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Rodrigo Echagaray: Welcome to this episode of Market Points. I am Rodrigo Echagaray, Head of Latin America Research and Global Head of Product Management. Today, I’m speaking with Alfonso Salazar, who covers Latin American mining, and Francisco Suarez, who covers industrial real estate, infrastructure, and ESG. Today, we’re going to talk about China’s increasing level of investment in Mexico, and what challenges and opportunities this presents for key sectors of Mexico’s economy and worldwide.
Hi, Alfonso. Thank you for being here today.
Alfonso Salazar Herrera: Great to be here.
RE: Francisco, thank you for being here today.
Francisco Suarez: Happy to be here as well.
RE: We think nearshoring is very interesting in that this year we have elections in the U.S. and investors are going to be particularly interested on what the candidates will do with regards to Chinese investment in the rest of the world, but particularly in Mexico, being a USMCA partner.
And so, we believe that today is crucial to analyze in depth what are the potential risks and opportunities that may arise from this increased oversight of Chinese capital going into Mexico.
Alfonso, from your perspective, why are investments from China increasing in Mexico?
AS: I think this is an important question. And you need to understand that for many years, even decades, China’s economic growth model relies to a great extent on the property market and infrastructure construction. But the era of massive construction in China seems to be over. Today, China needs to rely on manufacturing, and unfortunately, domestic consumption is weak.
And what it means is that under the new economic model, China has to increase exports. And the construction of new infrastructure and manufacturing capacity abroad is part of this new strategy. And this is actually aligned with Xi Jinping’s Belt and Road Initiative. Xi always considered China’s market expansion through investments that help position in China as the major manufacturing hub in the world.
The problem today is that countries like the U.S. are trying to de-risk their value chains by reducing exposure to China. And many companies that invested in China in the past are moving capacity to other countries because they fear that trade tensions may increase. Today, what is happening is that China is looking for ways to diversify investments away from the mainland and Mexico is very, very well positioned to access the large North American market, because it offers a great location, a cost advantage and it opens the door to sell products to the U.S.
RE: Now, let’s try to paint a picture of what these investments in Mexico look like, and what else makes these investments particularly important at this point in time?
AS: I think Chinese investments have really come into focus over the past few months, and this idea of decoupling from China is what in the first place led to this nearshoring opportunity and to these new investments in countries like Mexico. But now the concern is that China wants to bring capacity to Mexico to maintain control over the value chains they consider strategic. The problem is that, you know, quantifying the Chinese investments in Mexico has been very challenging.
We really don’t know exactly to what extent they are in Mexico. We found a lot of conflicting data, very limited information. And the best way that we had to quantify Chinese investments in Mexico was using data from the industrial real estate sector.
What I think is important to differentiate at this point is that there’s going to be Chinese investments that may be considered strategic for the U.S. and China. For example, anything related to electric vehicles or semiconductors. And there are some other investments that aren’t strategic at all. For example, think about China manufacturing flat screens or furniture in Mexico. I don’t see any problem with that, but for Chinese EVs produced in Mexico, I believe that the level of scrutiny from the U.S. authorities is going to be very, very high.
RE: What are presidential candidates saying about China and the increased level of investments in Mexico?
AS: I think there is a bipartisan effort from both candidates, Trump and Biden, to maintain investments made by China in Mexico in check and scrutinize everything related to anything that would be strategic for the U.S.
RE: Francisco, higher tariffs are obviously a major consideration in the next few months as we head into the U.S. Elections. But there’s also a sunset clause due in 2026 around the USMCA agreement. Can you briefly talk about that and what that means?
FS: Absolutely, Rodrigo.
The USMCA came into effect in July 2020. Every six years, the USMCA enters into a review and automatic reception period. That means that the next review of the USMCA is scheduled for 2026. So, this is the perfect time to implement any changes. In this case, if there is a concern that China is avoiding trade sanctions through Mexico, this is the perfect time to review and make any necessary amendments to the trade agreement.
Now, you have to understand that it really doesn’t matter who wins the U.S. election. And why is that? Because to begin with, you have to take into account that the USMCA as such, was a bipartisan effort. And what we have heard is that both parties are interested in protecting certain value chains. The question here is what sort of value chains are more likely to be disrupted.
And if you ask me, and I fully agree with what Alfonso has said, is that it seems that both parties are targeting those value chains that are key for national security from that U.S. point of view. For instance, there is a reason why the Chips and Science Security Act emerged, and that’s because it is about addressing the potential vulnerability that North America has on semiconductors.
RE: And if I recall on our first nearshoring podcast, we talked about some companies, global companies that were arriving in Mexico to benefit from these nearshoring trends. Has that continued or have you seen a slowdown?
FS: Great question, Rodrigo. We have seen actually the emergence of new companies that have never invested that much in Mexico, and this actually is a positive example of how the disruption of value chains in China is totally positive for Mexico.
Consider Taiwan – Taiwan, as you know, there's a risk that there might be a blockade of the country. So, people are talking about a full invasion of the country, and that is actually key for the most sophisticated microprocessors that exist worldwide. So, companies like PSMC are heavily invested in the United States, but along the value chain, the companies that are based in Taiwan, that are key players in the value chains of semiconductors are investing heavily in Mexico.
Those companies are corporations like Foxconn. To give you an idea, there's no iPhone without a Foxconn. So that company is particularly investing a lot in Mexico, along with other companies, similar companies like Quanta, or the previously Western-based companies that have invested over decades in Mexico, like Flex, like Jabil just to name a few.
RE: And I guess we’ve also seen increased investments on infrastructure assets, what do you make of that?
FS: I think that the investments that we have seen in infrastructure generally goes aligned with the public works. What I mean with this is that at the Federal and State levels, we have seen more infrastructure in the form of a subway, for instance, a train, a new airport or a new refinery.
And yes, we have seen much more investments from China in those particular projects.
RE: So, I guess even though today, from an FDI perspective, China is not a major partner of Mexico. The trend is definitely going up not only in the private sector, but also on the public sector.
AS: Yeah, that’s right. If you think about it, one of the reasons behind the Belt and Road Initiative is to get some soft power in other countries by investing in infrastructure projects. This is also a way to generate dependency on Chinese capital and technology. But in the case of Mexico, we don’t think this is a problem today, but we definitely need to keep an eye on this.
RE: And so maybe let’s continue with the private sector. You mentioned earlier electric vehicles, what are you seeing there? What are the risks? What are the potential changes to the value chains there?
AS: I think we need to understand China’s EV strategy, which has been under development for many years now.
The strategy included subsidies to new EV startups and subsidies to EV buyers to help develop in the industry. And today, production capacity of EVs in China is well above local demand. So, there is an overcapacity that is estimated around ten million vehicles a year. And this number should increase as new startups complete new plans.
China’s EV strategy was not only to supply the domestic market. It was always to export EVs. The two key export markets for China, of course, are Europe and the U.S. So, tariffs, could really be a big problem for Chinese strategy, especially if Europe follows the U.S. in implementing tariffs for EVs.
RE: Earlier, you talked about a fundamental problem for China, which is the overcapacity across different sectors and segments of the economy. You talked about EVs being one of them, but what about steel?
AS: The problem is that you have a lot of capacity at the same time that construction is weak. And will remain weak.
That means that China, which we observed last year, a big increase, sharp increase in steel exports from China. And the risk is that this continues for the coming years. The good news for North America is that we think that because of tariffs, there’s going to be very limited impact from Chinese exports getting into that region.
I think it’s going to be a problem in other places of the world in Latin America, in Asia, but in North America, we still think that the steel industry will be in some sort of sanctuary for the coming years. That is very positive because you need to think that this is going to be steel required for the construction of the infrastructure and their new plants, and then steel for manufacturing products that will no longer be produced in China but in North America. So, with the outlook for steel industry in North America looks very attractive.
RE: And now let’s try to put on an ESG lens on this theme. Francisco, you cover ESG for Latam, what are you seeing on that front? On the one hand, Mexico faces a lot of water scarcity problems, there is not enough energy. At the same time, there’s a lot of demand for new manufacturing capacity. So how do you make sense of all of the different variables in that?
FS: We are not that concerned about Chinese investment coming into Mexico. I am far more concerned about the limited availability of energy and water in the country, and that could result to be a bottleneck for nearshoring.
But now speaking specifically about ESG, our angle here is an approach focusing on value chains. This is something that we call the ESG trilemma, which basically speaks about the challenges of making a profit while maintaining a value chain security, and making sure that your value chain is also sustainable. And all at the same time, it is a huge challenge to do that.
So, I think that at the end of the day, you have to consider the following. Imagine that under the current legislation, a pension fund based in California is not allowed to be investing in companies that are exposed to modern slavery corridors.
So, in other words, I think that at the end of the day, what we are seeing from this major defragmentation process of global value chains, is that you have to understand that it is inflationary as it is. But Mexico has a role, over there, because of the cost advantage that Mexico has, it could make this pain go far easier compared to another alternative.
So, in my view, Mexico can help not only to ease the pain out of inflation of this process of value changing fragmentation, but also the overall framework and the legal framework that prevails in Mexico on the environment, is far more compatible to the U.S. or Canadian laws compared to what you see in China.
RE: Let’s wrap up the conversation with some thoughts on the role that China plays globally. Thoughts on that, Alfonso?
AS: Yes, for sure. Look I think it’s important to look at the implications of nearshoring, not only from Mexico’s standpoint, but also from China's. So what are the implications of decoupling from China?
Yes, of course, decoupling is bringing investments and the opportunity for Mexico to integrate into new value chains, but exactly the opposite is happening in China. And this means less investments, a weak labour market, a low consumer confidence in China as we speak. And on top, we shouldn't forget that China is starting to face a severe demographic problem. The total population is on a downtrend and is aging very fast.
So, to conclude, I think investors need to follow closely all the decisions made by the Chinese authorities to deal with all these challenges that the country is facing today, including nearshoring.
And as for Mexico, the nearshoring opportunity is here. If we use it well, Mexico should increase its participation in global value chains and become a bigger global player.
RE: Sounds a bit of a self-fulfilling prophecy for China where obviously, there is less appetite to invest there, and that, in turn, will weaken the economy further.
Well, this has been an interesting topic to dig into. There is lots to monitor as we move forward, and I want to thank you both for your insights today.
AS: Thank you, Rodrigo.
FS: My pleasure, Rodrigo. Thanks.
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