Mexico Industry and Finance Roundtable: Supporting Long Term Conditions of Growth and Capacity Building

Mexico City, October 2016:

Mexico is on track for a GDP growth rate of below 2.4% for the year 2016 according to the International Monetary Fund (IMF), while the Ministry of Finance and Public Credit’s growth estimations for 2016 are between 1.7 and 2.5%. Core inflation is at 3%, a figure that fits the Bank of Mexico’s target of between 2 and 4%. In the US, the Federal Reserve announced an increase of 0.25% from 0.5 to 0.75 in interest rates before the end of 2016, alongside the election of Donald Trump, a top contributing factor influencing the strength of the Mexican peso. These indicators paint a picture of an economy facing macroeconomic risks including the potential devaluation of the peso, higher inflation, an expected increase in public debt and rising interest rates.

The annual average Foreign Direct Investment (FDI) during the period 2009-2013 was around $23bn annually. From 2013 onwards, the annual average has increased to $33bn. FDI figures are at historically high levels and major investments are expected in several sectors of the economy thanks to structural reforms implemented by the current administration.

Financing:

• In terms of industry and manufacturing, it is important to differentiate Mexico from other countries. Mexico is the only country in Latin America where manufacturing exports are of greater importance than imports of raw materials. This presents a competitive advantage as the top five economies in the world buy more manufactured products than raw materials, an important opportunity for the country. Traditional bank financing is considerably lower compared to other countries in the region and market financing has lower penetration due to the perception that it exclusively serves large companies with larger capital requirements. However, new tools of market financing are more varied and have adapted to different needs of a wide variety of companies in the economy.
• Since their arrival to the market, the implementation of CKDs (Development Capital Certificates) has funded about MXN100bn worth of projects. In 2011, with a growing interest from investors for real estate projects, FIBRAS (Mexican REITs) were introduce, which have funded nearly MXN140bn worth of projects over the last five years. Structural reforms have generated interest to invest in Mexico alongside new financial products such as FIBRA E, but the sector needs to ensure a wider offering of financial projects in an ever more mature and sophisticated and internationalised market.
• The FIBRA E is a newly introduced tool aimed specifically at financing energy and infrastructure projects. The other new product is the CETES (Mexican Federal Treasury Certificates), similar to CKDs with different rules especially concerning corporate governance. It has the aim of standardising the rules of international corporate governance where the investor takes a more passive role and the administrator a more active role in decision making.
• Companies listed on the stock exchange, both capital and debt, are highly concentrated in certain Mexican states. More than 90% are in four states: Mexico City, Jalisco, Nuevo Leon and Estado de México. On the other hand, there are 12 states without any listed companies or any with short-term debt financing. There are a variety of companies that could benefit from this type of financing; a lack of knowledge about the different options available leads many companies to resort to traditional financing, which limits their growth potential. The debt market is ten times what is financed in capital markets, with the number one issuer of debt securities being the banking sector at roughly 70% of the market bonds. When it comes to capital markets, the manufacturing, financial, and consumer sectors are best represented. That being said, very few industries are taking advantage of the available funding that is competitive and does not necessarily require collateral. The stock exchange is a very important source of funding but companies see themselves as too small to be eligible for this type of financing. The lack of financial culture and knowledge is undoubtedly the primary cause of the low level of corporate finance participation in the country.
• Foreign investors are attracted to the country’s long term prospects, a view that is not necessarily shared from within Mexico. The US, Mexico and Canada form what is arguably the most economically solid trade bloc of the next two decades, with some of the greatest opportunities for investment available globally. Mechanisms such as CKDs have helped finance projects that capital markets were unable to finance previously. The biggest challenge is capital market liquidity. FIBRAS can provide just that, but more players in the market are needed. In Mexico, if the largest AFORES aren’t involved, projects will simply not gain any traction. To diversify the profile of players, the rules are being changed to allow insurers to enter the marketplace.

Industry:

• The availability of labour in Mexico varies per sector and region. In some parts of the country, for example in Chihuahua, there is relatively low competition when it comes to human resources, which is most likely related to the relatively low level of foreign investment in the region. In Bajío, investment has been concentrated in the aerospace, automotive and steel industries. The central geographical location is ideal to minimise logistics costs for companies. The industry in the region is starting to experience labour shortages in relative terms, especially at the base of the pyramid: technicians, machine operators, etc. It is fundamental to address these issues and increase technical training where it is most needed to all other actors along the value chain that can benefit.
• Universities specialised in engineering have multiplied their offering of courses and are more in tune with current and future needs of industry. The government has made a strategic investment on this front and Mexico has more engineers than the European Union as a whole, which ensures good growth prospects for the overall automotive sector. Moreover, the educational reform seeks to achieve an improvement in the base of the pyramid, but resistance has been too great, thereby slowing the progress of the reform’s implementation.
• In terms of the supply chain, Tier 1 providers in Mexico are of a global standard, meet the needs of the industry, and have sufficient capacity to serve the market. However, for Tier 2 and Tier 3 providers, a greater effort by the automotive manufacturers and suppliers is necessary to increase quality and capacity along the entire supply chain. Manufacturing in Mexico is much cheaper than in the US or Canada which can be attributed to the cost of labour; however, the lower cost of logistics is also fundamental to the country’s competitive advantage. In addition, the energy reform is very important in the development of the petrochemical industry. The automotive industry buys a lot of components from this sector and if plastic is produced overseas, it is only logical therefore to promote the development of this industry to ensure geographical proximity of the entire supply chain.

Energy:

• The electricity market in Mexico is relatively simple and is divided into three main parts: generation, network and market. The energy reform focuses exclusively on the generation segment. As a result, the country has experienced low prices never before seen in Mexico’s history. The electricity market in Mexico is valued at approximately MXN360trn annually and the country has an electrical network of over 800,000 km. In terms of technology, Mexico is overly dependent on foreign investment and technology. The NAFTA union has worked well, offering ample opportunities to improve the country’s network: Mexico’s dynamic manpower is matched by the financial tools and technology available in the US and Canada. However, NAFTA has been called for revision by the elected president of the US, Donald Trump.
• Mexico has undergone an unprecedented reform almost unheard of in the western hemisphere. The energy reform has brought 30 companies to the country in the hydrocarbon sector alone and 34 in the electricity sector and these new companies have committed investments totalling $30bn over the next six to seven years. The available reserves on the Mexican side of the Gulf of Mexico are more attractive than the US side with figures indicating resources that could exceed 30bn barrels. Investments related to exploration and production will begin to pay dividends in the next three years whereas deepwater developments can take between seven and ten years to come to fruition. Mexico has over a century of oil production and new companies entering into the sector are well aware of this potential.
• The oil industry needs to follow the lead in the manufacturing industry and develop technical schools, adequately provide sufficient human capital for industry growth and support long-term sector development. Many platforms do not yet have the right technology and are managed by engineers when in reality this labour must be performed by technicians. Undoubtedly, the training of more technicians will directly lead to increased competitiveness in the sector.