June 04, 2018 08:00 AM / Fitch Ratings / Header Image Credit: World Grain
Escalating trade tensions between Mexico and the U.S. will disrupt Mexican economic growth, which has already shown signs of deceleration, says Fitch Ratings. These tensions could also delay approval of the United State-Mexico Canada (USMCA) trade agreement.
On May 30, U.S. President Trump announced a 5% tariff on all imported goods from Mexico starting June 10 to force action on immigration from Mexico's administration. In a statement following the initial remarks, he said that tariffs would be raised to 10% on July 1 if the crisis persists and then by an additional 5% each month until reaching 25% on Oct. 1. The tariffs would remain until Mexico acted to curtail the flow of undocumented migrants from Central America.
The U.S. accounts for close to 80% of Mexico's exports, making it Mexico's largest trading partner. Mexico sent the U.S. $346.5 billion of goods in 2018, representing 28% of Mexican GDP. By comparison, China sent the U.S. $539.5 billion of goods in 2018, accounting for 4% of Chinese GDP. Mexico's net trade surplus with the US was $82 billion (5.5% of Mexico's GDP) compared to China's $420 billion trade surplus with China (3% of China's GDP).
Increasing trade tensions with the U.S. will undermine Mexico's already-weak economic activity. Recent growth has been led by sectors closely tied to the U.S. manufacturing sector. The value of manufacturing exports had grown 9.1% in 2018, the strongest since 2011. Mexico is particularly exposed to the auto industry, which accounts for around 3.5% of GDP, second only to Germany (4.5%) among large economies. Auto manufacturing exports account for 36% of total manufacturing exports, 82% of which go to the U.S.
Banxico has held rates at 8.25% since December 2018 when it raised rates by 25 bps. Increased exchange rate volatility and potential pass-through effects on inflation resulting from trade uncertainty decreases the possibility for a policy rate reduction for the rest of the year. The Mexican peso saw its biggest intraday decline in months, experiencing marked volatility against the dollar on May 31.
The tariff announcement comes on the same day when the Mexican Senate began deliberations on the USMCA trade agreement - a revision of the existing North American Free Trade Agreement. Passage of USMCA in the U.S. now depends on Congress and cannot be assured given U.S. political dynamics. The U.S. lifted steel and aluminum tariffs imposed on Mexico and Canada in mid-May, removing one obstacle to ratification; reciprocal tariffs on the U.S. were also lifted. However, this new set of tariffs will create renewed obstacles in Mexico and the U.S. for the approval process.
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