Mexico to see moderate expansion to return despite political uncertainty

Traditionally a barometer of a Mexico’s economic health, the construction sector saw investment slow in 2017 as a result of a dip in public spending on infrastructure works and uncertainty among private investors over the possible outcome of the renegotiation of the North American Free Trade Agreement (NAFTA). This could further push up the already rising costs of materials brought by the February 2018 hike in interest rates to a nine-year high of 7.5%. In 2017 construction’s output contracted to 2013 levels, as public and private investment in the sector declined by 3.7% from 2016, driven by a 10% drop in public works investment, according to the Centre for Economic Studies (Centro de Estudios Económicos del Sector de la Construcción, CEESCO) of the Mexican Chamber of Construction (Cámara Mexicana de la Industria de la Construcción, CMIC).

Sector Performance

Although Mexico saw GDP growth of over 2% in 2017, the construction sector posted a 1% contraction, generating MXN421bn ($22.8bn), down from MXN436bn ($23.6bn) in 2016. The sector accounted for 8% of GDP in 2017, making it the fourth-largest contributor to the economy, behind trade with 19.8%, industry and manufacturing (18.2%), and real estate (10.8%). With 6.1m direct jobs, the sector was responsible for 13.9% of national employment, behind only agriculture with 16.8% and trade with 16.1%. Also in 2017, 74% of the MXN2.8trn ($151bn) in total sector investment came from private sources. This has been increasing in recent years, and the government forecasts that the private sector’s share of construction investment could be as high as 83% by 2024.

Things improved in early 2018, as the sector began to outpace the wider economy: GDP expanded by 2.3% year-on-year (y-o-y) in the first quarter, and construction grew by 2.7% y-o-y in the first four months of the year. The latter gain was largely driven by a 4.9% and 5.8% hike in the private building and specialised works segments, respectively. Meanwhile, public works posted a 7.8% decrease in production in April 2018, marking its 25th consecutive month of decline. However, with an 8.1% increase in residential investment, this segment largely drove the 2.4% growth in investment recorded in the first two months of the year. In the same period the non-residential segment shrunk by 2.7%. While Mexico’s rapidly expanding population makes a decline in housing demand unlikely in the foreseeable future, uncertainty surrounding NAFTA and the new administration could slightly dampen investor interest in the broader construction sector.

PNI

While there are unknown external factors, the government remains committed to developing infrastructure. The National Infrastructure Programme (Programa Nacional de Infraestructura, PNI) 2014-18 aims to address the country’s structural needs. The MXN7.7bn ($416m) plan comprises 743 projects to upgrade communications and transport, rural, urban, energy, hydraulic, health and tourism infrastructure. While the PNI was initially slated for completion in 2018, CEESCO reports that only as much as 73% of the work would be finished by the end of the year.

Progress has largely fallen short of expectations due to the strict austerity measures employed by the authorities since 2015, with the national budget under pressure from easing oil prices and lower-than-anticipated economic growth. In 2018 spending at Petróleos Mexicanos (Pemex), the state-owned petroleum company, stayed at the same nominal level as 2017, which translated to a 4.6% decline in real terms. Meanwhile, spending on general salaries – including various urban development and infrastructure initiatives – increased by 48%. “What is needed are resources, as few have been earmarked for infrastructure projects due to government cutbacks,” Carlos Pantoja, leading partner in construction, hotels and real estate at Deloitte in Mexico City, told OBG. “The country needs a plan outlining its infrastructure needs. We are well behind other countries in Latin America in terms of infrastructure investment, ranking around 65th worldwide in these terms of investment in such projects, despite the country boasting the world’s 15th-largest economy.”

The need for such a plan has also been stressed by the CMIC, given the drop in public investment in infrastructure to 3.7% of GDP in 2016, its lowest level since 2008. Government expenditure on infrastructure, which represents 22% of the budget, is set to increase in 2018 after a 23% drop to MXN77.2bn ($4.2bn) in 2017.

Key Projects

The largest casualty of the PNI was the Mexico City-Querétaro high-speed train link, shelved due to a corruption scandal. This indebted the government to China Railway Construction, the leader of a consortium awarded the contract to build the link in 2014. The agreement was revoked on November 6, 2014 amid accusations of favouritism after Grupo Higa, a member of the consortium, was awarded a deal on favourable terms for the construction of a Mexico City mansion for the presidential couple. President Enrique Peña Nieto denied this and was exonerated in a subsequent investigation, but the project remains suspended.

The remaining major infrastructure project is the new Mexico City International Airport (Nuevo Aeropuerto de la Ciudad de México, NAICM), slated for completion in 2020. The $13bn venture is being developed as a public-private partnership (PPP) by Grupo Aeroportuario de la Ciudad de México (GACM). This will be a catalyst for related programmes, such as major urban developments featuring shopping centres, hotels, residential complexes, hospitals and transport infrastructure linking the terminal to the city, including a high-speed train.

However, uncertainty about the project’s future has emerged due to President-elect Andrés Manuel López Obrador’s stated opposition to it. He has threatened to cancel the project in favour of expanding the Santa Lucía military airport, arguing that the project is too expensive and full of corruption.

He subsequently softened his position in May 2018 to the relief of private players, announcing at the National Tourism Forum that he would be open to pursuing a concession for the project. If a compromise cannot be reached, this could create difficulties.

“It would be similar to closing the door on one of the country’s biggest sources of foreign income: tourism,” Carlos Frutos, former director-general of domestic engineering consultancy firm TDM, told OBG. “In addition, the positive economic implications for other aspects of the economy are so far-reaching that it would be self-inflicted punishment.”

In what has been seen by some sector players as a way of shoring up the project against attempts to cancel it, on March 23, 2018 GACM raised $1.6bn with an e-bond issuance of Mexico’s version of real estate investment trusts, fideicomisos de inversión y bienes raíces (FIBRAs), the largest to date of such bonds.

FIBRAs were launched in 2011 to increase opportunities for private investors and pension funds.

“FIBRAs have been a great success for the Mexican market,” Alejandro Ballesteros, CEO of real estate developer Grupo Copri, told OBG. “They boost liquidity while maturing, which creates confidence and eagerness for projects in the long term.”

Other ongoing infrastructure projects include the Mexico City-Toluca light rail project (estimated to cost $3.2bn and slated for completion by end-2018), and upgrade works to the ports of Lázaro Cárdenas on the Pacific coast (with $900m to be invested in the lead-up to 2022) and the Gulf coast port of Veracruz (projected to require $1.7bn in investment and set for completion in 2019). In March 2018 the Mexico City government announced plans to build an overhead railway connecting the Observatorio metro station – the interconnection point for the Mexico City-Toluca train line – to the current airport and eventually to the NAICM. If approved, construction would begin in 2019.

Internal Factors

Infrastructure suffered some high-profile setbacks in 2017, including a collapse of the high-speed lane of the Mexico City-Cuernavaca highway, resulting in two deaths on a stretch of road that opened months earlier. The government blamed Spanish firm Aldesa and domestic Epccor, which built the highway, for construction irregularities that caused the collapse. That same year, local construction firm ICA went into receivership as its US dollar-denominated debt swelled. While these are seen as isolated incidents not symptomatic of broader problems in the sector, they have unsettled the private sector and highlight the next presidential administration’s need to assuage those fears, according to Pantoja.

“Infrastructure requires more certainty and transparency in the assignment of resources and the awarding of projects to the private sector, given the government’s budget shortfalls,” he told OBG, highlighting the urgent need for a new national infrastructure plan. He said this would be a logical step due to the benefits it would bring in terms of job creation. He also suggested the construction industry would benefit from the creation of a regulatory body to oversee contract awarding.

Recommended Action

In addition, the government may need to shift its strategy to promote long-term and sustainable growth, according to some players. “Mexico needs to adopt a globally competitive and productive reindustrialisation policy, developing infrastructure, innovation and technology, and making the country more competitive in international markets,” José Antonio Hernández Balbuena, director of CEESCO, told OBG.

Meanwhile, CEESCO’s March 2018 outlook includes recommendations for the incoming presidential administration to revitalise the construction sector. Among the advised reforms are strengthening the rule of law, increasing citizen participation in infrastructure planning and following human rights best practices to support the US, Canada and Mexico, the NAFTA signatory countries. The centre forecasts construction growth of 0.3-1% in 2018, due in part to a 4.7% increase in public infrastructure spending. Strategic infrastructure projects will receive MXN65.9bn ($3.6bn) for the year, with the majority of this going towards road conservation (MXN35bn, $1.9bn), the Mexico City-Toluca train (MXN13bn, $703m) and the NAICM (MXN9bn, $486m). PPPs will be key to infrastructure growth in 2018, with 21 projects under way. Investment in the infrastructure segment totals MXN18.8bn ($1bn) for the year, covering construction, conversion, restoration, modernisation, operation and maintenance of projects.

Furthermore, the sector should be boosted by private investment in medium- and high-end residential developments; tourism, services and commercial infrastructure; and reconstruction after the two September 2017 earthquakes (see analysis). Segment growth is forecast to be strongest in infrastructure – between 4% and 5% – followed by specialised works, with 2-3%.

Trump & NAFTA

While the authorities can work to improve sector performance, the potential success of these effects will also depend on external factors. Among these are the NAFTA renegotiations; US President Donald Trump’s fiscal reform, which could affect Mexico’s long-term investment plans; and exchange rate instability. “It’s a vulnerable sector directly affected by changes in trade agreements; contractionary monetary policy that is meant to control inflation raises costs and inhibits project financing,” Hernández told OBG.

Uncertainty is expected to persist in 2018 and 2019, given Mexico’s vulnerability to the effects of policies implemented by President Trump’s administration, such as the tariffs on steel and aluminium imports into the US. A reformed NAFTA could increase the cost of materials, such as steel and cement, which have already become more expensive since 2016 due to the peso’s depreciation against the US dollar. This could reduce foreign direct investment (FDI) into the industry and manufacturing sectors, which would decrease the number of construction projects, affecting the employment market and demand for new construction projects.

The July 2018 presidential elections may negatively affect investment due to uncertainty of the policies to be adopted by the new government. Agreeing that a new infrastructure plan is needed to reactivate FDI flows – the decline of which has dragged down construction growth since 2016 – Hernández told OBG the main dangers to investment are external factors.

Manifestos

As investment is largely dependent upon market certainty, previous statements from the new administration could cause some players to delay investment. President-elect López Obrador, of the National Regeneration Movement (Movimiento Regeneración Nacional, MORENA), outlined plans for the construction sector in a national project proposal published in November 2017 that included cancelling the NAICM project and launching an infrastructure and public works programme entailing the paving of roads in rural areas and the construction of housing, which he claimed would generate around 500,000 jobs.

In contrast, the Institutional Revolutionary Party candidate José Antonio Meade had promised to respect the NAICM project and identified infrastructure as a priority for a future federal government, proposing the creation of a national infrastructure plan involving PPPs and development banks. Ricardo Anaya, the Por México al Frente coalition candidate, also pledged to launch an infrastructure plan, though neither candidate offered details of potential projects. All three called for greater transparency in the awarding of future construction contracts by the government.

Outlook

The sector is likely to benefit from an infrastructure development push by whatever government takes office in 2018, with all main candidates having stressed an agenda with infrastructure development as a main focus. It is also expected that there will be more public financial resources to allocate due to rising oil prices several PPPs being developed. Northern states, whose governments would also see a decline in tax revenue, would be most affected. Although the sector will continue to gain steam in 2018, according to CEESCO, such growth will be tepid, given that the factors impeding expansion remain, including the increasing cost of materials due to an unstable exchange rate, rising interest rates – making credit more expensive – and a decline in foreign investment as a result of fiscal reform in the US and uncertainty surrounding NAFTA.