CEO’s Executive Summary: This longer-than-normal update covers an eventful few weeks in the Trump transition and in Mexico. The President-elect has nominated or appointed a team responsible for key aspects of U.S.-Mexico relations composed of individuals who appear receptive to sustaining the cooperative and collaborative character of the bilateral relationship, notwithstanding Mr. Trump’s continued posturing on trade and the infamous “wall.” For his part, President Peña Nieto chose Luis Videgaray, his closest adviser, architect of Donald Trump’s visit to Mexico, and a strong proponent of a cooperative approach to the new U.S. administration, to be Mexico’s Foreign Minister. The combined impact of uncertainty over the future of NAFTA, rising interest rates and a falling peso indicates that the Mexican economy has a tough year ahead. And the popular protests against a January 1 gasoline price increase, which have dominated headlines thus far in 2017, are a clear indication of the challenging political context Mexico will face in 2017 as well.

Transition Watch

In December and early January, President-elect Trump made a series of selections for key posts in his administration with direct relevance to U.S.-Mexico relations. These include Marine Corps General John F. Kelly to lead the Department of Homeland Security, Exxon CEO Rex Tillerson to be Secretary of State, former Texas Governor Rick Perry for Energy Secretary, UC Irvine business professor Peter Navarro to head the new White House National Trade Council, and trade lawyer Robert Lighthizer to be the U.S. Trade Representative.

For Homeland Security, Trump selected retired four-star General John F. Kelly. Gen. Kelly’s tough tone on border security—as well as his stated concern that terrorists might take advantage of Mexico’s criminal networks to attack the United States—makes him a good fit for the approach thus far laid out by the new administration. His career experiences should prepare him to lead a department whose broad scope of responsibilities includes several that directly impact U.S.-Mexico relations: immigration, customs, border protection, and drug enforcement. Gen. Kelly has worked with Homeland Security agencies and their Mexican and Canadian counterparts, developed expertise on the Mexican security situation, and coordinated with regional governments to fight transnational organized crime. Gen. Kelly is expected to win Senate confirmation. While Gen. Kelly is undoubtedly well qualified to run the department, one concern is whether his bias toward security issues may delay or disrupt more business-friendly trade facilitation initiatives that have been launched under the Obama administration.

For Secretary of State, Trump has tapped former Exxon CEO Rex Tillerson. If confirmed, Tillerson will be the first Secretary of State without any prior experience in the public sector. A career Exxon employee, Tillerson rose through the ranks to take leadership of the firm in 2006. In that role he managed Exxon’s dealings with a diverse group of countries and regimes, developing skills that will serve him well as Secretary of State. His experience also included exposure to Mexico, its sociopolitical context, and its economic—particularly energy—reforms. Still, protecting a company’s private interests is quite different from advancing U.S. national interests. Tillerson faces a potentially contentious Senate confirmation.

Turning to Trump’s trade team, the President-elect appointed Peter Navarro to lead the new White House National Trade Council. A sharp critic of China, Navarro coauthored the Trump campaign’s economic plan with Commerce Secretary-designate Wilbur Ross. Nor is Navarro a fan of NAFTA, calling the original deal “Shafta,” although he toned down his criticism following the 1993 passage of the Clinton administration’s side agreements on labor and the environment. In a 2016 commentary for CNBC penned with Wilbur Ross, he blamed NAFTA for the loss of over 700,000 U.S. jobs since it was signed in 1993. Little is known about the role, function or authority of the National Trade Council at this point, or how it will relate to existing interagency coordinating mechanisms typically managed by the National Security Council’s International Economic policy deputy.

The final member of Trump’s trade policy triumvirate is Robert Lighthizer, nominated to be the U.S. Trade Representative. A longtime proponent of border taxes on imports to protect domestic industries from competition, Lighthizer brings to the team four decades of firsthand experience as a trade policy litigator and public servant. Like his trade policy counterparts, Lighthizer’s concerns have focused on China much more than on Mexico, which suggests he might be receptive to the Mexican government’s argument that Mexico should be viewed as a strategic partner in U.S. efforts to face down competition from China.

U.S.-Mexico Relations

Beyond Cabinet appointments, two other transition developments merit attention due to their significance for U.S.-Mexico relations. The President-elect met with Mexican businessman Carlos Slim at the latter’s request. The two apparently reconciled their deep campaign-era differences, opened a friendly line of communication, and raised hopes for a thaw between Trump and Mexico’s business elite.

This was followed by a quiet meeting between Trump’s son-in-law, Jared Kushner, and Luis Videgaray, President Peña Nieto’s closest adviser and former Treasury Secretary. The Mexicans requested the meeting to ascertain what the Trump team expects from Mexico. According to sources, the conversation left the Mexicans optimistic that it will be possible to build a productive relationship with the new administration.

This may have informed Peña Nieto’s January 4 decision to appoint Videgaray as Mexico’s new Foreign Minister. Videgaray replaced Claudia Ruiz Massieu, whom the Trump team saw as hostile and confrontational, in contrast to Videgaray’s perceived conciliatory and cooperative approach toward Trump. Videgaray brings to the post proven negotiating skills, expertise in economic matters, and the respect of Kushner, who will be a senior White House adviser to the President. Videgaray has been tasked by President Peña Nieto “to accelerate dialogue and contacts” to set the groundwork for “a constructive working relationship.”

Mexican Economy

The December Mexican manufacturing index dropped to its lowest level since June 2013, with new orders falling to their lowest level since the 2009 recession. Together with a further decline in consumer confidence for the 11th straight month—these are indicative of falling Mexican economic activity led by declining exports and falling investment. Fiscal constraints have contributed to the decline in public investment, while weakness in economic fundamentals and uncertainty about the impact of Trump’s Mexico policies have stalled private sector investment.

With regard to foreign investment in Mexico, President-elect Trump’s recent string of tweets criticizing U.S. manufacturers that produce in Mexico, including promises to impose a border tax on GM and Toyota imports from Mexico, seems to be having a limited impact. Anecdotal evidence suggests that many small- and medium-sized U.S. firms have slowed investment plans out of an abundance of caution. Nevertheless, while Ford reversed a previous decision to move its small car production to Mexico seemingly under pressure from Trump, a number of large firms are continuing to move forward with Mexican investments. For example, General Motors, Toyota and Honda announced they have no plans to cut back investment or production in Mexico. Citigroup restated its commitment to investing $1 billion in its Citibanamex operation, albeit possibly at a slower pace. Wal-Mart announced an increase to its previously announced $1 billion investment to $1.3 billion, and Delta finalized its merger with Aeroméxico. Meanwhile, many other foreign firms, such as Germany’s BMW, have reiterated their commitment to investing in Mexico.

Regardless of how Trump’s Mexico policy plays out, most analysts expect a tough year ahead for the Mexican economy. The Central Bank’s benchmark interest rate increased from 3.25% to 5.75% in 2016, stifling both investment and consumption. It is expected to rise further in February to curb inflationary pressures emanating from sharp gasoline and electricity price increases (discussed below), a nearly 10% increase in the minimum wage, and a 20% drop in the peso/dollar exchange rate in 2016 (and its continued weakness in early 2017). The worrisome trend in the peso continues in the opening days of 2017, reaching new historic lows, despite Bank of Mexico intervention.

New Uncertainty and Increased Social Unrest

Energy Price Increases

In the energy sector, price increases have drowned out good news. Pemex, still basking in the glow of its recent successful auction to select its first-ever joint venture partner for deepwater exploration, easily placed a US$5.5 billion bond issue at lower-than-expected interest rates. Meanwhile, oil prices hit 18-month highs, with benchmark crude reaching $54/barrel early in the new year before falling back to $52—good news for cash-starved Pemex, but bad news for Mexican consumers.

But the energy story dominating the news—and earning public ire—in Mexico is the sharp increase in energy prices, driven by the combined impact of eliminating price subsidies as mandated by the 2013 energy reform, increases in global petroleum prices, and the depreciation of the peso.

Last November, the Congress moved up the elimination of gasoline and diesel price subsidies from 2018 to this year. The process began January 1 with double-digit price increases for gasoline and diesel (14% for regular, 20% for premium and 16.5% for diesel). The size of the increase—referred to as the gasolinazo—reflects rising oil prices, Mexico’s reliance on gasoline imports from the United States (which hit a record high in October), and last year’s 20% depreciation of the peso. This initial adjustment will be followed by two more in early February before hourly free market-style adjustments begin on February 18. The ultimate transition to market-determined prices will occur region by region beginning later in the year.

Nearly concurrent with the announced gasoline price increase, the Federal Electricity Commission announced a 2.6%-4.5% increase in electricity rates—for a whopping year-over-year hike of 53% for industrial users, 37% for commercial users and 25% for residential users. This increase was driven by rising natural gas prices, the main fuel used in electricity production in Mexico today, and the peso’s weakness, as the vast majority of Mexican gas is imported from the United States.

Popular Protests

The fuel price increases have been greeted with widespread public anger and protests. Protests organized by left-leaning opposition politicians against the gasolinazo in the first days of the year, including blockades of highways, urban streets, gas stations and distribution centers, spun out of control leading to three days of looting. Hundreds of stores were looted, thousands more closed out of caution, and over 1,500 looters arrested.

Beyond the looting, peaceful protests have persisted and touched virtually every Mexican state. Mexicans are incensed that as they are being asked to pay higher prices for gasoline, government officials and politicians receive huge year-end bonuses, including coupons for free gasoline, while doing little to bring corrupt governors to justice.

The private sector immediately complained about the impact of the increase on its bottom line. Business leaders presented a list of 23 priority measures that the government should take to counterbalance the negative impact of the price increase on competitiveness and called for a meeting with government officials to discuss measures to overcome the crisis. The January 9 meeting also included labor leaders and produced a tripartite pact to contain the negative impact of higher gasoline prices on Mexican families’ income by limiting price increases for other basic consumption products. The agreement also pledges the government to cut the salaries of senior government officials by 10% and private sector to encourage capital repatriation.

Politicians of all stripes, including some PRI governors and senators, have registered their opposition to the gasoline price increase. Interestingly, however, most politicians have NOT called for a reversal of the price liberalization process but rather for actions to mitigate its impact on consumers. PAN politicians have promised to introduce legislation to cut fuel taxes in half when Congress reconvenes on February 1. PRD politicians are demanding that price liberalization be postponed until 2018 to allow for a more gradual phase out of subsidies and have called for a national protest on January 15 to demand this change. And all are attempting to transform anger over the gasolinazo and government unpopularity into support for their party in the 2017 gubernatorial elections and the 2018 presidential contest. In particular, Andres Manuel Lopez Obrador has blamed the price increase on the energy reform and corruption, arguing that the only solution is the “peaceful overthrow” at the ballot box of the “corrupt regime” that allowed this to happen.

The government, meanwhile, has largely held its ground, arguing that the price increases merely reflect rising global energy prices and that eliminating subsidies is “pro poor” because gasoline subsidies mostly benefit the rich. While the government is not expected to backtrack much, a weak and unpopular government has been unable to mollify its critics.