BMI View: Mexico's central states look set for robust manufacturing sector-driven growth in the coming years, with foreign firms likely to be drawn to the region's strong transport links, increasing number of incentive programmes and easy access to a rapidly expanding domestic market. However, as the central states begin to more closely resemble the wealthier north, this will only emphasise the substantial income inequality gap between Mexico's economically stagnant south and the rest of the country.
Over the coming decade, we believe the Mexican economy is set for rapid economic growth, though not all regions will benefit equally. On one hand, the central region of the country looks poised to experience an economic boom. Indeed, the manufacturing clusters in the centre west Bajío region (comprised of Aguascalientes, Colima, Jalisco, Michoacán and Nayarit) and centre east (Guanajuato, Hidalgo, México, Querétaro, San Luis Potosí, Zacatecas) are likely to expand rapidly in the coming years on the back of increasingly strong transport links and greater cost competitiveness, spurring economic growth. On the other hand, we anticipate that the southern states will continue to see weak economic development. The southern states presently trail their northern counterparts in almost all socioeconomic metrics, not least GDP per capita, and there are a number of factors, including the region's weak human capital and limited political influence, which suggest this trend is unlikely to change in the near future. With the centre of the country set to boom and the south unlikely to break out of its weaker growth trend, this implies we will see a widening of the socioeconomic gap between Mexico's poor south and the rest of the country.
|Source: BMI, INEGI Note1: Yucatán Peninsula: Campeche, Yucatán, Quintana Roo; Note2: North: Baja California, Baja California Sur, Sonora, Chihuahua, Coahuila, Durango, Sinaloa, Nuevo León, Tamaulipas; Note3: South: Chiapas, Guerrero, Oaxaca, Puebla, Tabasco, Tlaxcala and Veracruz; Note4: Bajío: Aguascalientes, Colima, Jalisco, Michoacán and Nayarit; Note5: Eastern Central: Guanajuato, Hidalgo, México, Querétaro, San Luis Potosí, Zacatecas|
Centre Gaining Ground
We anticipate a substantial uptick in manufacturing sector growth for Mexico's central region in the coming years, such that while it is currently more socio-economically similar to the poorer south, by the end of our 10 year forecast period, we believe it will more closely resemble the wealthier north. In the last two decades, manufacturers, especially those in the automotive industry, have begun to 'cluster' in both the centre west 'Bajío' region and the centre east, but the areas have continued to play second fiddle to the nation's main manufacturing hub in the north. However, as Mexico becomes an increasingly attractive destination to manufacture in, (see 'Stronger Growth Ahead, But Reforms Still Needed', October 11, 2012), we believe foreign firms will increasingly look to the centre of the country to set up shop. This underpins our view that the Bajío and central eastern clusters will grow in size over the coming decade, eventually merging to create a second hub, and helping to drive growth in the region. Indeed, aside from the Federal District - which receives the vast majority of foreign direct investment (FDI) as company headquarters tend to be setup in the capital - it is the northern states, which over the past decade have garnered the greatest foreign investment. However, in recent years the central states have begun to see a modest uptick in inflows, and we expect investment there will continue to rise.
|Is Central Mexico Looking At The Start Of A Manufacturing Hub?|
|Mexico - States In Which Auto Parts Makers Currently Have Major Operations|
There are a number of reasons we are optimistic in our outlook on manufacturing in the central states:
First of all, we highlight the potential cost savings offered by operating in the central states. Data from INEGI indicates that manufacturing sector wages tend to be lower in the centre of the country, with the majority of the region falling into the lowest minimum wage band. Moreover, we have seen a number of the central states like Guanajuato beginning to take aggressive steps to attract investment into the manufacturing sector, offering tax abatements for companies, training programmes to reduce companies' outlay on workers and even donating the land to build factories.
|Federal District And North Dominate|
|Mexico - FDI By Region 2000-2012, %|
Second the region's increasingly strong transport links suggest it could serve as an attractive location to export to both the US and global markets. While the north has long benefitted from its geographic proximity to the US, Mexico's largest trade partner, our Freight & Shipping team has previously highlighted the transport links throughout Mexico have improved noticeably in recent years (see , 'Freight Growth Linked To US Recovery', March 21). Indeed, US rail company Kansas City Southern has invested substantially in its Mexican subsidiary. With rail lines running directly from the central states up through the US mid-west, this suggests easy access despite the greater distance.
|Central States Benefit From Good Rail Connections|
|Mexico - Map Of Kansas City Southern's Shipping Routes|
Moreover, manufacturing in the central states offers easy access to global markets, with substantial investment in ports throughout the region. The Port of Veracruz (opening out onto the Gulf of Mexico) has recently been expanded, and on the Pacific Ocean a new container terminal is being built at the Port of Lázaro Cárdenas (in Michoacán). With rail lines linking the the ports of Lazaro Cardenas and Veracruz as well a fairly good network of roads, this suggests the central states are well placed to compete with the north as a manufacturing hub.
Third, manufacturers looking to access a growing Mexican consumer market are likely to be attracted to the central states, especially given our forecast that the Mexican consumer story is going to expand rapidly in the coming decade. The centre of the country offers a greater population density as well as easier access to the Federal District, accounting for nearly one-fifth of Mexico's GDP. As such, we believe firms looking to take advantage of the growing domestic demand are likely to prefer to be located in the centre of the country.
Finally, we highlight that all of the aforementioned factors have begun to create a 'clustering effect' for some of the larger industries, which is, in its own right, a draw for further investment and manufacturing sector growth. Indeed, in the autos sector, we have seen an increasing number of parts suppliers set up shop in the region. Moreover, with nascent steps toward vertical integration making production more time efficient and reducing exposure to currency risk, the centre's rapidly improving supply chain is likely to draw further automakers in the future.
South Facing Widening Income Inequality Gap
That said, while we hold an optimistic outlook for growth in Mexico's central region, we believe the south will continue to remain largely economically stagnant, and combined with our expectations for strong growth in the central region in the coming years, will only deepen entrenched socioeconomic divisions. The country has long faced a noticeable income inequality gap between the north and south, and this was only exacerbated by the signing of the North American Free Trade Agreement (NAFTA), as the agreement both prompted substantial financial inflows flood into the country's northern-based manufacturing sector as well as allowing more competitively priced agricultural products to enter Mexico, hurting the south's economic prospects. Moreover, while there is currently a relatively smooth progression from north to south, with the central states outside of the immediate proximity of the highly developed Federal District acting as a socioeconomic halfway point, as the centre begins to boom and more closely resemble the north, as highlighted above, we believe this will further emphasise the economic stagnation of the south.
At present the southern states rank near the bottom of almost all indicators measuring socio-economic and human development in Mexico. They have among the highest levels of poverty nationally, the lowest educational attainment as measured by the number of school years finished, and poor infrastructural development, with most of the states in the bottom quarter on measurements judging access to basic state services like paved roads, water and sewage. Moreover, we see a number of reasons suggesting that a rapid uptick in growth is unlikely over the coming years.
|Poverty Is A Southern Problem|
|Mexico - Population In Poverty In 2010, % Total Population|
First of all, we note that the region's substantial inbuilt obstacles, including weak infrastructure, and a poorer and more dispersed population, will likely continue to act as a significant disincentive to foreign interest in the investment starved region. Indeed, several past administrations have tried to tackle the problem, with President Vicente Fox (2000-2006) launching Plan Puebla Panama to attract investment and schemes to pay businesses to create jobs, while former President Felipe Calderón (2006-2012) attempted to address the region's infrastructure deficit. However, none of these were able to act as growth engines given the challenges facing firms considering operating in the region. As such, while in recent weeks the states of Oaxaca, Veracruz, Chiapas and Tabasco have come together to sign an 'Isthmus Development Agreement', a programme to drive advances in infrastructure and telecommunications, we remain sceptical of its chances for success.
|South Lags Behind In Educational Attainment|
|Mexico - Grade Completed At School, Years|
A second, and interrelated problem, is that the southern voters have little political sway, suggesting the federal government may be less willing to expend substantial resources or political capital there. Historically, the south had been the main power base for the ruling Partido Revolucionario Institucional (PRI), but in the 2012 election we saw a substantial shift right by the historically centre-left party. Indeed, during his election campaign, President Enrique Peña Nieto's rhetoric was calibrated to appear more conservative, appealing to the northern and centrally-based Mexican middle class. The strategy seems to have worked with the voting breakdown indicating that the PRI won largely by taking the north ( see map below). This suggests that while we may see the administration tout programmes such as the recently initiated 'Crusade Against Hunger', meant to tackle malnutrition in the 400 poorest municipalities in the country (mostly in the south), it will be hesitant to spend the necessary funds to truly transform the southern states' economies. Therefore, we believe the government is likely to focus more on initiating programmes which will aim to tackle the most obvious symptoms, but leave the cause of the poverty unaddressed.
Indeed, of the states we have grouped as 'southern', the only one for which we see strong growth potential is Puebla. The state is currently comparatively poor on a per capita basis, at MXN81,675 as of 2011 , with high levels of poverty and weak human capital. However, given i ts historical ties to both the F ed eral D istrict and the automotive industry, we believe that it could be draw n into the emerging manufacturing hub in the centre of the country. This suggests that, while for now we characterise it at a souther n state, over the coming decade, it could see greater growth than its neighbours more southern neighbours , escaping its current poverty trap.
Risks To Outlook
There are two main risks to our view for an economically stagnant south and booming north and centre. First of all, as we had previously highlighted, we expect the central states are likely to see an uptick in violence in the short-to-medium term, as the country's drug cartels fracture ( see 'Security To Be Peña Nieto's Achilles Heel', March 21). We do not believe the increase will be prolonged enough to detract from the region's otherwise increasingly strong business environment, highlighting further that even in the north where we have seen elevated violence for several years, investment has remained relatively strong. That said, we cannot completely rule out the risk that an increase in violence hinders the development of a second manufacturing hub, and weighs on the growth of the central states. Second, should the government push through energy sector liberalisation or if we were to see tourism move from the Yucatán Peninsula inland, these could act as catalysts which would bolster investment and spur growth in the south. That said, our core view remains for only piecemeal energy sector liberalisation, and tourism alone is unlikely to act as a sufficient driver of growth.