Why Mexico's expected nearshoring boom is at risk

Nearshoring, or the relocation of supply chains, could benefit Mexico as companies set up shop closer to the US market, but its future is at risk due to rising uncertainty, above all because of a planned judicial reform.

While Mexico has close infrastructure links and favorable tariffs with the US, nearshoring-related foreign direct investment (FDI) is slow to materialize.

In a report, Grupo Bursátil Mexicano (GBM) wrote that only 11% of the 118 nearshoring-related investments announced since October 2022 and involving US$123bn have begun to materialize, mainly in the automotive and machinery sectors in northern Mexico.

“The remaining 89% have not yet started,” GBM wrote.

The firm added that total FDI has not grown compared to the average of the past 10 years, indicating that no nearshoring benefits have been registered. However, sectors related to nearshoring have been the main drivers of investment inflows and have recently demonstrated notable growth rates.

GBM said that while Mexico has strengthened its trade relationship with the US, driven by growth in 10 key manufacturing categories, some statistical indicators suggest downside risks.

Uncertain future

Having a privileged geographical location with the world's largest market and being partners in the USMCA trade agreement with the US and Canada does not seem to have been enough for Latin America's second largest economy to attract more capital and the situation could worsen due to the uncertainty caused by constitutional reforms, especially to the judiciary, proposed by President Andrés Manuel López Obrador, whose term ends on October 1.

As the new legislature with ample majorities of AMLO's Morena party started its term on September 1, both chambers are expected to approve the presidential initiative to reform the judicial system in the coming days.

James Salazar, deputy director of economic analysis at CI Banco, identified risks to nearshoring and its potential benefits for Mexico.

"The main concern is that independence will be lost and that judgments, in this case judicial decisions, may be compromised, and this has implications for strengthening the rule of law and respect for contracts," he told BNamericas.

"If a foreign investor is considering where to go and Mexico is one of those places, if they think that there may be a risk to investment due to legal issues, judicial issues, they will think twice," he added.

On Tuesday, the International Chamber of Commerce (ICC) asked congress to “act with caution” regarding the proposal because it could jeopardize the independence and impartiality of the courts, generating “serious consequences” for local and foreign investment.

Salazar said that a solid rule of law is a key element for investors considering relocating their operations, aside from electricity, water and labor issues, but legal certainty is what the reform would call into question.

“The USMCA requires that the legal framework be completely independent and that the verdicts issued be unbiased, especially that in an important bilateral or trilateral matter, there is no preference for local companies or issues. In that sense, let's say that there is a risk of complaints under the USMCA and this is a vehicle or instrument that, within all these opportunities for nearshoring, ends up being the catalyst,” he said.

“Companies would come to Mexico because of the USMCA, as the opportunity to sell to the largest market in the world with preferential tariffs creates a huge incentive. So, the fact that the reform to the judicial branch casts doubt on the legal framework of the USMCA, on the rules of the trade agreement, discourages or at a certain point could discourage investments or taking advantage of this nearshoring situation,” Salazar added.