Industry Trend Analysis - NAFTA Renegotiation Less Of A Risk Than Previously Thought - NOV 2017

BMI View: W e believe the downside risks to automotive production in Mexico have been reduced after the USTR stated its objectives for the renegotiation of NAFTA and, therefore, provided some clarity as to the direction talks will take. The biggest risks that we identified in previous analyses , including the introduction of permanent tariffs or a significant rise in rules of origin requirements , have both lessened substantially but some risks still loom.

We believe the risks to Mexican production stemming from the renegotiation of the North America Free Trade Agreement (NAFTA) are less serious than we had originally anticipated in the months following the inauguration of President Trump in November 2016 ( see ' Trump Presidency: Implications For Mexican Autos ' , November 10 2016). We originally believed risks to our outlook for vehicle production were considerably high given President Trump's pledge to either radically redraft NAFTA or, in a worst case scenario, scrap the agreement all together. The result would have been a dramatic rise in barriers to trade and investment across the US-Mexico border. However, following the publication of the United States Trade Representative's (USTR) NAFTA renegotiation objectives in July 2017, it appears these fears of an increase in tariffs and much tighter rules of origin were mostly overblown.

Exposed Brands Can Breathe A Sigh Of Relief
% Share of Mexican-Made Models In North America Light Vehicle Sales
Source: AMIA, Company Data, AIAMC, BMI

As our Country Risk team has set out, the USTR's objectives take a relatively non-confrontational stance, which makes it likely that NAFTA will remain largely intact following renegotiations ( see ' NAFTA Renegotiation: Fears Likely Overblown ' , August 4). Despite Trump's threats of a return to tariffs on certain industrial and agricultural imports - including autos - these threats are not reflected in the publication. Instead it stresses the US' desire to improve and extend duty-free access across the three North American markets and increase the abilities of US companies to invest in Canada and Mexico. Thus, the likelihood of exports of Mexican-built vehicles to the US being derailed by new permanent tariffs following a scrapping or radical redrafting of NAFTA looks less likely than before.

Furthermore, a contentious issue for automotive producers and suppliers has been the rules of origin requirements for manufacturers in the region but even here the USTR has not gone as far as suggesting a substantial increase in local content thresholds. The US still aims to strengthen rules of origin but will do so by pursuing better ways of calculating and determining rules of origin rather than simply raising the official percentage share of local content that must be sourced from within the NAFTA region. The US has alluded that it could pursue national content requirements, as opposed to regional content requirements, which would create serious administrative challenges for the Autos industry given that components may cross the borders of all three countries several times. However, we believe this goal will encounter much objection from both Canada and Mexico and is unlikely to make it into the final draft.

Despite Softening, Risks Are Still Present

Though the renegotiations look set to bring about milder changes to NAFTA than we had originally anticipated, this by no means suggests that downside risks to Mexican production have disappeared completely. We stress that some less severe trade barriers between Mexico and the US could still emerge.

One key example is that the US will prioritise its goal of reducing the goods trade deficits it runs with its NAFTA partners. The US runs a large deficit in the trade of goods with Mexico, with Autos being a major contributor to this ( see chart below). Thus, it is likely that Autos will remain a contentious sector that could be slapped with sector-specific restrictions such as tougher red tape or tougher government procurement requirements.

Autos-Related Sectors Still In The Firing Line
US Trade Deficit With Mexico By Category, 2015 (USDmn)
Source: TradeMap, BMI

Furthermore, the risk of some temporary tariffs being applied to autos products is still present thanks to the US' aim to alter the current trade dispute settlement system. Under the current system, the US is greatly curtailed from imposing anti-dumping tariffs on Mexico and Canada due to it being subject to international arbitration. By removing this settlement system, the US would be able to impose anti-dumping tariffs without as many international checks and balances. In theory, this would make it easier for the US to raise tariffs on autos imports from Mexico if it determined that Mexican-made vehicles and components were being sold into US markets at a price below their Mexican market price. This is a very contentious issue, however, and both Mexico and Canada are likely to push back against this proposition.

Another risk is that the US wishes to codify international labour rights norms - such as the right to collective bargaining and minimum wages - into the NAFTA agreement itself. This could, in theory, limit Mexico's ability to exploit its lax labour laws, low trade union representation, and lower wages that together give it an export advantage in manufacturing sectors like Autos. The effect of this would be felt more strongly by lower tier suppliers producing the more commodity-like and labour-intensive components such as electrical harnessing. In contrast, vehicle manufacturers' position in the media spotlight and strong corporate social responsibility programs already require them to uphold globally accepted labour standards in their Mexican plants so the codification of labour rights into NAFTA would have a limited effect.