CEO’s Executive Summary: January was a truly extraordinary month in U.S.-Mexico relations, with the relationship between the two countries arguably deteriorating to its most uncertain and tense point in decades. In fact, as this alert goes to print, new developments continue to undermine the relationship. President Trump has wasted no time in advancing his strongly protectionist views on trade, especially concerning Mexico, that began with his inaugural address and continued into his first days in office, where he issued Executive Orders withdrawing from the TPP, issuing instructions to commence building the infamous wall and instituting an immigration ban targeting certain Muslim countries. Despite Mexico’s attempts to keep the bilateral dialogue open—including by sending two top cabinet officials to begin discussions with the White House—President Trump doubled down on his prior statements and actions, suggesting by Tweet the Mexican president cancel his visit to D.C. unless he was prepared to commit to paying for the Wall. President Peña wasted no time in cancelling his visit, which was greeted with great public support in Mexico—a welcome development for the president whose public approval fell to 12% in early January. A subsequent hour-long phone conversation between the two leaders was first reported to have gone well to help cool down the rhetoric, but recent purported leaks of the transcript of the discussion, which have been denied by the Mexican foreign ministry, suggest a much more confrontational discussion that has the Mexican public and social media again outraged. Meanwhile, the Mexican Congress opens its spring session on February 1, as the nation begins to gear up for June 4 gubernatorial elections in three states, including the all-important State of Mexico. On the economic front, slowing growth and the uncertainties generated by the Trump administration threaten Mexico with a downgrade of its credit rating. On a positive note, the peso appears to have stemmed its recent slide, while a tax amnesty law promises to generate new investment.

Transition Watch

On February 1, by a vote of 56-43—said to be one of the most contested votes for Secretary of State ever—Rex W. Tillerson was confirmed as the 69th U.S. Secretary of State. Tillerson knows Mexico well from his years at the helm of Exxon Mobil, and while his confirmation testimony was largely limited to issues concerning security cooperation with Mexico, his statements suggest he has a solid appreciation of the importance of the U.S.-Mexico relationship. Other cabinet nominees continue to move through the process, though much more slowly than the White House would like. Most relevant to Mexico, Commerce secretary-designate Wilbur Ross revealed some of what the U.S. is apt to ask for in any renegotiation of NAFTA: fix “shortcomings” in environmental and labor standards, change the rules of origin in the auto sector and modify a procurement clause that opens up publicly funded U.S. projects to bids from Mexican and Canadian companies. Regarding the use of trade restrictions, Ross referred to himself as “not anti-trade” but “pro-sensible trade.” He insisted that tax and regulatory reform would be the administration’s first option to bring investment and production back to the United States. For Ross, tariffs have a “useful role” as a negotiating tool to correct “inappropriate practices.” He further stated that Commerce would “self-initiate” anti-dumping actions rather than wait for U.S. companies to register complaints. Ross clearly has the confidence of President Trump, who, on February 2 at a meeting with Republican congressional leadership, again railed against NAFTA, emphasizing the central role that Ross will play in renegotiating the deal.

The absence of confirmed cabinet and sub-cabinet officials has not kept the White House from engaging on substantive trade and other issues with Mexico. It appears that White House officials Jared Kushner, Peter Navarro (head of the new but still undefined White House Trade Council), Stephen Bannon and Stephen Miller have each participated in recent bilateral talks with senior Mexican officials. Sources suggest that Peter Navarro has played a particularly dominant role on trade-related discussions, placing substantial emphasis on concerns about trade remedies to address “unfair trade.” Most of the discussion to date has centered on issues related to manufactured goods, with virtually no reference to date to trade in services.

U.S.-Mexico Relations: A New Low?

In the week leading up to President Trump’s inauguration, Mexico began to lay out its negotiating position in anticipation of promised NAFTA renegotiation talks. President Peña Nieto noted that Mexico would bring “all the issues that define our bilateral relationship to the table in a clear signal that it would use U.S. reliance on Mexican cooperation in security and migration matters as leverage in those negotiations. At the same time, Mexico announced plans to diversify its trade away from the United States in preparation for possible adverse changes to, if not the dissolution of, NAFTA. Mexico has tried this in the past, but it hasn’t been easy given Mexico’s reliance on the U.S. to absorb more than 80% of its exports. But this time may be different. Mexico is accelerating negotiations with the European Union to update its FTA with Mexico, and President Peña Nieto has already ordered the economy minister to begin negotiations with the six TPP signatories with whom it does not already have an FTA. Stepping into the breach, several countries, including Spain and Japan, have expressed their solidarity with Mexico and reaffirmed their intentions to invest and do business there. Chinese state-owned auto maker JAC Motors has announced a $212 million deal to make Chinese SUVs in Hidalgo, Mexico. Meanwhile, Economy Minister Ildefonso Guajardo stated that Mexico would impose retaliatory tariffs in response to any U.S. border tax on companies importing goods from—or moving production to—Mexico. He went on to say that Mexico could pull out of NAFTA if a renegotiation did not advance Mexican interests, reaffirming what appears to be Mexico’s stated policy that “no deal is better than a bad deal.”

The deterioration of bilateral relations has moved at a lightning pace, despite Mexico’s best efforts and good intention to avoid it. As a parting gift to the Obama administration, and reflecting a desire to get off on the right foot with the new Trump administration, the Mexican government extradited drug kingpin Joaquin “El Chapo” Guzman to the United States on January 19. It also arranged for Foreign Minister Luis Videgaray and Economy Minister Ildefonso Guajardo to meet with White House officials on a January 25–26 visit to Washington, D.C. in advance of an anticipated visit by President Peña Nieto in Washington on January 31. For its part, the Trump Administration repeatedly sent strong and antagonistic messages to Mexico at every turn. It began by the President signing an Executive Order withdrawing the United States from the Trans-Pacific Partnership trade agreement. In the lead-up to that order, the White House hyped the President’s intention to sign a similar order instructing the U.S. to commence the renegotiation of NAFTA, but to date no such order has surfaced. Then, on the very day that Secretaries Videgaray and Guajardo arrived to initiate talks, President Trump signed an executive order initiating “the immediate construction of a physical wall” along the U.S.-Mexico border. Given Mexico’s sensitivity on this issue, the move was seen as a serious diplomatic affront.

Videgaray is reported to have told Trump adviser Jared Kushner that President Peña Nieto would have to cancel his trip to Washington if Trump insisted that Mexico pay for the wall. In the signing ceremony, Trump refrained from repeating this claim. Videgaray tweeted that he noted “a desire to work with Mexico” in the administration and a willingness “to reach agreements.” Guajardo said he believed the U.S. was interested in preserving NAFTA but updating it to strengthen the North American region.

But in a later interview aired on ABC news Trump said: “We’ll be reimbursed at a later date from whatever transaction we make from Mexico.” In response, and under heavy domestic pressure, President Peña Nieto put out a brief, diplomatic video statement on the President’s website. He forcefully criticized the wall as an unfriendly act and repeated his insistence that Mexico would not pay for it, but still left the door open to the January 31 meeting. Trump then tweeted that Peña Nieto should not come if he is going to refuse to pay for the wall. This left the Mexican President with no alternative but to cancel his visit to Washington. As the president of the Inter-American Dialogue noted, January 26 was “the worst day [in U.S.-Mexico relations] in memory.”

In an effort to save face, the White House insisted that the cancellation was a mutual decision. At the same time it floated the idea of a 20% border adjustment tax—a tax Trump has previously dismissed as too complex. Trump Press Secretary Sean Spicer argued this was the equivalent of a 20% tax on imports from Mexico, the funds from which could be used to pay for the border wall. This proposal generated massive push-back from U.S. importers, including the Koch brothers, and criticisms that U.S. consumers would ultimately be forced to foot the bill. The administration quickly backed away from the idea.

In what was first reported as a successful effort to reduce tensions, Presidents Trump and Peña Nieto spoke by telephone on January 27. The two talked for an hour, and according to statements issued following the call, they agreed to turn down the rhetoric and deal with their differences on the wall “as part of a comprehensive discussion on all aspects of the bilateral relationship.” Since then, neither side has publicly mentioned the border wall. Even so, on February 1, the AP filed an explosive report of the purported transcript of the call, alleging that President Trump had spoken in a hostile and extremely offensive tone to the Mexican president, calling into question the Mexican army’s competence and willingness to deal with the “bad hombres” and drug trafficking problems in Mexico. Citing an excerpt of the purported transcript, the AP reported that Trump threatened to send U.S. forces to do the job if the Mexicans weren’t willing or able to do it. While the White House has not denied the comments, instead characterizing them as “lighthearted” banter in the context of a “pleasant and constructive” dialogue with Mexico, the Mexican government, perhaps fearing further backlash against Peña Nieto, has flatly denied the authenticity of the account. Even so, the AP (and corresponding Mexican versions of the report) has created an enormous public relations crisis and public backlash in Mexico and on social media.

Mexican Domestic Politics

Meanwhile in Mexico, voices from across the political spectrum, including leftist politician Andrés Manuel López Obrador (AMLO), have expressed support for Peña Nieto’s decision to cancel the January 31 meeting and have called for national unity behind the president in this time of crisis. But Mexicans are also pressuring the president to take a tough negotiating stance. Voices as politically diverse as former president Ernesto Zedillo and current presidential candidates Jorge Castañeda, along with AMLO, have all suggested that it might be preferable for Mexico to leave NAFTA rather than weather a long process of negotiation, bilateral tension, and uncertainty. Interestingly, these voices are NOT pressuring the government to implement more protectionist policies but instead to diversify economic relations away from the United States. And in a rare press conference, billionaire Carlos Slim backed the government in its dealings with Trump, especially its call for an increased focus on developing the domestic economy.

With just a 12% approval rating according to the latest Reforma poll, President Peña Nieto has very little room to maneuver in either foreign or domestic policy matters. This could have the unintended benefit of giving Mexican red lines in trade negotiations an added measure of credibility. Due to the anti-Trump sentiment in Mexico, where the U.S. president has just 6% approval, the Peña Nieto administration will have a very little support for making concessions that appear to run contrary to Mexican interests.

The national unity in Mexico generated by the Trump administration has also overshadowed the protests against the gasoline price increase and public corruption which has persisted into mid-January. This moment may give Peña Nieto an opportunity to rally greater popular support behind his presidency for its remaining two years.

The Mexican Congress begins its spring session on February 1. Legislators will need to deal with several issues left pending at the end of the fall session including items related to the new National Anticorruption System (SNA) and police reform. Regarding the SNA, Congress must appoint the head of the Specialized Anticorruption Prosecutor’s Office. On police reform, Congress will decide if it should reduce the number of weak municipal police agencies by creating either a single, unified agency in each state or a mixed system that retains the municipal police from large cities. New items on the legislative agenda include measures to defend Mexicans in the United States from risks of deportation and discrimination under the Trump administration, an Institutional Revolutionary Party(PRI) initiative to reduce the size of the Congress, a National Action Party (PAN) initiative to cut the gasoline tax in half and an initiative from the left to reduce federal subsidies for political parties. This congressional session is probably the last chance to pass significant legislation until after the 2018 presidential election. Soon, politicking will make the compromises needed to form a legislative majority extraordinarily difficult.

Mexico is also gearing up for the June 4 state and local elections in four states. The State of Veracruz will elect new mayors, Nayarit and Coahuila will elect mayors, legislators and governors, and Mexico State will elect a new governor. The latter two states are the most important contests as they are states where the PRI has never lost a gubernatorial race. Mexico State is by far the most critical race for the PRI because its size and economic might has long provided a rich war chest for PRI presidential campaigns. As the last electoral contests before the 2018 presidential race, analysts argue that Mexico State is a must win for the PRI if the party is to have any chance in the race for the presidency. Early polls show a tie between the candidates of the PRI and the PAN in Coahuila. In Mexico State the PRI has the early advantage in what is shaping up to be a four-way race since an alliance among opposition parties never materialized.

Mexican Economy

The IMF and the World Bank revised down their growth estimates for Mexico in 2017 owing to tight monetary policy and the uncertainties created by the Trump administration. The IMF cut its forecast from 2.3% to 1.7% growth, 0.6% less than the October estimate. More optimistically, the OECD released a 2.2% growth forecast for 2017, arguing that a weaker peso will boost exports and thus growth. Formal sector employment reached a record high in December.

In an effort to stimulate a slumping economy, President Peña Nieto signed a January 17 executive order launching a tax amnesty law that will permit investors to repatriate capital to Mexico at a tax rate of 8%, well below the existing rates of 30–35%. To qualify, the money must be invested in fixed assets or in research and development, and must remain in Mexico for a minimum of two years. The government estimates it will generate $10 billion dollars in investment during the six months the measure will be in effect.

Still, Moody’s sees a 50/50 chance of a downgrade in 2017. Despite Mexican efforts to shore up fiscal stability following Moody’s 2016 warning of a possible downgrade, the uncertainties created by U.S. policies under President Trump are weighing on Mexico’s credit rating. Nor will it help that consumer prices increased 4.78%— the fastest rate in 18 years—during the first two weeks of January. Driven by a slumping peso and a huge jump in energy costs following the January 1 gasoline price increase of 20% (the “gasolinazo”), the benchmark Infosel poll now estimates inflation in 2017 will be 4.8%.

The peso hit a new record low of 22 per U.S. dollar in mid-January, before recovering and demonstrating surprising stability amid the open dispute between the United States and Mexico over a border wall and tariffs. It then rose after the hour-long January 27 Trump-Peña Nieto phone call, closing near 21 at month’s end. On the up side, a cheap peso could mitigate the impact of any border tax the Trump administration might implement. And in conjunction with efforts to send money before Trump’s threatened limits on remittance flows, it has helped strengthen remittance flows to Mexico. November flows were up 25% over the same month last year, December flows were up 6.2% and total 2016 remittances were up 8% over 2015, just short of $27 billion, a new record high.