NAFTA: Key Risks For Mexico As Negotiations Continue

Uncertainty about the future of the North American Free Trade Agreement (NAFTA) continues to cloud the outlook for Mexico, the closest and one of, if not the largest trading partner for the US. Moody’s Investors Service says in a new report risks are looming as negotiations drag on and all sides continue to dig in.

Moody’s baseline scenario remains that an agreement for a revised treaty will be reached by the end of March 2018. A successful renegotiation would support a slight acceleration in Mexico’s growth in 2018-19 to 2.0%-2.5%, annually.

However, Moody’s has also assessed a number of alternative outcomes that could unfold if talks extend past the first quarter of 2018, with the most severe, risk of a unilateral US withdrawal from the original treaty, weighing on Mexico’s credit profile.

In the first alternative scenario, negotiations continue past the initial deadline April 1, but progress continues to be made. Under this scenario, Mexico, Canada and the US eventually reach an agreement to update NAFTA–most likely in mid-2019. And policy continuity reduces uncertainty, supports investment and supports medium-term growth.

The second scenario contemplates an end to NAFTA, but the trade relationship between the US and Mexico transitions to a bilateral agreement based on WTO rules. The loss of NAFTA would not be too damaging to longer-term growth prospects, and the stronger effects would be felt on financial variables in the short term rather than on longer-term fundamentals.

The Mexican peso could depreciate by as much as 30%, but the effect would be transitory and the peso would see a moderate correction thereafter. It is unlikely that the peso would strengthen to pre-shock levels despite the future correction and the exchange rate would settle at a higher level than under Moody’s baseline forecasts.

Lastly, there could be a stressed transition wherein the US exits NAFTA and imposes trade restrictions on Mexico, resulting in an economic recession in Mexico. This scenario considers the effects of an end to NAFTA with the US selectively imposing tariffs higher than those allowed by World Trade Organization (WTO) rules in several cases, in addition to introducing several non-tariff barriers to trade.

The magnitude and duration of the shock would be significantly larger, according to Moody’s. The main risk under this scenario is related to the heightened level of uncertainty associated to US trade policies and the Mexican authorities’ reaction to that. The shock associated with this scenario would be less severe, but more protracted than the one observed in 2009.

Photo Credit: Mexican Economy Minister Ildefonso Guajardo, Canadian Foreign Minister Chrystia Freeland and US Trade Representative Robert Lighthizer speak to reporters in Montreal on January 29, 2018 — as the last round of NAFTA talks wrapped up © AFP/File / Peter Mccabe.