Trade opportunities in Mexico under NAFTA
June 01, 1993
by Teresa Acklin
By John Nichols, president, Almidones Mexicanos, S.A. (Almex), Guadalajara, Mexico, a maize wet milling subsidiary of A.E. Staley Manufacturing Co. of the U.S. Mr. Nichols also is president of Promotora de Productos Alimenticias (PROMER), a manufacturer of branded foods and a Staley subsidiary based in Mexico City. This article was part of a presentation made to the 1993 annual meeting of the Grain Elevator and Processing Society.
The purpose of North American Free Trade Agreement (NAFTA) is to allow eventually all goods to be traded freely between the United States, Mexico and Canada. NAFTA has established a separate set of rules for each agricultural commodity, one set of rules for maize, a different set of rules for soybeans, another for soybean meal, and so on. Rules for each commodity include the designation of the period of time before that commodity is really traded freely and definition of what conditions will prevail during each commodity's transition period. After its transition period, a commodity will be freely traded with no duties, no quotas or no import licenses.
Mexico is a country of 85 million people. Its population is growing at a rate of more than 2% per year. In seven years, in the year 2000, there will be another 15 million mouths to feed in Mexico.
Mexico annually consumes approximately 16 million tonnes of maize, 4.6 million tonnes of wheat, 7.7 million tonnes of sorghum, 2.4 million tonnes of soybeans, 1.9 million tonnes of soybean meal, 1.8 million tonnes of beef, 850,000 tonnes of pork and 1 million tonnes of chicken.
In recent years, Mexico has produced an average of 12.7 million tonnes of maize, 5.3 million tonnes of sorghum, 4 million tonnes of wheat and 626,000 tonnes of soybeans. But by only considering these statistics, one misses the fundamental point of NAFTA: economic growth. If NAFTA is successful, it is going to help stimulate a cycle of investment in Mexico that will lead to significant economic growth in the Mexican economy and a significant improvement in the standard of living of the majority of the Mexican people.
To help grasp the size of this growth opportunity, consider how the per capita consumption in Mexico of maize, wheat and soybeans compares with consumption in the U.S. (see Table 2 on page 8).
I am not implying that Mexico will reach the consumption levels of the U.S., but I am confident that, if NAFTA is successful, per capita consumption in Mexico will move closer to U.S. levels.
In 15 years, all commodities will have completed their transition periods and will be freely traded. The population in Mexico will be about 115 million. If, by that time, Mexico moves only half way toward equaling today's per capita consumption levels in the U.S., I calculate that Mexico would need (Table 1 on page 8) an additional 27.9 million tonnes of maize, 4.8 million tonnes of wheat and 6.3 million tonnes of soybeans. This is substantially more than the current market in Mexico. While I will let the economists argue what level consumption will actually reach, it does not take sophisticated analysis at this stage to figure out that the growth potential for grains and oilseeds is big.
For some commodities, like maize, the big payout may not arrive until the end of transition period, 15 years from now, in the year 2008. What businessmen want to know is how to start making money out of NAFTA now, and during the early years of the agreement.
To get at this, we need to quickly review the NAFTA clauses for each of the major commodities. Let's first look at maize, sorghum, soybean meal and beef.
The transition rules for maize under NAFTA are more restrictive than those for any other grain or oilseed, and market forces will be substantially limited from functioning in the maize market until the end of the transition period.
Mexico currently restricts imports of maize through the use of import licenses. NAFTA will eliminate import licenses for maize and replace the import licenses with a system of quotas and duties. In the first year, the duty-free import quota will be 2.5 million tonnes of maize. Each year for 15 years, the quota will be increased by 3%. At the end of the 15 years, the maize quota will be eliminated, and duty-free imports of maize will be unlimited.
During this same 15-year transition period, there will be a duty placed on all maize imports into Mexico in excess of the quota. This duty will start high and be reduced to zero by the end of the transition. In the first year, the duty on all maize in excess of the quota will be $206 per tonne. At current prices for maize in Mexico, this duty will prohibit the import of any maize in excess of the quota. During the first six years, 24% of this duty will be eliminated. During the final 11 years, the rest of the duty will be phased out.
NAFTA is far more favorable toward sorghum imports than maize. Mexico already has no duty on sorghum imported from Dec. 16 to May 15. During the rest of the year, from May 16 to Dec. 15, Mexico applies a duty of 15% on sorghum imports.
NAFTA eliminates the 15% duty on sorghum beginning with the first year of NAFTA. This means that there is no transition period for sorghum. Sorghum will be allowed into Mexico all year round without duties starting with the first year of NAFTA.
NAFTA treats soybean meal in a straightforward way that will allow market forces to operate. The current duty in Mexico on soybean meal imports is 15%. This will be reduced by 1.5 percentage points each year until it is eliminated in 10 years.
Now let's compare the transition rules for maize, sorghum and soybean meal, with the those for beef.
Mexico previously had a zero duty on imports of beef and live cattle. But in November 1992, Mexico reinstated a duty of 20% to protect its beef industry and to conserve hard currency. NAFTA will return the duty on beef to zero, starting immediately with the first year.
The U.S. will eliminate in the first year of NAFTA its duty on beef cattle imports from Mexico, which is currently 1 cent per lb (about 2.2 cents per kg).
What does this mean? First, it means that for the next 10 to 15 years, beef from U.S. feedlots will have free access to the Mexican market, while Mexican beef producers will be competitively disadvantaged in their feed costs.
If you are in the maize business, and you have good logistics to the U.S. feedlot industry, you will not have to trade directly with Mexico to benefit substantially from NAFTA.
The beef industry is not the only industry that will consume more grain and oilseeds in the U.S. in order to meet increasing demand for their products in the Mexican market. Other industries that should increase sales to Mexico include soybean crushers, maize wet millers, wheat flour millers and brewers.
There is another conclusion that we can make by looking at how NAFTA treats maize versus sorghum. Sorghum exports to Mexico could see a boost in the early years of NAFTA because of the more stringent restrictions on maize. But, sorghum's relative advantage will disappear by the end of the 15-year transition period for maize. Depending on how the Mexican government manages domestic farm policy, this relative advantage could vanish overnight at the end of the 15 years. Whichever way it is managed, the point is that you don't want to get over-committed to exporting sorghum to Mexico for the long term.
WHITE NOT YELLOW.
Finally, I want to mention another aspect of the maize opportunity. Approximately 85% of the maize that Mexico consumes is white maize, not yellow maize. Tortillas are made from white maize, not yellow maize. The Mexican government currently guarantees the Mexican farmer the equivalent of $6 per bu (about $236 per tonne) for white maize and $4.82 per bu (about $190) for yellow maize. Based on this, I would make three points.
First, even with high guaranteed maize prices, most Mexican maize farmers live in extreme poverty. By the end of the 15-year transition period, either the Mexican government will be paying a huge subsidy to its maize farmers, or a substantial amount of cropland currently devoted to maize will go out of production or be planted in another crop. I predict a combination of both, which will mean that while some maize continues to be grown in Mexico, the majority of maize consumed in that country will come from the U.S.
Second, the U.S. may need to substantially increase the cultivation of white maize to meet the Mexican opportunity. The demand for white maize could increase sufficiently to bring that grain into the mainstream of commodity trading rather than being seen as a specialty. Seed companies will need to accelerate their white maize hybrid development programs and increase their white maize seed supply. U.S. farmers may become confident enough of the demand for white maize that less of the white maize produced in the U.S. will need to be contract grown. Elevators positioned to serve Mexico may choose to specialize in handling white maize. And, the premiums for white maize over yellow maize should shrink.
But my third point is, don't get in too big of a hurry to cash in on white maize. It's possible that the Mexican government may not allow the U.S. to compete for white maize until the end of the 15-year transition period. White maize premiums in the U.S. and international markets vary considerably, but in general, U.S. farmers have been willing to contract grow white maize for a premium of up to 70c per bu (about $28 per tonne) over yellow maize prices. Mexican farmers are receiving a premium of $1.18 per bu (about $46 per tonne) for white maize over yellow maize. Therefore, traders have probably already figured out that the Mexican market would save a lot of money if the duty-free maize that Mexico will import under quota is white maize rather than yellow maize, letting the Mexican farmers grow the additional yellow maize.
I don't think the Mexican government is going to let that happen, at least not during the first few years of NAFTA. Mexico is running a large commercial deficit. There is talk that the Mexican peso is overvalued and needs to be devalued. And the Mexican government is trying to give farmers financial incentives to stay in the countryside instead of migrating to the cities. I contend that to minimize the outflow of hard currency and in order to support the Mexican farmer, the Mexican government will prefer to pay more to the Mexican farmer in Mexican pesos to grow white maize and restrict maize imports to yellow maize. It may take the entire 15-year transition period before the white maize market in Mexico opens up.
NAFTA gives soybean imports a more favorable treatment than soybean meal imports during the transition period. Mexico currently has a 15% duty on soybeans from Aug. 1 to Jan. 31 of each year. For the other six months of the year, soybean imports are duty free. The duty under NAFTA will be reduced to 10% in the first year and to zero over 10 years. And instead of applying the duty during six months of the year, the duty will only apply for the three months of October, November and December.
The treatment of soybean oil, like soybean meal, is less favorable than the treatment of soybeans. The current 10% duty on crude soybean oil will be reduced to zero over 10 years. And the current duty of 20% on refined soybean oil will be reduced to zero over the same 10 years.
What does this mean? All things equal, the preferential treatment given soybean imports versus imports of soybean products would appear to favor the raw product in trade with Mexico. But, things are not equal. Most Mexican crushing and refining plants are small, antiquated and inefficient. Production losses 20% to 50% greater than normal losses in the U.S. are not uncommon. Almost all of the Mexican soybean processing plants need capital and technology. It will be interesting to see if the transition rules for the soybean complex will favor Mexican or U.S. crushers during the transition period.
WHEAT AND FLOUR.
Mexico currently restricts wheat imports with a system of import licensing. This system will be eliminated by NAFTA. Unlike maize, wheat will simply have a duty of 15% starting the first year of NAFTA. This duty will decrease 1.5 percentage points each year until it reaches zero in 10 years. Soft wheat in Mexico is primarily grown on irrigated land. Mexican wheat farmers have been receiving the equivalent of about $254 per tonne for their wheat.
Wheat flour will be treated exactly the same as wheat. It will have the same 10-year transition period starting with the same duty of 15% in the first year and declining to zero duty in 10 years.
It is not clear to me if U.S. wheat will move directly to Mexico, to Mexican flour millers, or if U.S. wheat will move to U.S. flour millers, who, in turn, will ship flour to Mexican bakers. This will depend on the economics of distribution and manufacturing costs of U.S. mills versus Mexican mills. But, I do predict that Mexican consumption of white bread will increase with economic growth in Mexico.
The last commodity I want to mention is edible beans. Mexico consumes about 1.275 million tonnes of edible beans a year.
The NAFTA provisions governing trade in edible beans run parallel to those for maize. The import licensing system for beans will be replaced by a duty-free quota and a tariff. In the first year of NAFTA, the U.S. quota will be 50,000 tonnes. This quota will grow by 3% per year for 15 years. Imports in excess of the quota in the first year will have a duty of at least $480 per tonne. Over the first six years of NAFTA, 24% of this duty will be eliminated. The rest will be eliminated over the last nine years of the transition period.
Eventually, there will be a substantial opportunity to trade edible beans from the U.S. to Mexico. But, just like white maize, the Mexican government may not allow significant access to this market until the quota has been eliminated.
I'd like now to take a different perspective on opportunities in Mexico. When you do business in Mexico or with Mexico, you may confront situations such as difficulty in collecting payment even against letters of credit, excessive shrinks, difficulties with communications, unexpected demurrage bills, inexperienced trading partners, even broken contracts. For those who can figure out how to successfully work through these situations, you may find yourselves with a significant competitive advantage.
There is considerable opportunity for consulting and training in Mexico covering all aspects of commodity trading.
Another important aspect of the Mexican opportunity is that very few traders in Mexico are experienced. Until three years ago, the state-owned company CONASUPO conducted all agricultural trade. It was a bureaucratic monster in which no one except those at the highest levels participated in a complete transaction. As a result, most commodity traders in Mexico have traditionally bought only flat price without hedging their position. While this creates some pricing opportunities from time to time, mostly I view it as an obstacle to market liquidity and market growth. For commodity futures brokers, this is an excellent opportunity to educate an entire market of traders.TABLE 1: Production, consumption, new demand potential for maize, wheat and soybeans in Mexico
|New demand potential ||27.9||4.8||6.300|