NAFTA, Trump and the future of financing in the Americas

NAFTA, Trump and the future of financing in the Americas

Mexico Economy & Policy Corporate & Sovereign Strategy US

 2017 JanFeb cover  
Citibanamex can’t catch a break. It has been hammered by a fraud scandal, had its management shaken up and weathered a lengthy period of uncertainty over whether its parent would hang a for-sale sign above it. The Mexican lender looked to be putting those worries behind it last year, when Citigroup in the US announced a billion-dollar investment in the bank.

Then the US election changed things again. With the future of trade and foreign policy towards Mexico murky, Citi’s chief financial officer told investors the bank might adjust the speed of the planned investment.

John Gerspach said Citi was “broadly constructive” on Mexico, and still plans to make the investment by 2020. Yet his suggestion that cash infusions will be slower at the start of that period highlights the depth of concern across the emerging markets concerning the policies of Donald Trump. The US president-elect campaigned vigorously on an agenda of protectionism, vowing to rip up trade agreements and slap tariffs on imports. His most extreme campaign-trail promises would spell economic and political chaos for Mexico, Latin America and emerging markets as a whole.

Observers don’t expect the administration that takes power on January 20 to push ahead with all of its campaign rhetoric. But sifting which actions will be implemented and which won’t is difficult, especially given Trump’s unconventional communications style. The president-elect granted a smattering of interviews and no press conferences in the two months after the election, preferring a one-way transmission through Twitter and speeches to supporters. That left little opportunity to interrogate the incoming leader on what might become substantive policy and what can be ignored as bombast.

That lack of clarity has immediate implications. Investors took fright in the days after the election, dumping assets, pushing bond spreads wider for Latin American issuers and forcing some, such as Argentine airport operator AA2000, to postpone new deals.

Even as Trump’s cabinet takes shape, many questions remain. Can the US’ free trade agreement with Mexico be replaced with a 35% import tariff? Even if it could be, would the new administration take a punt on such a radical measure? 

For Latin America’s companies, banks, governments and investors, the answers to those questions will shape the political, economic and financial course of the region in the years ahead. 

“The knee-jerk reaction to the election result has been negative as markets try to discern whether we’re going to get candidate Trump as president, or whether his bark is worse than his actual bite,” says Sean Newman, emerging market senior portfolio manager at Invesco. The asset management firm had $202 billion of fixed income assets under management at the end of November.

“What is beginning to emerge is that the president-elect’s tweets are not going to be his deeds. The negative ramifications on trade may be a bit more nuanced versus broad-brushed. And the policies around fiscal spending may not be as big bang as markets may have priced in.”

 Jumping to conclusions

Financial markets reacted quickly, with investors yanking some $6 billion of portfolio cash from the eight biggest emerging markets in the days after the election, according to the Institute for International Finance.

But the trade relationships between the US and Latin America are perhaps where the region’s economies have most at stake. Two-way trade in goods and services between the US and Latin America is worth around a trillion dollars a year. With Mexico alone, it’s $583 billion, according to the office of the US Trade Representative (USTR). In just a few months, that trade flow could be entirely unraveled.

As president, Donald Trump could pull the US out of the North American Free Trade Agreement (NAFTA). In the most extreme case, he could give notice of doing so on January 20, and the treaty could dissolve six months later.

If that unusual scenario unfolded, says Kelly Hardy, partner at law firm Hogan Lovells, “the existing tariffs would stay in place for a year. That being said, a president does have the ability to impose tariffs” up to 50% higher than those in place in 1975. Further, the USTR would have broad authority under presidential direction to introduce higher tariffs under special circumstances, such as in retaliation to unfair trade practices.

In early December, Trump reiterated his enthusiasm on a campaign trail promise of a 35% tariff on companies that move production out of the US.

 Nafta in Numbers  
If NAFTA is renegotiated — the more likely scenario — then all bets are off. Former President Bill Clinton needed congressional approval to pass the treaty when it was originally negotiated, and some observers believe President Trump would need the same green light to reopen negotiations. Others believe that now that the treaty is in force, different rules apply.

“My main concern is the uncertainty that will be generated, and the length of that uncertainty,” says a Mexican trade specialist, regarding a potential renegotiation. “Ideally, the parties can commit to saying, we won’t renegotiate the whole of NAFTA, just certain chapters.”

Michael Shifter, president of the Inter-American Dialogue, says he expects the incoming administration to stop short of completely walking away from NAFTA.

“We do still have a Congress, and it’s in Republican hands. Although there is an anti-trade faction, most of them — like [House Speaker] Paul Ryan and [Senate Majority Leader] Mitch McConnell — are pro-free trade. There are limits to what Trump can do from the executive branch and Congress is going to play an important role.”

He adds, though, that returning to the negotiating table may not be all bad for Mexico. “The way to look at it — at least potentially — is as an opportunity to address problems that were neglected by both governments as they charged ahead with this free-trade framework.”

Mexico has been a shrewd negotiator in the past. It slapped $2 billion of retaliatory tariffs onto US imports in 2009, after the US blocked Mexican trucks coming into the country in contravention of NAFTA. The new duties, dropped once the US agreed to advance with the cross-border trucking program, were carefully targeted at products important to the backers of the ban, according to Hogan Lovells.

“We have very skilled and sophisticated negotiators on both sides of the border,” says Hardy. “Just as our trade people understand the Mexican market, the Mexican trade representatives understand our market and which industries really count on trade with Mexico.”

 Policy vs show

Yet the question remains: of Trump’s rhetoric, what is going to become reality? How to sift the bluster from an actual change in the prevailing wind?

“My instinct is that we are likely to see a lot of symbolism and theater,” says Shifter. He points to Carrier Corporation’s decision to continue production of air conditioning units in the US. The company reversed course on its plans to move a plant to Mexico after discussions with the president-elect. 

“It was a way to show that he was serious about what he said in the campaign,” says Shifter. “But a gesture is not a policy.

“Some underlying policy issues will probably change at the margins. But there will be a heavy dose of symbolism to show supporters that he’s carrying out his promises.”

Others expect more substantial changes.

“I do expect a policy shift,” says the trade specialist. ”I think they will realize that these one-by-one interventions will show diminishing returns, and they will want a policy shift. Some kind of revision or renegotiation of NAFTA is unavoidable."

Yet the unpredictability of policy has real implications. Economists have already cut their expectations for Mexico’s economy this year, saying a weaker peso, higher funding costs and tough fiscal targets could constrain growth.

And it’s not only Mexico. Despite the rise of China, “the US is a major trading partner for the whole region,” says Ramón Aracena, chief economist for Latin America at the IIF, which predicts weaker growth across Latin America this year as a result of changing US policies.

“The US is a systemic country. Whatever they do regarding policy has implications for everyone — even if you are far away.”

He indicates the Pacific Alliance countries in South America — Chile, Colombia and Peru — as a case in point. “They all have free-trade agreements with the US. That’s been a main asset: if you invest in Colombia, you can export to the US. If that’s not clear, it’s going to affect investment.”

Others are less pessimistic.

“Colombia is one country that could be on the periphery of being hurt by a more aggressive protectionist policy in the US, given the manufacturing sector,” says Jim Barrineau, co-head of emerging markets debt at Schroders, which managed some $487 billion of assets at end-September.

“The rest of the region, though, is tied more to global growth. One reason why Latin America, aside from Mexico, has done pretty well is that the market expects that US growth should be better. Aside from the protectionist fears, that is always a good thing for Latin America in general.”

Others cite indications that the new administration will plow money into US infrastructure. That could spur demand for metals exported by Andean countries like Chile and Peru.

Diplomacy asunder

In the months between the election and Trump’s inauguration, the uncertainty about the US’ new relationship with emerging markets inched higher as the president-elect cast aside established rules of engagement.

Yet by mid-December, some hope was emerging that Trump might act more benignly toward Mexico than indicated during the campaign, after news broke that he had held a meeting with telecom billionaire Carlos Slim.

“I think it’s a sign that the worst kind of policy fears are not going to be realized,” says Schroders’ Barrineau. “Carlos Slim certainly has a big stake in the Mexican economy and keeping Mexico integrated with the US. Just the fact that Trump wants to meet him suggests there’s a dialogue there.

“When people are speaking, generally you don’t get the most negative outcomes.”

Trump’s approach towards other parts of Latin America is similarly unclear. He had a reportedly amicable call with Argentine President Mauricio Macri in mid-November. Both parties denied rumors that the pair had discussed a Trump business development in Buenos Aires.

Whether the new administration will continue the rapprochement towards Cuba that was launched by outgoing President Barack Obama is unclear — although Trump all but broke out the champagne when Fidel Castro passed away. “Today, the world marks the passing of a brutal dictator who oppressed his own people for nearly six decades,” Trump said in a statement on the transition team’s website.

 Studying the tea leaves

With much of the cabinet nominated by mid-December, analysts were able to get greater clarity on the policy direction of the new administration. Many were private sector executives.

“He was supposed to be the big anti-banks guy, the big anti-markets guy. And what has he done? He’s hiring hedge fund managers and Goldman Sachs bankers,” says Jan Dehn, head of research at Ashmore Group, a specialist emerging markets firm managing some $55 billion of assets at end-September. 

Dehn says he expects only small tweaks to NAFTA as a result. “The truth is, he’s going to ease financial conditions. He’s going to repeal parts of Dodd Frank. He’s going to make it easier for banks to lend money.”

The USTR was one important nomination that remained pending in mid-December. One name circulating as a possible nominee was Dan DiMicco, Trump’s trade adviser on the campaign and part of the USTR transition team. A staunch opponent of free trade, the possibility of DiMicco’s appointment had some Mexican officials worried.

At the same time, the commerce secretary nominee, private equity investor Wilbur Ross, suggests that the new administration will advance on Trump’s campaign trail pledge. Ross, as reported by US media,  described NAFTA as a “logical starting point” on the roster of the new administration’s priorities.

Markets will be looking closely at further signposts in the weeks ahead. Trump’s inauguration speech on January 20 is top of the list, followed by any pronouncements that may come in the days after. The State of the Union address in March should fill in any remaining gaps.

Going to extremes

The financial markets’ immediate reaction to the election was to bet hard on US growth — spurred by fiscal stimulus — and against the fortunes of developing economies. The $6 billion pulled from emerging market portfolios in the days after the US election was several times greater than the investor flight during the 2013 taper tantrum and the shock from Chinese currency moves in mid-2015, according to the IIF.

Spreads on Latin American bonds widened around 30 to 60 basis points. New equity and bond issues alike were put on hold.

For contrary investors, the exaggerated market reaction offered a buying opportunity.

“I think Mexico has been oversold,” says Dehn, who suggests that Latin America as a region has been “beaten up” more than other emerging markets. “I don’t think that we will see really draconian policies toward Mexico, not at all. A lot of it was election rhetoric.”

Dehn expects the incoming administration to focus overwhelmingly on the domestic economy in its first two years, in the hope of growing its majority in the Senate in mid-term elections to get through other policy changes, such as ending Obamacare.

“We’ve probably already seen the extent of the foreign policy initiatives, which was basically to end the Trans-Pacific Partnership. There was no surprise in that.”

Others are more cautious. Invesco’s Newman agrees that US policy towards emerging markets is unlikely to be as negative as Trump indicated during the campaign, but reserves judgment until he sees how events will unfold.

“We still have to go through a period of price discovery and, on a day-to-day basis, evaluate who the policy nominees are for various key roles,” he says

Upside and downside risks exist, says Schroders’ Barrineau. An aggressive stance on protectionism or weaker-than-expected US growth would both be bad for Latin American investors, he says.

“If we get a more reasonable Trump administration, Latin America will outperform the rest of emerging markets, just because we’ve had this fear about it.”

Access to capital tightens

On the other side, Latin Americans wanting to raise capital internationally “should fasten their seatbelts,” says one head of debt capital markets for Latin America. “I’m advising clients to access markets in the first window that comes available and to have a plan B.”

Those back-up strategies might include setting up lines of credit with banks, looking to local markets for funding and, for sovereigns, seeking contingent support from organizations such as the IMF. Asset sales and operational efficiencies might be another strategy, says the banker, who did not want to be quoted suggesting clients look beyond debt capital markets for funding.

Mexico’s Pemex heeded the advice in December, when it stepped into the bond market with a triple-tranche bond issue. The state-owned oil company has been a regular issuer of such deals in Januaries past. Its decision to get in sooner suggests it wanted to avoid any further bad news that might hit the market around the inauguration.

The timing — which also came days after OPEC opted to limit oil production — paid off nicely for Pemex. The borrower raised slightly more and paid a lower yield than it had in its $5 billion January 2016 bond sale.

Chief financial officer Juan Pablo Newman says the change in administration in the US won’t have any negative impact on the oil company. “The hydrocarbon sector isn’t included in NAFTA. It wasn't included from the start, so it avoids any volatility.” Recent participation by US oil companies in Mexico’s deepwater oil and gas auction is a sign of continued interest from the northern neighbor, he adds.

Manufacturing is more likely to be hurt by changes to US trade policy, says Thomas Mueller-Gastell, a partner at law firm Ritch Mueller in Mexico City.

International capital markets activity by Mexican companies may slow down because of the volatility of the peso and rising interest rates, he says. “I suspect local capital markets will perhaps become more active.”

As for direct investment, both foreign and domestic, plans that are already in place will likely continue, says the chief executive of Mexico’s export-import lender, Bancomext.

“What we have gauged from our clients is that they continue with their plans,” says Alejandro Díaz de León. “As you can imagine, some of these investments are really long-term investments that take time to execute. Of course the uncertainty may have an effect on some of the early versions of new projects. To a large extent, on the ongoing projects, we continue to see a lot of interest and a lot of appetite for our financing.”

Cheerleading for NAFTA

Mexican President Enrique Peña Nieto was heard in late 2016 to be planning a meeting with the US president-elect ahead of the January 20 inauguration, as drumming up support for bilateral trade on both sides of the border looked to be more important than ever.

“There’s a lot of incomplete information about NAFTA for the US,” says the trade specialist. “Probably Peña Nieto could mobilize American businesses that are clear winners of NAFTA to give the administration a more balanced view of what’s going on.”

Bancomext’s Díaz de León is already on message. “Global value chains in North America are very much intertwined,” he says. “Going forward, even in a world where globalization per se is downplayed and where the local agenda regains some resonance, I do believe that regions matter. And I do believe that North America is going to continue to be a strategic region for all its members. It’s a region where we produce things together and we can sustain strong competitiveness levels and compete with other regions.”

At the same time, investors expect Mexican policymakers to be in crisis mode in 2017, especially with last year’s disappointing growth numbers.

“We believe the country needs a catalyst,” says Invesco’s Newman. December’s energy auctions may kick-start some activity, he says, but overall it will be tougher for consumption-led growth to continue. Slower economic expansion will make Mexico’s debt load look heavier and raise concerns over ratings downgrades. “We believe Mexico needs some additional policy measures for a broad-based growth plan so that the economy can continue to grow,” says Newman.

Adding to the external uncertainty for Mexico is a change of leadership in two key positions. Finance Minister Luis Videgaray stepped down — ironically, after receiving criticism for having orchestrated a meeting between Peña Nieto and candidate Trump — and was replaced by José Antonio Meade, who had previously held the job. In December, Central Bank Governor Agustín Carstens announced his departure after six years, to lead the Swiss-based Bank for International Settlements. A replacement has not been named. 

Investors are broadly relaxed about the changes. Invesco’s Newman says the two institutions are filled with astute policymakers — and that anyway it may be time for a new hand on the wheel.

“Mexico has a deep policy bench,” he says. “The changes are certainly not negative but they do open the door for a fresh approach and a different set of perspectives on the challenges the country faces.” LF