The pandemic exposed the fragility of many supply chains for companies across the world. As geopolitical tension rises, the trend for ‘re-shoring’ or ‘near-shoring’ is gathering steam. With its proximity to the US and skills in key sectors, could Mexico be a beneficiary?
Globalisation has been an important factor in supply chain planning since the 1990s. It has allowed companies to locate manufacturing in the cheapest location, snaking supply chains across the world. This has been a driving force for GDP growth for many emerging markets.
This has started to reverse in recent years as rising geopolitical tension, particularly between the US and China, has disrupted fluid trade between nations. Former hotspots of low-cost manufacturing have seen labour costs rise, making it less economic for companies to outsource manufacturing. In particular, the pandemic showed how quickly supply chains could be disrupted and the potential repercussions.
Companies have started to reconfigure their supply chains, bringing supply closer to home (‘nearshoring’), or onto friendly territory (‘friendshoring’ or ‘allyshoring’). In Asia, many companies have developed a ‘China plus one’ strategy, adding alternative manufacturing options to their existing capability in China.
Mexico’s potential
Mexico is ideally placed to be a beneficiary of this trend. Its proximity to the US makes it a natural option for international companies looking to move. In a recent research report, Oxford Economics said: “Mexico is the emerging market with potentially the greatest to gain from the trade decoupling between US and China. Since 2017, Mexico has surpassed Canada to become the US's largest trade partner after China, thanks to its geographically privileged position, competitive production costs, and a comprehensive free trade deal (USMCA).”
We believe this could be a driver for Mexican GDP growth over the next few years. Mexican growth has been stable but unexciting. The IMF expects GDP growth of 1.8% in 2023 and 1.6% in 2024. This does not look high compared with the growth emerging from Asia, but is relatively strong compared to its Latin American peers.
Our meetings with companies on the ground suggest that they are already benefiting from the nearshoring trend, with international companies building manufacturing capability in the region.
There were also encouraging signs on foreign direct investment. In the first quarter of the year, investment was 48% higher than the first quarter of 2022 (excluding two one-off deals – Televisa-Univisión merger and the restructuring of Aeroméxico). It will not happen quickly, but should be an incremental tailwind for economic growth over the next few years.
Selected sectors
However, the benefits will not be universal. To date, they have been concentrated in particular industries. Mexican suppliers in sectors such as automotive, minerals and machinery have successfully managed to displace suppliers in other countries. Smaller sectors such as food & beverages and metals have outperformed too – Mexico's beverage industry has grown the most.
However, there are other areas where Mexico has not managed to take market share. Nor has it proved the main beneficiary for companies moving out of China. In sectors such as electronics, furniture, and clothing, Mexican exporters have not yet managed to capitalise on the move away from China.
Fears over political risk have deterred some international businesses from relocating to Mexico in recent years. However, a change of government in 2024 may usher in a more business-friendly environment, which could allow Mexico to capitalise on the nearshoring trend still further.
The outlook for the Mexican economy remains positive. It remains a defensive choice in Latin America with strong government finances. When the stock market is experiencing a period of robust growth and positive returns, investors may perceive higher levels of risk associated with potential market corrections.
Thus, more recently, we have reduced our weighting a little, because the stock market has performed well. We are also cognisant that the Mexican economy could be more sensitive to a potential slowdown in economic activity in the United States.
Nevertheless, we believe the shifting of global supply chains will provide a boost for the whole economy.
Sam Vecht is co-manager on the BlackRock Latin America Trust. The views expressed above should not be taken as investment advice.