Regional Focus

Mexico: trading up

Published: May 2014

Key facts

Population:
120.8 million1
GDP per capita 2013 (US dollars):
$10,629.882
GDP percent change 2013:
1.1%2
Current account balance 2013 (US dollars/billions):
-22.332
Inflation (average consumer prices) percent change:
3.804 (2013)2
Ease of doing business (2013) rank:
3 out of 189 globally1
Corruption perceptions index (2013) rank:
Joint-106 out of 175 globally3

The birthplace of several advanced civilisations such as the Maya and Aztec, Mexico has a rich and colourful history. Conquered and colonised by Spain in the 1500s, it became an independent nation some 300 years later. Today, the country has a GDP of $1.18 trillion and is Latin America’s second largest economy, after Brazil. The service sector makes up the lion’s share (60%) of Mexico’s free market economy, with industry (37%) also contributing significantly to the economy. Following the ‘Mexican Miracle’ of growth between the 1940s and 1970s, the country’s economy has slumped and recovered several times, but has never matched the consistent growth achieved during its golden period in the mid-20th century.

In 2013 Mexican economic growth fell to 1.1% – the slowest the country has seen since the recession of 2009, and well below the 3.9% it recorded in 2012. One key factor that has played a part in Mexico’s sluggish growth is the slowdown in the US manufacturing sector. With almost 80% of its exports going to the US, changes in economic conditions north of the border do not take long to filter down to Mexico. Even the weather in the US can affect Mexico’s economy, according to Mexican central bank Governor Agustín Carstens.

However, while it is liable to feel the impact of negative developments in the US, Mexico’s close ties with its influential neighbour have also contributed to the Latin American country’s relative macroeconomic stability. Inflation in Mexico has not topped 6% since 2001. This stability is also reflected in the movements of the free-floating Mexican peso (MXN). For five years the MXN/USD exchange rate has hovered largely between 12-14.

Marco Oviedo, Chief Economist for Mexico at Barclays, sees the MXN (which is not subject to any exchange controls) maintaining its steady course for some time to come. “As the US continues to reduce the monetary stimulus, we believe the peso will be stable compared with the rest of the emerging market currencies. Long-term the MXN has followed the USD, and if the dollar strengthens, the peso will strengthen with it. We are expecting the MXN to close this year at 12.95, implying that it will hover around 12.90-13 during the year,” he says.

Another factor contributing to the country’s stable exchange rate is the North American Free Trade agreement (Nafta), signed by Canada, Mexico and the US 20 years ago. “Nafta has been key to Mexico’s currency stability,” says Juan Pablo Cuevas, Head of Global Transaction Services for Latin America and the Caribbean at Bank of America Merrill Lynch. “It has also made Mexico’s banking sector more competitive and led to the development of a host of new banking products and services between the three countries.” Certain practices can only be carried out between Nafta members, too. Cross-border sweeps for cash concentration between resident and non-resident entities, for example, can only be conducted within the bloc.

Mexico is also negotiating with the US and Canada as to how the Nafta members can fit into the Trans-Pacific Partnership (TPP). If the three North American countries become part of the trade agreement, which was originally signed in 2005 by Brunei, Chile, New Zealand and Singapore, it could forge stronger trade links between them and the signatories on the other side of the Pacific.

Political credibility

Closely aligned to Mexico’s economic stability is a political credibility that is starting to inspire confidence, both domestically and further afield. “This is the best political environment since Mexico became a modern democracy and we saw a lot of reforms approved last year,” says Barclays’ Oviedo. “Though the political parties will begin to move on with their own agendas before the 2015 elections, we don’t have radical politicians in the congress, and the political conditions are very positive right now,” he says.

Mexican president Enrique Peña Nieto of the PRI (Partido Revolucionario Institucional) party, has instigated a number of aggressive reforms (such as the establishment of an autonomous federal authority to challenge the dominance of telecommunications giant Telmex, and a banking reform initiative to make lending easier) to encourage economic growth through increased competitiveness since he assumed office in December 2012. Peña Nieto even featured on the cover of Time Magazine in February – further evidence of his standing as an economic reformer.

Despite the determination of its leader and the many opportunities offered to Mexico through collaboration with its neighbouring economies, the country still faces significant challenges to growth.

A country divided?

In a research paper, entitled “A tale of two Mexicos”, management consultant McKinsey & Company said the country’s two-speed economy, in which large companies are highly productive while smaller firms have their output stymied by red tape, is acting as a brake on Mexico’s growth.

“A modern, fast-growing Mexico, with globally competitive multinationals and cutting-edge manufacturing plants, exists amid a far larger group of traditional Mexican enterprises that do not contribute to growth,” says McKinsey in the report. “These two Mexicos are moving in opposite directions. The largest companies are raising productivity by an impressive 5.8% a year, while the productivity of small, slow-growing enterprises is falling by 6.5% a year. And with employment growing faster in the traditional Mexico, more labour is shifting to low-productivity work.”

Mexico’s cash-driven ‘informal economy’ is an additional challenge here. “Thirty percent of Mexico’s total economy continues to be informal, and this portion of the economy runs entirely through cash,” says Barclays’ Oviedo.

This large informal economy is a problem for Mexico in the lost tax revenue and social security contributions it represents. Indeed, some analysts believe it is holding the nation back from fulfilling its economic potential, although to what extent is unclear. What is certain, however, is that this portion of the economy – which accounted for 60% of total employment in Mexico in 2013 – is of huge significance to the country.

Interestingly, while its large informal economy relies on cash as a means of exchange, Mexico has a sophisticated payments network relative to its Latin American contemporaries to support its larger businesses.

Mexico
Payment statistics Millions of transations % change
2004 2008 2012 2004-2012
Cheques 165.4 150.0 108.2 -35
SPEI transfers 4.53 41.71 171.9 3795
ACH credit transfer 12.7 22.36 127.9 1007
ACH direct debits 2.38 21.40 15.7 660
Credit card payments N/A 387.1 383.8 -1 (2008-2012)
Debit card payments N/A 414.0 752.2 82 (2008-2012)

Payments infrastructure

The central bank, the Banco de México (Banxico), has driven the development of the country’s payments system. “Mexico’s payments infrastructure has been undergoing an incredible evolution over the last ten years,” says BofAML’s Cuevas. “The Banco de México has made a concerted effort to improve the system, trying to get rid of paper and move towards electronic payments. They have also created a very efficient market for the compensation of high- and low-value cheques,” he says.

“Mexico has one of the more efficient and developed payments systems in the region, and it is constantly improving.”

Simon Shingleton, Regional Head of Multinationals Sales – Global Payments and Cash Management, Latin America, HSBC

The Sistema de Pagos Electrónicos Interbancarios (SPEI) is Mexico’s real-time gross settlement system, and is owned and operated by Banxico. SPEI operates on a T+0 basis. In 2012 there were 172 million SPEI transfers with a combined value of almost MXN 200 billion – an increase of 55.3% in terms of volume and 11.3% in value on the previous year.

New regulation, coming into effect in September 2014, will require domestic priority payments on SPEI to be closed within five seconds (the limit is currently 30 seconds), effectively enabling instantaneous same-day transfers to be made.

The Centro de Compensación Bancaria (CECOBAN) is a compensation centre owned by a consortium of banks in Mexico. It processes interbank cheques, credit transfers and direct debits in the country. CECOBAN operates on a T+1 basis.

“Mexico has one of the more efficient and developed payments systems in the region, and it is constantly improving,” says Simon Shingleton, Regional Head of Multinationals Sales – Global Payments and Cash Management, Latin America, at HSBC. “Like the rest of Latin America, there is still a lot of cheque usage, especially for low value payments and in the industrial and service sectors, but electronic payments are on the up and same-day transfers are being heavily promoted by the central bank,” he adds.

Cheque usage remains prevalent, accounting for 108 million transactions in 2012, although it is steadily decreasing (from 165 million and 150 million transactions in 2004 and 2008 respectively). Both MXN- and USD-denominated cheques can be drawn on Mexican banks.

Liquidity management

Corporates operating in Mexico have almost the same range of liquidity management services at their disposal as their counterparts in Europe and the US. Cross-border cash concentration is allowed in Mexico, as is zero-balancing, although with the latter corporates must keep different currencies in separate structures.

Neither notional pooling nor inter-bank cash pooling, however, are permitted in Mexico. In order to work around this restriction, some banks allow their clients to sweep MXN or USD out of Mexico into a multi-currency notional pool abroad, with the funds being swept back the same day. This arrangement effectively allows an entity to conduct notional pooling without being domiciled in Mexico.

“Despite concerns over its sprawling informal economy and the continuing problem of security, Mexico’s sound economic growth and stable currency make it an attractive regional base for corporates.”

Simon Shingleton

“Besides notional pooling, all the liquidity management services a corporate would expect to have in Europe, Asia and North America, are available in Mexico, and increasing numbers of MNCs are looking to centralise regional operations in the country,” says HSBC’s Shingleton.

From May of this year, banks in Mexico are required to support mobile payments, and in September, mobile payments will be allowed beyond normal business hours, from 6am to 1pm, 365 days a year.

Furthermore, a financial reform package consisting of 34 financial and banking laws was published in January 2014. The new laws are intended to strengthen banking regulation and the legal framework by guaranteeing collection, increasing competition and enhancing transparency in the sector. Standard and Poor’s has said the reforms could ultimately lead to a higher banking penetration in Mexico in the long run.

The largest banks in Mexico (by total assets) are BBVA Bancomer (part of BBVA Group), Banamex (part of Citigroup), Banco Santander México (part of BSCH Group), Banco Mercantil de Norte (part of Banorte) and HSBC Bank Mexico. Seventy-five percent of banking assets in Mexico are foreign owned; Banorte is the only private bank in the country that remains majority owned by domestic shareholders.

Useful information for treasurers

In addition to its fellow Nafta members, Mexico has free trade agreements in place with Bolivia, Chile, Columbia, Costa Rica, El Salvador, the EU, Guatemala, Honduras, Israel, Japan, Nicaragua and Uruguay. Mexico has a free trade agreement on cars with Brazil. Imports are subject to VAT of 16%, or 11% for goods imported into border regions. Certain products, including electricity, are subject to an export tax of 25-50%.

The federal corporate income tax rate in Mexico is 29%. This will fall to 28% in 2015. Withholding tax is not imposed on dividends.

Demand for bank credit is rising in Mexico. In April, Banorte, the country’s largest domestically owned bank, reported a 27% rise in first-quarter profits, which it said was partly the result of increased lending activity. The bank said its loan portfolio grew 12% over the year to MXN405 billion, with consumer loans up 17% and loans to SMEs up 20%. And this trend could well continue as a result of Peña Nieto’s banking reform bill, which has the increase of credit provision to the private sector as one of its key goals.

Though nurturing private sector growth through banking reform has been warmly welcomed by many Mexicans, others feel Peña Nieto’s reforms have not addressed one of the biggest problems facing the country: organised crime.

Security concerns

In fact, security, particularly the ongoing problems with drug cartels, remains a challenge for Mexico. Mexico’s murder rate was 21.5 per 100,000 people according to a United Nations report published in April, and around 85,000 people are estimated to have died in drug-related killings since 2007. Barclays’ Oviedo says that while many have lauded current government’s economic reforms, there has been less enthusiasm over its approach to dealing with organised crime. “Security is the elephant in the room in Mexico,” he says.

“Fighting the drug cartels was one of the main pillars of the previous administration, but since Peña Nieto came into office the government’s strategy on tackling the issue has not been particularly clear or coherent. Kidnappings and extortion have increased in certain areas of the country, although assassinations and killings have fallen on the whole. There are still a lot of security issues that need to be addressed.”

Reactivation of confidence

Despite concerns over its sprawling informal economy and the continuing problem of security, Mexico’s sound economic growth and stable currency make it an attractive regional base for corporates, and HSBC’s Shingleton says there is a strong argument in favour of centralising treasury operations in Mexico.

“Treasurers can come with confidence into the country,” says HSBC’s Shingleton. “From a liquidity management perspective, it makes sense to consider Mexico as part of a North American or global solution, as you can move money into and out of the country freely, which is not possible in some other Latin American countries. Mexico is very much geared up to work with MNCs, and many are looking at setting up SSCs there,” he adds.

In April Mexico’s economy showed signs of picking up after its sluggish 2013 and beginning to 2014. Inflation fell from 4.48 to 3.89, while the consumer confidence index rose from 84.5 to 88.8, in what Banxico Governor Agustín Carstens described as a ‘reactivation’ of the economy. Now the question is whether MNCs can learn to share Mexican consumers’ confidence in the nation’s economy.

  1. World Bank
  2. IMF World Economic Outlook April 2014
  3. Transparency International

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