The fifth round of renegotiations regarding the modernisation of the North Atlantic Free Trade Agreement (NAFTA), which brought together nearly thirty groups, was held in Mexico City on 17 -21 November. While all involved parties reaffirmed their commitment to moving the negotiations forward, no progress was made on the major points of contention and as a result significant conceptual gaps remain.
Now it is the turn of the sixth round of negotiations that will take place in Washington in December 2017. The aim is to reach some kind of agreement during the first quarter of 2018, a period during which US Republican primaries take place in several States, which may be an additional complication.
As Irina Topa-Serry, strategist of AXA IM, points in a paper dedicated to the meeting “even if a deal is signed”, it will only be implemented in late 2018 at the earliest as the US a dministration needs to notify Congress , 90 days before signing a prospective trade pact, which becomes 180 days if there are plans to change the unfair trade provisions such as NAFTA Chapter 19.
Complicating matters further, the current Trade Promotion Authority (TPA), through which Congress defines US negotiating objectives, expires in July 2018 and thus, an extension will need to be secured from Congress, sometime in April 2018. According to Topa-Serry, there could also be interference from the Mexican Presidential elections taking place in July 2018 that are likely to put pressure on the Mexican peso, but as long as there remains a willingness to pursue the process , “these could prove to be buying opportunities along the way.”
However, the analyst of AXA IM, believes that a lengthy negotiation process could eventually weigh on fixed investment and overall growth.
As a vibrant investment destination, Mexico may suffer disproportionately. Still, this has not been the case so far. Looking at the Mexican Fibra (Fideicomisos de Infrastructura y Bienes Raices- Mexican real estate investment trusts’), while the prices of these real estate stocks experienced a massive sell- off as inflation and rates crept up in 2016, their pipelines are very solid, vacancies are low – and those metrics have remained robust since the beginning of the negotiations.
While this is not AXA IM’s central scenario, there is still a risk that the negotiations break down. If Canada and Mexico flatly reject the US proposals, US President Donald Trump’s power to terminate becomes a central question. This path is not straight forward and will probably end up being an even longer process than the renegotiation itself.
In theory, Trump could terminate NAFTA and he would only need to give six months’ notice if he decides to withdraw. There is no law binding the President to ask for the approval from US Congress. Yet, in order to implement a change in legislation, he will need to seek advice from the trade advisory committee and the International Trade Commission (ITC) and submit reports to the House Ways and Means Committee as well as the Senate Finance Committee, all exchanges that require a 60 day waiting period before new tariffs could take effect.
In case of a NAFTA break -up, the World Trade Organization’s (WTO) Most Favoured Nation (MFN) rules would replace NAFTA tariffs. As Topa-Serry explains:
US import tariffs bound by the WTO are relatively low, 3.5% on average, suggesting a modest effect on Mexican exports to the US. Mexican import tariffs will need to be quickly revised towards the average 7.1% under WTO terms from the current 35% level . As such, we believe the impact on the trade balance could be limited. Incorporating the US proposals on the Rules of Origin should have a significantly more negative effect on trade flows.
The risk of a temporary negative impact on foreign direct investments (FDI) in Mexico could threaten the economic outlook.Foreign companies may limit investment flows in an uncertain and less – investment -friendly environment. Longer term, this move may be smoothed out given Mexico’s industrial competitive advantage, linked to its strategic geographical location, its cost -competitive skilled labour force and its strong manufacturing supply chain structure.
Another aspect to be monitored closely would be Mexican workers’ remittances from the US, which may be altered by changes in migrant flows and protectionist rules .
The currency should bear the brunt of the adjustment quickly. Banxico may intervene to limit the excess depreciation. In the past, it has pledged some US$ 20bn to be made available through an FX auction programme (NDFs 4 ), and, in extreme cases, it may use contingent instruments such as tapping US swap lines or the International Monetary Fund’ s credit line. Still, the currency should trade much lower that where it would be if NAFTA were intact. Short term, bond and equity markets could sell- off driven if foreign investors decide to exit.
For Mexico, NAFTA is more than just a trade agreement – its signature in 1994 was the trigger for its transformation from a state- owned, closed -to- the- world country into an export oriented economy. But would a break-up impact Mexico’s future path? AXA IM think it is unlikely.
Mexico has show n its commitment to an open economy model, continuing trade negotiations with the European Union, deepening the economic relationships within the Trans Pacific Partnership (TPP), continuing structural reforms and keeping sound public finances – all necessar y ingredients to overcome the short term pain. A shift in perception and sentiment could however ensue.
