Thoughts

November 29, 2024 | 15:40

Mexican Standoff

Economist

Senior Economist and Director
Economics

Sarah Howcroft conducts risk analysis across a range of countries and industries in which BMO has strategic inte... (Read more)

Sarah Howcroft , CFA

Senior Economist and Director
Economics

Sarah Howcroft conducts risk analysis across a range of countries and industries in which BMO has strategic inte... (Read more)

Unlike in Canada, Trump’s pledge to impose a 25% tariff on all imports from Mexico is not entirely unexpected given what occurred in his first term. However, it’s unclear whether the intention is genuine or simply an opening tactic in bilateral negotiations. If the President-elect were to follow through, it would undeniably have a major impact on Mexico’s economy. This explains the initial sharp reaction in the peso following Monday night’s announcement, though it has since recovered.

Mexico’s economy appears much more vulnerable to the tariff threat than Canada, even though the U.S. accounts for a similar share of total goods exports for both countries (around 75%-80%). Measured by importance to the overall economy, Mexico’s exports to the U.S. account for nearly 30% of GDP versus 20% for Canada. Our rough calculations show a 25% tariff could cut Mexican real GDP growth by 5 ppts in 2025 via the direct trade channel, a bigger hit than in Canada (or even China, which is also facing a potential sharp increase in U.S. tariffs). Given that the IMF is forecasting growth of just 1.3% next year, one can easily infer that a universal tariff in the proposed range would tip the Mexican economy into recession.

One oft-cited concern is whether Mexico is being used as a back door for Chinese goods to evade U.S. tariffs, a claim which the Sheinbaum Administration has denied. As far as the evidence goes, the data show Mexican imports from China have risen since 2020, but not nearly to the same extent as exports to the U.S. Moreover, though rising, the level of Chinese shipments to Mexico still pales in comparison to the level of direct exports to the U.S. from China. Still, the Morena government has launched a campaign to identify Chinese inputs and encourage businesses to substitute them with Mexican or North American alternatives. According to the economy secretary, Mexico will even start making microchips by 2025.

The impact of increased U.S. trade protectionism would be amplified across multiple channels in Mexico, including foreign direct investment (FDI). Mexico is a large recipient of FDI, with net inflows amounting to around 2% of GDP. Canada, on the other hand, is typically a net provider of FDI—though, it’s worth noting that China invests more in Canada than in Mexico. Of course, Mexico faces another key challenge from the incoming administration, which concerns immigration. Not only has Trump demanded Mexico end illegal migrant crossings into the U.S., but he has also vowed to deport millions of undocumented immigrants already living in the country. This could cause a steep fall in workers’ remittances from the U.S. to Mexico. These remittances have been an increasingly important driver of consumer spending and GDP growth, reaching a record US$47 bln through the first three quarters of 2024, equivalent to over 3% of GDP.

Key Takeaway: President Sheinbaum is already hard at work to avoid getting tariffed, including by threatening to raise Mexico’s tariffs. Beyond tit-for-tat retaliation, it seems like the brunt of the shock would be absorbed via a significant weakening of the peso, likely back to 2020 lows. Whether or not tariffs are ultimately imposed, ongoing friction is likely to dampen Mexico’s economic prospects in the coming years, especially as the USMCA is up for review in mid-2026.