jan. 1 this year.

Energy

A new narrative highlighting private investment in the petroleum sector and Pemex restructuring now exists alongside persistent reports of declining petroleum reserves, production and exports in Mexico. A private company began drilling for oil in Mexican waters for the first time in 80 years, and the National Hydrocarbon Commission authorized Pemex’s first on-shore joint venture projects and scheduled auctions to select Pemex’s partners for Oct. 4. Also, on June 19, twelve firms from ten countries won the right to develop 10 of the 15 shallow-water tracts available in the first phase of the country’s second round of petroleum auctions. These contracts should collectively generate nearly $8.2 billion dollars in investment.

There are also more private gasoline stations in Mexico and private investments in gasoline storage. And while Pemex and the Energy Regulatory Commission indefinitely postponed opening gasoline pipelines connecting Mexico and Texas to investment by private participants, 22 firms lined up to rent pipeline capacity to import gasoline, which will be auctioned off later in 2017.

In the electricity sector, the energy ministry noted that 20% of Mexico’s electricity currently comes from renewable resources and pledged to increase Mexico’s clean energy capacity by 165%, upping solar capacity by 54% and wind by 460%. Meanwhile, bidding has been postponed until the end of 2017 for the construction of a transmission line between the Isthmus of Tehuantepec and the center of the country.

Finally, billionaire Carlos Slim’s Giant Motors is working with a Mexican electric vehicle maker and four Mexican universities to develop a prototype electric taxi designed to reduce air pollution in Mexico City.

Mexican Politics

Mexican politics in recent months has been dominated by the June 4 state and local elections in four states. In these elections, the ruling PRI party emerged victorious in the all-important State of Mexico election and in a very close race in Coahuila. A coalition between the National Action Party (PAN) and the Party of the Democratic Revolution (PRD) won handily in both Nayarit and Veracruz. Financial markets cheered this result, pushing up the peso’s value more than 1.5% the day after the election.

The State of Mexico election was seen as a crucial test of the PRI in a place that has long formed the bedrock of its political power. And while the PRI survived, it did not thrive. The PRI’s vote count was just over half of what it received six years ago, and its margin of victory fell from 20 percentage points to just three points. Delfina Gómez, the candidate from Andrés Manuel López Obrador’s Morena party, finished second, doubling her party’s vote count in the state from just two years ago. Morena is now the first or second political party in Mexico’s two most populous states, Mexico City and the State of Mexico, a fact that reinforces López Obrador’s front-runner status for the 2018 presidential election.

López Obrador immediately denounced the electoral fraud he believes denied his party victory, demanded a complete recount of the vote to uncover this fraud and promised a fight to overturn the result, albeit without “violence or confrontation.” In the state of Coahuila, the second-place PAN candidate also denounced fraud in his PRI opponent’s narrow 1.5% margin of victory and is fighting to overturn the result. It is unlikely that the results will be reversed in either state, but the postelection conflicts are apt to further weaken confidence in electoral authorities.

As a result of the disputed election results in the State of Mexico and Coahuila, a decision on whether to hold a much-needed special session of Congress has been postponed, with it unlikely that one would begin before July. This special session would address legislation left pending following the April 30 close of the last session. Congressional leaders are currently haggling over what should be included on the agenda and when the session should start. There is general agreement that Congress must take the final steps needed to create Mexico’s anticorruption system, including establishing a new Attorney General’s office, naming the country’s anticorruption tsar and its 18 anticorruption magistrates, and providing a budget for the new system. But there is less agreement on security matters. The PRI is demanding the president’s National Security Law be considered in any special session, while the PAN insists the session also debate its proposed police reform in the states. The PRI, with the strong support of Morena, has also refused to consider a PAN proposal for a constitutional reform to permit a second round of voting in the 2018 presidential election.

Finally, three headline-grabbing events in May/June were a reminder of the security challenges facing Mexico. A violent incident in Puebla between army troops and petroleum thieves drew attention to an endemic and growing problem—organized criminal siphoning of an estimated 27,000 barrels per day of gasoline from Pemex pipelines. The May 15 murder of journalist Javier Valdez, presumably by a drug cartel, was a stark reminder of the insecurity, especially for journalists, and criminal impunity that persist in much of Mexico. And on June 19, the New York Times published a front page article reporting evidence of the Mexican government’s use of sophisticated spyware to eavesdrop on journalists, an anti-corruption activist and human rights defenders. This final incident undermined further the already weak public confidence in the Peña Nieto administration.

Events, Speeches, Publications

May 19: MJGS Chairman Ambassador James R. Jones participated in the CEO Dialogue’s North American Competitiveness Leaders meeting.

May 22: MJGS Managing Director Andrew Rudman commented on the U.S.-Mexico sugar dispute in the Latin America Advisor, publication of the Inter-American Dialogue.

May 24-27: MJGS President and CEO Michael Camuñez led a delegation of 25 members of the Pacific Council on International Policy to Mexico as part of the Council’s Mexico Initiative, which Camuñez chairs.

May 24: MJGS Chairman Ambassador James R. Jones was a featured speaker at a CitiBanamex meeting in Washington, D.C.

June 14: MJGS Chairman Ambassador James R. Jones moderated Arizona Governor Doug Ducey’s keynote presentation at the "Building a Competitive U.S.-Mexico Border" conference hosted by the Wilson Center's Mexico Institute and the Border Trade Alliance.

June 15: MJGS, in conjunction with Manatt, Phelps & Phillips and Canada’s Tactix, launched a trilateral NAFTA newsletter.