Under pressure
Mexican trade is under pressure, despite an investment grade status and a privileged trade relationship with the US. The ever-present shadow of China is one factor threatening Mexico‘s trading environment. Luis Waldmann reports.
In short, two components make up Mexico’s foreign trade: the country borders the US, home to the largest economy in the world; and it and pumps nearly as much oil as Iran. So the main challenges ahead for Mexico are to grip more tightly the US market, which already buys 85% of all Mexican exports, and to ratchet up crude production.
Mexico is Latin America’s biggest exporter, selling abroad almost double the amount Brazil does. However, Mexican exports are under strong pressure and oil output may start declining soon.
China is flooding the US with cut-price electronics, auto parts and textiles, the same products Mexico used to be very competitive at. In fact, the US has been importing more from China than from Mexico since 2003, according to the US Department of Commerce.
And state oil monopoly Petríleos Mexicanos (Pemex) is strapped for cash despite high oil prices.
Still, country risk as measured by the OECD is comparable to that of Saudi Arabia and lenders are confident enough to comb small and medium-sized customers for better margins.
Mexico is also the leading importer in Latin America, bringing in three times more than Brazil.
Underwriting challenges
As a result of Mexico’s excellent sovereign rating, top-quality risks are priced at very low rates,says Lin Franklin, president of credit insurer FCIA in New York.
Besides Mexico, only Chile boasts an investment grade rating in the region. Top-level risks include government-owned entities, banks and investment-grade private companies, he notes.
Conversely, pricing for middle-market companies is much higher, reflecting the smaller size and limited amount of reliable credit and financial information, combined with a legal system that doesn’t work for creditors, Franklin says.
“The weak transparency in much of the middle market and the poorly functioning legal system make Mexico one of the most difficult underwriting challenges for our underwriters,” he complains.
And obligor risk in Mexico is often worse than that in countries like Brazil, Franklin comments. “In Brazil, the overall quality of FCIA’s obligor risk is probably better than Mexico, but the political risk for the Brazilian portfolio is higher,” he explains. “In general, my view is that the higher the country rating, the lower the quality of obligor risks we will be requested to insure.”
If there is no concern over the country risk, the insured then faces only the obligor risk “and they will select the weaker risks on which to buy insurance,” Franklin adds.
FCIA can write business in Mexico up to five years, although demand for such cover tends to be on middle-market companies to which support is generally limited to three years, he says.
Mexico is FCIA’s largest foreign exposure and key sectors include paper and agricultural products, and chemicals. Its portfolio in the country is a mix of first and second-tier companies, Franklin remarks.
PRI and trade credit
Insurer Zurich covers companies in the US selling to Mexico as well as banks and investors financing those exports, says Dan Riordan, executive vice-president and managing director of the emerging markets unit at the insurance company. The bulk of its portfolio amounts to political risk insurance and trade credit, he comments, and spans such industries as telecommunications, general manufacturing, and oil and gas.
“Given that Mexico is investment grade, it would not be considered by most investors to be the riskiest place to operate,” Riordan says. “They do often have high exposures because of the amount of trade within Nafta.”
The North American Free Trade Agreement (Nafta) will turn 13 years old next January and groups Mexico, the US and Canada.
For political risk, insurance policies can bear as much as US$80mn and go as long as 15 years. For trade credit, that’s US$35mn and seven years, respectively.
As for Amsterdam-based Atradius, SMEs make up 15% of its export credit insurance portfolio in Mexico, and that hasn’t changed in one year, says Virginia Vargas Cervantes, senior manager at Atradius in Mexico.
The policies cover exports with mostly 90-day terms, and the average premium is 0.43%. Cervantes could not disclose what the premium was one year ago.
Atradius’s exposure in Mexico grew 65% between August 2005 and August 2006, she notes, and sales to the US account for 72% of it, followed by Latin America with 19%, she says.
“Competition has been tough this year and we have reduced some premium rates to win the business,” she concedes.
Gabriel Barrera, executive vice-president for international promotion at Mexico’s Banco Nacional de Comercio Exterior (Bancomext), names the following sectors as those posting fastest growth in Mexico: fresh and processed foodstuffs, among them non-alcoholic beverages, conserves and tequila, automotive and auto parts, electronics, information technology, metals, chemicals, medicines and textiles.
Concerning Asia, in the last 18 months Bancomext took 10 groups comprised of Mexican businessmen to China and recently opened offices in Beijing and Shanghai, Barrera says.
Bancomext, a Berne Union member, supports and promotes Mexican exporters internationally. The bank also attracts foreign investment and help Mexicans invest abroad. It has 31 offices in 20 countries and 60% of its clients sell to the US.
Larger companies dropping LCs
Top-level and middle-market companies that enjoy a good relationship with suppliers abroad are dropping letters of creditin favour to international collection, says Anatol von Hahn, chief executive officer of Scotiabank Mexico.
“We offer both options to our customers and it’s up to them which instrument to use,” José Manuel Surez, head of trade finance at Scotiabank Mexico, comments.
However, small and medium-sized enterprises (SMEs) “are still working heavily or almost exclusively on letters of credit,” adds von Hahn. The bank charges 50% less for a collection than for a LC, he adds.
As far as trade and export finance guarantees are concerned, von Hahn says: “If you look at the mid-market on down, there will be a need for guarantees, whether they’re personal guarantees or the hard security. If you’re dealing with the corporate market, there are probably no hard guarantees.”
Sectors like telecommunications, electronics, mining and agricultural importers form the bulk of Scotiabank’s trade finance portfolio in Mexico, says Surez.
Short-term import and export financing is done with an average of 180-day tenors, Surez comments. Long-term import financing is given tenors between three to five years, while longer periods are available case by case, he adds.
“The situation of the Mexican market has changed dramatically in the last two years,” Surez claims. “In specific markets and deals, we can see loans for 10 years or more.”
Scotiabank has roughly 470 branches and over 7,000 employees in Mexico. Number one business line for Scotiabank is federal government risk, including loans to Pemex, says von Hahn. That is trailed by the retail market, which comprises loans in the sectors of cars, mortgages, credit cards and personal overdraft.
The bank’s growth in Mexico averaged 20% in the first nine months of 2006, he remarks. Scotiabank is also in Central America, the Caribbean and South America, and its presence in Mexico dates back to the 1960s, when the bank first opened a representative office.
ECAs prove attractive
The leading export credit agency for Mexico is US Ex-Im Bank, whose most important client is Pemex, says Valentino Gallo, Americas head of export and agency finance at Citigroup in New York.
ECA support in Mexico is concentrated in the transportation and energy sectors, he adds.
“Large companies like Pemex, DaimlerChrysler and Aeromexico are still using ECA financing to support some of their import requirements at extremely competitive terms,” he remarks. ECA backing is also utilised by corporates in telecommunications, metals and mining, and in the power sector, he claims.
However, Gallo comments that the most important companies are also entitled to alternative sources of financing, against which ECA financing schemes are difficult to compete.
“All top-tier names have access to multiple sources of financing, like capital markets, both domestic and international,” he says. “The investment grade credit status enjoyed by Mexico makes the market particularly competitive.”
Mexico is rated two out of seven levels by the OECD, the same as Saudi Arabia, Chile and China. ECA premiums are based on OECD country risk ratings.
In an attempt to reach all areas within Mexico, US Ex-Im works closely with commercial banks, especially to take advantage of their large customer database.
“By utilising commercial banks, we can reach south, central and northern Mexico,” says Xiomara Creque, international business development, regional director for the Americas at US Ex-Im Bank. “It’s a way for us to reach non-traditional areas in Mexico.”
Creque comments that second-tier companies and smaller businesses, which do not have access to funding, are where US Ex-Im “can come in to level the playing field and allow the US exporter to sell more to those companies”.
Mexico is US Ex-Im Bank’s number one market, followed by China and South Korea. The bank supports US transactions to Mexico mostly in the sectors of oil and gas, electricity, aerospace, commercial aircraft, agriculture, construction and medical equipment. Creque also notes US Ex-Im programmes towards medical and security equipment.
Toronto-headquartered Scotiabank is very active with Export Development Canada (EDC), says von Hahn.
“We are not tied to funding from [ECAs], but if it makes more sense for the company and the borrower, we have no problems in doing it,” von Hahn says. “There are other sources including our own book.”
The bank is presently closing negotiations with EDC on a new programme aimed at Mexican SMEs and their import needs from Canada, anticipates Surez. He adds that Scotiabank enjoys a good relationship with US Ex-Im and has no deals with European ECAs.
China taking over
China’s cheap labour, efficient infrastructure and undervalued currency are giving it an edge over Mexican exporters.
“In general terms, the commercial structure of Mexico and China towards the US is very similar,” says Enrique Dussel Peters, professor and researcher at Universidad Nacional Autínoma de México. Electronics, vehicles, auto parts and textiles represent as much as 70% of the total exports of both countries, he notes.
Nevertheless, Dussel Peters remarks that Mexico differs from China in that it is a net exporter of oil, something China hasn’t been since 1993. And the Asian country only started automotive exports two or three years ago, he adds.
“The new Mexico administration will have to devise a strategy to meet the challenges posed by growing Chinese competition,” says Shelly Shetty, a senior director in the sovereign group at Fitch Ratings in New York. Felipe Calderín, 44, was elected president last July and will take office in December.
And not only is the US importing more from China, but so is Mexico.
By the end of 2005, the participation of the US in all Mexican imports was below 50%, with the main reason being massive imports from Asia, particularly China, Dussel Peters says. Historically, the US accounted for about 80% of all Mexican imports, he adds.
“The three Nafta countries have such huge and widening trade deficits with China that this is more than a trade and economic problem. It has converted into a political problem,” he says.
In 1995, the US had nominal trade deficits equalling US$34bn with China, US$16bn with Mexico and US$17bn with Canada, according to US Department of Commerce data. In 2005, the deficit widened to US$202bn with China, US$50bn with Mexico and US$78bn with Canada.
Mexico’s major advantage against China is its proximity to the US, says Robert Pastor, vice-president of international affairs at American University in Washington, DC. However, trucking is the biggest problem hampering US-Mexican trade, since trucks handle two-thirds of commerce between the two countries, he says.
“The fact that every container needs to be offloaded three times when it gets to the border is a significant hindrance,” he claims.
Nafta success
Since Nafta came into effect on January 21, 1994, trade and investment among its three member countries have nearly tripled, Pastor remarks.
“That is a sign that Nafta succeeded in what it was designed to do, which was to dismantle trade and investment barriers,” Pastor says.
Jorge Mittar, deputy director of the United Nation’s Economic Commission for Latin America and the Caribbean (ECLAC), cites the following as Nafta benefits to Mexico: greater export dynamism, increased foreign direct investment inflows, rise in technology-laced exports, wide surpluses with the US helping make up for deficits with other countries and bigger integration between Mexican and US electronics and automotive industries.
According to Pastor, the primary issues for the next decade are to narrow the income gap between Mexico and its northern neighbours, to address the lack of planning for transportation and infrastructure among the countries, and factors related to immigration and security.
Regarding Pemex, he says the company is compelled to turn over a significant share of its net income to the state in terms of taxes and that has therefore reduced funds for investment. An easier way to secure investment is to make it easier for international firms to invest in Mexico’s gas and petroleum production and distribution, he says.
Pastor cites as a ‘sad anomaly’s the fact that although Mexico is nestled on significant oil and gas reserves, it finds itself importing a quarter of its natural gas from the US, which itself is a net importer of natural gas.
“That is the case because of the extraordinary inefficiency of Pemex and the lack of sufficient investment to exploit their natural gas reserves,” he says. “But one hopes that the new administration of Calderín will correct this problem.”
Mexico pumps 3.8mn barrels of oil per day, just short of Iran’s 4mn, according to the BP Statistical Review of World Energy, June 2006. The US relies on Mexico for 15% of its oil imports, making the Latin American country its second biggest supplier.
For the years to come, Mexico – and the rest of the western hemisphere – will have to learn how to cope with mounting competition from China. South America isn’t faring much better as imports from Asia’s largest economy are quickly outweighing shipments of soy, copper, iron ore and other commodities bound to China.
