Hola Mexico

GUADALAJARA IS MEXICO’S second-largest city and most important cultural centre. It is the home of foot-tapping mariachi, the traditional music of Mexico. It’s also the home of tequila. But Guadalajara’s big money comes from hi-tech manufacturing: The city produces 40% of the country’s electronic goods, and hosts industries as diverse as aerospace and food processing.

But manufacturing, however hi-tech, is not what’s occupying the soft-spoken 39-year-old Pedro Ruiz Gutierrez, minister of the city of Guadalajara for economic development. Gutierrez is trying to make his city into a digital hub—the first in the country, and, indeed, Latin America. The global digital economy has been valued at around $4 trillion (Rs 250 lakh crore) by consulting firms such as Boston Consulting Group and Gartner, and Mexico, specifically Guadalajara, wants a slice of that. “It is about creating an ecosystem where creative industries such as animation, digital movies, interactive multimedia, and videogames can not only thrive but also export to the rest of the world,” explains Gutierrez.

Guadalajara already boasts some of the biggest names in information technology, including Dell, HP, Intel, and Tata Consultancy Services (TCS). But the city wants more. It has entered into a partnership with Dublin, which has a digital hub of its own, and plans to invite digital players from Bangalore, California, Seoul, and other tech hotspots across the world. “Indians are welcome to be a part of this exciting new journey,” says Gutierrez, who was recently in New Delhi as part of the Mexican delegation at the Confederation of Indian Industry (CII)-Latin America conclave.

Something similar is going on in other Mexican states, where spokespersons like Gutierrez are going all out to seize “Mexico’s moment”. Despite problems of drug-related crime, illegal immigration, and slowing growth, Mexico is seen as a strong competitor to investment destinations like Brazil. Larry Fink, who heads BlackRock, the world’s largest asset-management company, has described Mexico as an “incredible growth story”, and Standard and Poor’s, the rating agency, revised Mexico’s long-term sovereign credit rating from stable to positive in March last year. And, according to media reports, private equity player Bain is the latest to consider creating a Latin America-focussed investment fund, following the examples of The Carlyle Group and Advent International Corp. Global auto major General Motors is planning to spend $691 million to build and expand its factories in Mexico. Today, companies from the U.S., Europe, Japan—and even China and India—are setting up factories in Mexico to take advantage of the lower wages there.

Jim O’Neill, the Goldman Sachs analyst who promoted the idea of BRIC (Brazil, Russia, India, China) is now pushing MINT, an acronym said to have been coined by fund managers at mutual fund giant Fidelity. The MINT countries—Mexico, Indonesia, Nigeria, and Turkey—could well be the next economic powerhouses. Mexico, say experts, is open for business.

OVER CENTURIES, MEXICO has been squeezed of much of its wealth and natural resources by successive conquerors and rulers, starting with Spanish conquistador Hernán Cortés, who claimed the land for Spain. Cortés oversaw the building of Ciudad de México (Mexico City) on the ruins of Tenochtitlán, the most important Aztec city, and was appointed governor of Mexico (which was renamed New Spain). The viceroyalty of New Spain included large swathes of what is today the U.S., Mexico, and much of Central America (Costa Rica, Nicaragua, etc.), and was ruled from Mexico City. Spain’s empire, from the 1500s, included much of Europe, the New World, and later, the Philippines.

Till 1813, when Mexico won its independence, the country’s coffers belonged to Spain. Even after independence, the country was squeezed by unscrupulous, often dictatorial, leaders such as Antonio López de Santa Anna, who became President on five different occasions between 1833 and 1855, swinging from liberal to conservative depending on the mood of the people.

At a time of political uncertainty, Mexico also had to cede pretty much all its territories in North America (New Mexico, Colorado, Utah, Nevada, Arizona, and California) to the U.S. after a long war.

That was followed by civil war between the conservatives, who wanted the church to control government, and the liberals, who fought for a secular government. By 1850, all the political unrest and internal corruption had destabilised Mexico’s economy. Politically, Santa Anna was coming to the end of his long reign, and his conservative government was overthrown by the military in a coup in 1854. A series of military leaders followed, and in the process, Mexico’s economy suffered even more. Faced with empty state coffers and huge debts, especially to Britain, Spain, and France, liberal President Benito Juárez decided to suspend repayment of all foreign debt for two years from 1861.

Nervous that they would not see their money again, Britain, Spain, and France jointly sent troops to Mexico to collect their dues. While the government managed to placate Britain and Spain, the French troops marched to the capital, where the conservatives welcomed them. Juárez and his government fled. But Juárez, widely considered Mexico’s Abraham Lincoln, overthrew the French and was re-elected President in 1867, a post he held till his death in 1872. Almost all history books agree that Juárez’s domestic reforms set the stage for Mexico’s modernisation.

For the next few decades, Mexico saw a period of great prosperity, but social unrest. Governments after Juárez ignored the peasants who lived in poverty. A revolt against the rich was brewing and it led to the Mexican Revolution of 1910. The revolution saw the rise of Mexican warlords, and their ultimate end close to two decades later. The Partido Revolucionario Institucional (the PRI, or the Institutional Revolutionary Party) was founded in 1929 by Plutarco Elias Calles—who had become President in 1924—as the National Revolutionary Party and later renamed the Mexican Revolutionary Party, as an attempt to lead Mexico out of its period of conflict—with peasants, the church, as well as with the U.S. The party started out espousing military leadership and almost total state control of business. (Pemex, Mexico’s state-run oil monopoly, was the creation of the PRI.)

The PRI has also been accused of widespread corruption and ballot rigging, including a particularly egregious exercise in buying votes for Enrique Peña Nieto in the 2012 elections. Voters were given 100 peso (roughly $7 or Rs 469 at current rates) prepaid gift cards that could be redeemed at a popular grocery chain. The party denied that it was involved in buying votes. Ironically, Peña Nieto won on a campaign promising a transparent and clean government. In an interview with Time magazine soon after the results were announced, Peña Nieto argued that the party was changed. “The PRI has eminently changed because Mexico has changed. This is another Mexico today, a democratic culture, and we are competing strongly again precisely because our proposals promise even more change in Mexico.”

Under Peña Nieto, Mexico has been aggressively pushing reforms. In the same interview, he said: “Mexico urgently needs a series of structural reforms that will detonate its true economic potential and generate more public welfare. Energy, labour, tax, and social security reforms are imperative.” This was in acknowledgment of the fact that Mexico’s economy, till his election, had averaged a disappointing 2% rate of growth since 2000.

His reformist zeal seems to have borne fruit; in the past couple of years, Mexico has managed to thump its far bigger neighbour, Brazil, on several economic and growth parameters. Mexico’s growth rate at 3.9% was nearly 1.4% higher than that of Brazil in 2012. The rate of inflation has also been more subdued in the smaller country, and foreign investments in Mexico were close to five times that in Brazil. Mexico’s GDP in 2012 was $1.2 trillion, smaller than Brazil’s $2.2 trillion. However, Mexico has seen a spurt in GDP growth: 4.3% between 2010 and 2012. Compare this with the sharp fall in Brazil’s growth: from 7.5% in 2010 to 1.5% in 2012.

Political leadership plays a large role in economic reform, as seen in Brazil and Mexico. While Peña Nieto is busy welcoming foreign companies and aggressively pushing reforms, Brazil, under President Dilma Rouseff, is turning more conservative. “While Rouseff is carrying forward the pro-poor agenda of her predecessor Luiz Inácio Lula da Silva, she does not seem to be as pro-market as the former President. Brazil has become more inward looking,” says R. Viswanathan, former Indian ambassador to Argentina, Uruguay, and Paraguay.

In just about a year, Peña Nieto has shaken up the economy by allowing foreign competition in the hitherto closed sectors of the economy such as entertainment and telecommunication; sweeping reforms in education, government finances, and politics through constitutional amendments, and a law to reform the monopolistic energy sector, despite strong opposition.

ONE OF THE MOST welcome signs of Mexico opening up is the flotilla of free trade agreements (FTAs) signed with some 44 countries. Apart from increasing the depth of Mexico’s trade, these FTAs are seen as an attempt to reduce the country’s dependence on its largest trading partner, the U.S. (Trade with the U.S. accounts for $493 billion, or almost 80% of Mexico’s total foreign trade.) Its FTAs with the EU and countries like Japan mean that Mexico’s industries can export goods to these countries without paying any import duty. “It provides a huge opportunity for Indian companies which plan to market their products either in North America or in countries with which Mexico has an FTA,” says Viswanathan.

Mexico’s advantage is that most of its industrial hubs are located just 1,200 km from the U.S. border. “With the easing of customs clearance rules between the two countries, goods can reach the U.S. markets in 24 hours,” says Ricardo Kumar Dadoo, founder and CEO, Logistics Dadoo, a consultancy firm for logistics companies in Mexico.

Mexico is also building bridges with its neighbours; it’s part of the four-nation Pacific Alliance, which could well be the precursor to an European Union-style economic and political union of countries in the region. At the moment, the Pacific Alliance is an economic pact between Mexico, Colombia, Peru, and Chile. The Alliance, based on an idea proposed by then Peruvian President Alan García, was formed in 2011 to create an economic bloc that could negotiate trade with other countries. These countries have not only eliminated all tariff barriers but have also integrated their stock exchanges to move into an economic and customs union. “What these countries have done is to marry their destinies. Instead of challenging the globalisation forces of the 21st century, they have decided to embrace it fully,” says Deepak Bhojwani, former Indian ambassador to Colombia, Cuba, and Venezuela.

A number of countries, including some that are not even in the Pacific, have observer nation status; the Alliance has invited the ASEAN (Association of South East Asian Nations) to be an observer. Other observers include Australia, Guatemala, New Zealand, and Uruguay. With the Alliance and the raft of FTAs, Mexico under Peña Nieto is busy opening its doors to foreigners.

Companies from across the globe are taking up the invitation. “Not only is Mexico close to the biggest market in the world, the U.S., and in the same time zone, it also offers certain advantages because of its membership of the North American Free Trade Agreement [NAFTA],” says Ankur Prakash, COO, Latin America, TCS. His company has three offices in Mexico—in New Mexico, Queretaro, and Guadalajara.

A growing and more open Mexican economy is good news for Indian manufacturers—those who want to set up base there, and those who export to it. “Mexico has been a major hub of vibrant activities for automotive makers, and we see this trend continuing,” says Vivek Chaand Sehgal, chairman of the Samvardhana Motherson group, which makes auto components. Sehgal says the total turnover from Mexico for the group is over €135 million (Rs 1,141 crore).

Information technology majors such as Infosys and HCL are already there, as are BPO (business process outsourcing) players such as Wipro and Genpact and pharmaceutical companies such as Dr. Reddy’s Laboratories. Trade between the two countries has touched $6 billion and experts believe that it can touch $10 billion by 2015.

“The single message that the President is sending out is that Mexico is open to global business and investments. He is willing to prise open even the critical and more lucrative sectors of the country’s economy to foreigners, despite all the demonstrations and protest,” says Dadoo. These reforms, he believes, are here to stay, not just because there is a consensus among the main political parties but because the country has rarely gone back on reforms. “When the country signed NAFTA, there were huge demonstrations, but no attempt was made to scrap the treaty.”

The other big attraction for companies is that Mexico is a promising point of entry to the Spanish-speaking population of the world, which is around 450 million today. There are already about 112 million in Mexico, some 40 million in Spain and an equal number in the U.S., as well as the sizeable population in other Latin American countries. “So, for instance, if an Indian IT company can make software like banking service code in Spanish, it can serve the entire 450 million population by setting up a base in Mexico,” explains Viswanathan.

For manufacturers, Mexico is fast emerging as a cheaper option to China. Wages have been going up rapidly in China, while they have remained stagnant in Mexico. According to Carlos Capistran, chief economist at Bank of America-Merrill Lynch, 10 years ago Mexican labour rates were 188% higher than those in China, but today it is about 20% less than China. An ageing population and the draconian one-child policy (only now eased), combined with huge demand for labour in Chinese manufacturing units and state policies designed to push up minimum wages, have led to a substantial increase in wages in recent years.

“Mexico, on the other hand, with its young and growing population, has seen wages stagnate, giving it a labour cost advantage over China besides its advantages in terms of proximity, speed of delivery, and operating at the same time of the day as the U.S.,” Capistran writes in a report. Since 2010, he adds, Mexican imports have been up 32%, while those from China are up just over 20%. “The manufacturing boom is going to continue because Chinese wages are not likely to come down,” says Viswanathan.

Add to that the appreciation in the Chinese currency and growing shipping costs, and investing in Mexico suddenly makes far greater sense than going to China.

BY OPENING UP its largest state-controlled sectors, Mexico has also become far more attractive to big industry. In power, for instance, the government has ended the monopoly of the state-owned Comisión Federal de Electricidad over power generation, and private players are being allowed in. However, the government has control over transmission and distribution.

The government has also come out with an amendment that has transformed its role in telecommunications and expanded its power to curtail media monopolies. It can now sanction or split companies engaged in monopolistic practices and establish ad hoc restrictions to minimise undue market advantages for dominant players in industry—defined as companies that capture 50% market share through their number of users, capacity, or network infrastructure. While this may be bad news for Mexico’s telecom czar Carlos Slim Helú, it’s good news for telecom companies that have been trying to enter an industry dominated by Slim’s América Móvil (which controls close to 80% of the mobile and fixed-line markets).

Most important is the move to open up the hydrocarbons sector to international competition. The state-controlled energy monopoly, Pemex, has been treated as a cash cow by various administrations—using its profits for pro-poor policies. Pemex was nationalised in 1938 because of a potential takeover by U.S. oil majors, and since then, there has been little effort to modernise and upgrade the company. Over the last decade, Pemex has reported a 20% drop in production, and has been a loss-making organisation for about as long. “Mishaps and other losses are expected to result in a $7.7 billion loss to the company in 2013,” says a U.S. Congressional research report on Mexico’s oil and gas sector.

Peña Nieto threw his weight to amend the laws governing Mexico’s energy sector, which now allow Pemex to form profit-sharing partnerships with international companies in exploration and production; and also sign agreements with private companies for transporting oil and gas, refining, and producing petrochemicals.

“These reforms (as and when they are implemented) will not only make a tremendous difference to Mexico’s productivity but also to investments needed in offshore and deepwater. These are things that you can’t do on your own; even Brazilian state-owned oil major Petrobras, which is much bigger than Pemex, finds that it cannot do so on its own,” says Bhojwani.

While all these are welcome steps for international business, they also point to Peña Nieto’s political acumen. He has managed to get the left, right, and centrist parties to agree to these reforms in what is called the Mexican Pact. Under this, all parties, regardless of their agendas, have come to an internal agreement on 95 otherwise contentious issues.

Putting an end to preferential tax treatment is one of them. Since the 1960s, maquiladoras—including American businesses set up on the U.S.-Mexico border—have produced everything from televisions to clothing and medical devices and paid preferential tariffs. A low tax rate had been offered to them to encourage them to set up shop in Mexico rather than in the U.S. Now they will have to pay a value-added tax of 16%, hiked from the earlier 11%.

In a bid to increase tax collection for social welfare schemes and road infrastructure, the government has increased the tax rate on high earners—from 30% to 32%; levied a tax on junk food, as well as on private education, concerts, and stock market gains. Lawmakers had earlier considered adding a tax on food and medicine but later dropped the idea.

The fiscal reforms have come in for some flak across the country. “These reforms do little to enlarge the tax base and only target the captive middle- and upper-class taxpayers,” says Dadoo, adding that the President may have been dissuaded by the continuing marches and social disruptions by opponents to the education and energy reform packages presented earlier to Congress. Proponents of the tax reforms see this as an important move to revitalise the economy and catapult the country forward in terms of development and living standards.

There are other problems that the government has to solve, including drug cartels and drug-related violence, high levels of poverty and rampant inequality, and poor educational standards. Moreover, as Luis Arcentales, Morgan Stanley’s Mexico analyst, points out, while the new administration has proved successful in manoeuvring Mexico’s political terrain with innovations like the Mexico Pact, its record of implementation is still limited. “The real challenge for the President in 2014 will be to move away from enacting a series of wide-ranging reforms to beginning to implement them,” he says.

But something seems to have really changed for Mexico for the world to take notice and tout it as the new superstar, and a manufacturing hub that is giving China a run for its money. They are no longer the lonely people, uncomfortable in the company of foreigners as Mexican writer and Nobel laureate Octavio Paz wrote in his classic The Labyrinth of Solitude, but are far more open and welcoming of outsiders. As Viswanathan says: “The changed mindset among the leaders and the people has made all the difference.”