Morgan Stanley: Yuan Peg Move Bullish for Latam Commodity Producers Like Mexico
Gray Newman of Morgan Stanley is the third analyst this week who has been making Mexico-bullish noises due to the Chinese peg move.
In his recent research piece called "Latin America: The Renminbi Impact" he says we have to be cautious regarding the overall impact of the Yuan move. At a minimum, any appreciation is bound to be modest. But, of course, the announcement could be taken as a positive for how Chinese officials view their own economy as well in spite of the property bubble. Newman makes this case, indicating they may also be bullish on the sustainability of global growth. I am more cautious here.
But, at a minimum, the Yuan announcement will be a boon to commodity producers in Latin America like Chile, Brazil or Mexico. Newman saves his most bullish statements for Mexico.
The Case for Mexico
But while the immediate impact, however large or muted, might be seen in commodity producers, the medium-term impact of the latest news from China is unambiguously positive for Mexico. While the ascension of China during the past decade has been welcomed in most of Latin America as a new source of demand for the region’s commodities, Mexico has long viewed China warily as a threat to Mexico’s low-cost manufacturing and assembly model. Indeed, I can recall a decade ago when many investors began to argue that China "would eat Mexico’s lunch". The criticism of Mexico mounted in 2002 and 2003 as Mexico’s market continued to slump even as China gained ground (see "Mexico: Convergence or Divergence?" This Week in Latin America, June 6, 2004). Within another two years, China had replaced Mexico as the leading trading partner of the US and we were being told that the Mexican model – built around its role as an outsourcing arm for the US manufacturing industry – was over.
The only problem with the "China eating-Mexico’s lunch" view is that it stopped working five years ago. Since early 2005, Mexico’s share of US imports first stabilized and then more recently has rebounded sharply. Luis Arcentales has written about this extensively (see "Mexico: More than Just Cyclical?" This Week in Latin America, June 14, 2010). Some argue that recent gains in market share are tied to Mexican peso weakness: an interesting idea but it does not seem to hold up well with a longer review of Mexico’s market share in the US. Yes, the peso weakness has been associated with Mexico’s recent gains in market share, but Luis can find plenty of examples where Mexico lost market share with a weak peso and periods where it gained shared with a strengthening peso in the past two decades. Some argue that Mexico’s gains in 2006 were the lagged consequence of China’s move to allow its currency to revalue beginning in mid-2005. Perhaps that played some role, but Mexico once again lost those gains in market share in early 2008 long before the Chinese stopped the currency’s revaluation path.
Indeed, I would argue that a key driver for Mexico’s export gains has been foreign direct investment and I would expect the most recent news from China to provide a boost for the outlook for investment in Mexico. Even before the latest news, the low-cost labor advantage that China had enjoyed over Mexico a decade ago was evaporating. And the reading from the recent currency move in China is likely to reinforce the message: whether through wage increases or through a stronger currency, or a combination of both, the days of China relying primarily on its low-cost status are likely over.
Newman does note that this might "reduce the risk of a trade spat between China and the US." Morgan Stanley doesn’t believe protectionism is a significant risk here. I believe this risk is still high. See the link to comments by Sherwood Brown in my last post on Mexico as an example. Nevertheless, even in the event of a trade dispute, Mexico wins as US companies view Mexico as the next destination alternative for foreign direct investment.