S&P, Fitch detail how Nafta's end would hit Mexico

Experts continue to hold out hope for a successful outcome to Nafta talks despite a rocky fourth round last month. However, the recent extension of the negotiation timeline and comments from each government following the conclusion of the latest round have highlighted growing uncertainty and risks to the treaty, according to Fitch Ratings.

Though the ratings agency said in a report it does not believe Nafta talks would result in full abrogation of the treaty, both Fitch and S&P have updated their outlook for the negative impact on Mexico's economy, as trade officials from Mexico, the US and Canada prepare for the fifth round of negotiations in Mexico City.

How a US exit would hit Mexico

Fitch said a unilateral US withdrawal from the FTA would likely trigger "an immediate confidence shock and short-term market volatility" in the Mexican economy.

"Growth would slow through the medium term, from an already modest base, as the initial disruption would likely result in lower investment and trade dislocations with potentially sustained effects on consumer confidence," said Fitch, adding, "It would also act as a negative productivity shock affecting potential growth rates through the medium- and long-term."

The ratings agency added the collapse of Nafta would mean defaulting to World Trade Organization (WTO) rules, yet "WTO rules are not as comprehensive, and tariffs could rise on certain Mexican export sectors" with the local auto industry and other diversified manufacturing sectors with highly interconnected supply chains most exposed.

On the Mexican consumer side, prices for many US-sourced finished goods, such as whisky, breakfast cereals and pet food could jump suddenly. A report bylocal media outlet El Financiero with data from JP Morgan, showed US red meat alone could see a 24.6% price jump if Nafta is scrapped.

Fitch also said non-manufacturing sectors such as real estate, retail and banking would be affected too from lower growth, reduced investor confidence and FX volatility.

"However, the high level of supply chain integration and underlying cost advantages of manufacturing in Mexico would still act as an incentive for production depending on the scale of new tariffs," according to Fitch. "This is especially the case owing to the high capacity utilization of auto factories in the US (94% in 2016)."

In addition, steep peso depreciation after NAFTA withdrawal would also enhance competitiveness of export-oriented industries, said Fitch.

Financial sector

In its analysis, S&P suggested that Mexico's financial sector should be able to absorb the impact fairly well, despite the increased volatility.

"If the US unilaterally revokes NAFTA, we believe Mexican banks are well-positioned to weather the uncertainties and the impact to the Mexican economy," said the agency, adding a pullout would trigger lower GDP growth, higher inflation and interest rates, and peso depreciation in Mexico, potentially affecting some of their loan portfolios.

S&P said this view stems from the low share of total loans granted to Nafta-sensitive sectors.

"On the other hand, we think that domestic nonbank financial institutions (NBFIs) could see lower growth and slight weakening in asset quality in the short term stemming from the negative impact the end of Nafta could have on the country's economic growth prospects."

The agency said it believes some NBFIs, particularly those that lend more to the transportation sector and export a high share of their production to the US, could see business volume decrease, "but not enough to undermine their credit standing."

US exit not inevitable

The post-Nafta scenario the agencies describe would nevertheless be rendered moot in the event an agreement is reached or if talks simply break down and the status quo remains.

"Our base scenario is that the negotiations will be successful in light of all the lobbying that has been done by several US companies to get the Trump administration to keep Nafta or that the changes made to Nafta not be modified significantly between the three member nations," said Banorte-IXE senior analyst Alejandro Cervantes in an interview with BNamericas.

Cervantes said that even though talks are only in the fifth round, a complete US withdrawal is improbable.

"This is very intuitive, but there is a reason why this trade relationship between Canada, the US and Mexico exists," said the analyst. "The three countries benefit from this trade relationship."