Experts caught off guard by latest Trump Nafta scare, wary of tax proposal

Fears sparked by an apparent reversal in US policy on the North American Free Trade Agreement (Nafta), combined with emerging details of US President Donald Trump's long-awaited tax reform proposal, sparked a bout of uncertainty in Mexican markets, including the largest slide in the peso in months.

However, pulling yet another 180-degree change in stance, only hours after a New York Times story cited a senior US administration official as saying Trump was preparing to sign an executive order declaring the country's exit from Nafta, the unpredictable leader posted on Twitter that the US would move forward on renegotiation of the trade agreement.

"I received calls from the President of Mexico and the Prime Minister of Canada asking to renegotiate Nafta rather than terminate. I agreed ... subject to the fact that if we do not reach a fair deal for all, we will then terminate Nafta," read the communiqué. "Relationships are good - deal very possible!"

Potentially a negotiating tactic, the move succeeded in reigniting concerns that had been calming since February.

"With respect to the negotiation of Nafta, we're going to have good days and bad days," said Barclays' chief of LAC economic analysis, Marco Oviedo, in comments to BNamericas. "This is going to exacerbate volatility in the markets, but not at the levels seen in January."

The peso-dollar exchange rate rose to a historic high near 22:1 just before Trump's inauguration in January. However, the peso began to show sustained improvement in late February with comments from US trade secretary Wilbur Ross and trade representative Peter Navarro that seemed to move towards a win-win scenario for all parties in NAFTA and suggesting the nations work towards turning North America into a manufacturing powerhouse.

The rally leveled out in April to around 18.5-18.6 pesos to the dollar. However, this latest scare on April 26 generated a nearly 2% loss for the peso. The next day, after Trump's tweets, the rate fell again to around 19:1 in mid-day trading.

Earlier in the week, Mexico's central bank governor Agustín Carstens, in an interview at IMF offices in Washington, DC with local daily El Universal, suggested that initial fears over the future of US-Mexico trade relations had calmed after Trump entered office and began facing the realities of altering the 23-year-old arrangement with the US' largest two trading partners.

"Obviously there has been a learning process with the US government," said Carstens. "I think there is a big difference between being in an electoral campaign and being in charge of the government."

"It seems that once [in power], one must govern for all and not just a group of people, and obviously one has different views on certain subjects," added Carstens, noting the remaining possibility of a win-win scenario with Nafta renegotiation.

Also on April 26, Trump unveiled the first details of a long-awaited tax reform proposal. So far, it does not appear to include a proposed border-adjustment tax that had made the rounds in late January and in February, which appeared to lose steam with a lack of support in the business community.

It did, however, propose a dramatic cut in corporate taxes to 15% from the current 35%, which would be one of the lowest corporate tax rates in the world. That and other changes face significant challenges in congress, not the least of which is the loss in revenue and resulting surge in debt.

Nevertheless, aspects of the still-emerging plan have already rattled some nerves.

Herbert Bettinger, managing partner at Bettinger Asociados (a Mexican firm specializing in tax law), commented to El Universal that the well-crafted strategy of the deal could actually achieve victory and a large corporate tax cut - even if it does not fall all the way to 15%.

"It's not a ridiculous reform. It's prudent, and it's going to paralyze global tax systems, because everywhere [in the world] has rates for businesses above 30%," he told the daily.

Raúl Feliz, a professor for economic think tank CIDE interviewed for the same article, said the tax proposal would place Mexico at a disadvantage if it does not respond with a similar shift in its tax code.

Mexico would need to replace current tax laws via "comprehensive tax reform that has been postponed for a long time in Mexico," said Feliz. "What Mexico has to do is generalize the [VAT to all goods including medicine and food] and lower the corporate [tax] rate."

Oviedo, speaking to BNamericas, suggested the economic impact would be minimal for now, until it becomes clearer what will actually pass legislatively.

"The tax plan will not have an impact yet," he said. "It will have to be seen whether these taxes are of a permanent or temporary nature. If it is the latter, the effect will be more limited."