Stall in the Fast Lane : That ‘Giant Sucking Sound’ Is the Peso Crisis Letting the Air Out of Mexico’s Auto Industry
Lavender Ford Mustangs, sturdy Jeep Cherokees and economical Nissan Tsuru sedans waited in showrooms here last week for what car dealers hoped would be a crush of customers ahead of a government-scheduled 6% price hike.
But few buyers--or even window-shopping tire kickers--showed up, and the handful who did were driving hard bargains.
“I am going to every Nissan dealer in town and checking the price of 1994 models,” said Adela Perez, who was helping her newly retired father spend his severance pay on a vehicle he could use as a taxi.
As for herself, Perez said, buying a new car now--about two months after Mexico’s ballooning trade imbalance set off a dramatic devaluation of the peso--is out of the question. As a bank employee, she could get a car loan, but the interest would be an outrageous 60%.
The empty showrooms and crestfallen consumers are street-level proof that Mexico’s latest financial crisis, woeful news to the typical consumer here, is also a major setback for what had promised to be the showcase industry of the North American Free Trade Agreement.
The devaluation of the peso has given new meaning to the phrase sticker shock, sent auto loan rates to crippling levels and knocked Mexicans’ assumptions about the future out from under them. As a result, Mexico’s passion for new cars--which had been fueled by the boundless optimism surrounding the free-trade pact--has been doused.
Production schedules have been pruned at assembly plants from Cuernavaca to Ft. Wayne, Ind., demonstrating how intertwined--for better and worse--the economies of Mexico and the United States have become.
“It highlights the degree of interdependence that already exists,” said James Donlon III, controller for Chrysler Corp. “If this had occurred further into NAFTA’s integration, it would have had an even greater effect.”
Even before the trade pact took effect Jan. 1, 1994, the auto industry was a significant part of Mexico’s effort to participate in the world economy. In fact, its autos are second only to oil among exports.
Since NAFTA, auto makers have accelerated efforts to coordinate their production operations in the United States and Canada with those in Mexico.
Integrating North American production has meant importing more vehicles and parts into Mexico, exporting more to the United States and shifting assembly of certain vehicles across borders for lower costs and maximum efficiency.
Mexican auto parts makers, long protected by domestic content regulations that forced manufacturers to buy from them, were suddenly exposed to competition from other countries with better made products. To compete, many suppliers invested heavily in new equipment and beefed up quality control.
At the same time, auto makers and suppliers were salivating to gain a toehold in Mexico, the last great growth market for autos in North America and among the most promising anywhere.
Mexican motorists were equally enthusiastic. No longer would they be second-class customers, paying higher prices for a narrow selection of out-of-date models. For the first time in three decades, Mexicans could buy a Jeep made in Ohio. A Ford Contour coming off the assembly line in Cuautitlan was as likely to cruise the streets of Chicago as the roundabouts of Guadalajara.
The auto industry projected sales doubling to about 1.2 million by decade’s end from 600,000 vehicles this year. Auto makers already building cars in Mexico laid out ambitious plans to expand; those without a presence, like Honda, BMW and Jaguar, prepared to rush in.
The peso’s free fall, however, has torn up the industry’s economics, from the factory to the showroom. The price of a German, Japanese or U.S.-built transmission bound for installation in a Mexican assembly plant, for instance, jumped 30% to 40% from what it was before Dec. 20, the day the government devalued the currency. A pickup truck with major components from Mexico could now be assembled in Mexico City at a significantly lower cost for shipment to Los Angeles, where somebody might find it cheaper than a truck built in Kentucky. At the same time, the purchasing power of the Mexican consumer’s peso has been severely undercut.
As a result, auto makers have scurried to revise production and sales forecasts drastically downward and are rethinking their strategies.
The extent of the damage is unclear, but even the most optimistic observers expect auto sales in Mexico to tumble by 30% this year from last. Others say sales could fall 50%, as they did after the 1982 devaluation that marked the beginning of the Third World debt crisis.
One early indicator reported last week: Truck sales in Mexico tumbled 88% last month from January, 1994.
It is clear that imports from the United States will slow to a trickle. Ford Motor Co. sent about 30,000 vehicles to Mexico in 1994 and had projected a near doubling of that number this year. Now Ford expects a decline in 1995.
“We were hoping for 50,000 this year, but that obviously is not going to happen,” said David McCammon, Ford vice president of finance.
One reason for the import slowdown is that the Mexican government’s price-stabilization plan discourages imports and encourages exports. It is allowing prices of imports to rise 30%--reflecting the higher value of the dollar--while attempting to keep a tighter cap on those for domestically produced vehicles.
Dealerships, in attempting to deal with the situation, have been offering shoppers interested in imports a generous exchange rate of 4.5 pesos to the dollar (compared with the current 5.7 pesos). At the same time, salesmen said, some dealers have raised sticker prices sharply on domestically made autos--exceeding government guidelines--to have a chance of unloading the imports.
As if higher prices were not hurdle enough for buyers, the government obsession with avoiding another inflationary spiral and recession has choked off credit. One salesman lamented: “Everybody is used to buying cars on credit and only one bank is still offering loans . . . at 60% interest.”
With most buyers forced to the sidelines, auto makers are responding by cutting back production.
Volkswagen, Nissan, Mercedes-Benz and Ford all closed their Mexican factories temporarily in January in expectation of a falloff in demand. Other closures are expected.
Fiat of Italy dropped plans to build a new factory with Grupo Dina, Mexico’s big truck maker.
The devaluation was particularly ill timed for Nissan of Japan, the second-largest auto maker in Mexico. Just the day before, the company had announced a new production strategy for North America that included plans to import 2,000 U.S.-made Altima sedans and Quest minivans to Mexico.
The company has since said it will put its Altima and Quest plans on hold but go forward with plans to export 24,000 Sentra sedans from its Aguascalientes plant to the United States. The factory currently exports to Canada and South America.
Still, Nissan is negotiating with its union to eliminate an entire production shift at its Cuernavaca plant that would result in 1,100 jobs being cut. The company said it would produce 180,000 vehicles this year, 30,000 fewer than anticipated before to the devaluation.
“We know that the domestic market is going to drop,” said Ana Luisa Alcudia, spokeswoman for Nissan in Mexico. “We are going to have to be more active in foreign markets.”
VW, which uses its massive Puebla plant south of the capital to serve all of North America, also plans to ship 175,000 Mexican-made vehicles to the United States and Canada this year--up 25,000 from last year. It is offering a nothing-down $199-a-month two-year lease to entice U.S. buyers.
VW shut down Mexican operations for five days in January and a company official said some production lines could be idled this month, depending on sales.
One assembly line that will almost surely be stopped, the VW official said, is the one that produces the “beetle,” still Mexico’s cheapest and most popular car. The reason being that bug buyers typically have limited budgets and are least able to buy cars in hard economic times.
The U.S. Big Three have been noncommittal about their Mexico plans, but company officials and industry analysts said they are considering keeping the Mexican plants running by shipping more vehicles North.
Chrysler said the company could keep its Mexican plants operating by sending more vehicles to the United States. For instance, the extended-cab Dodge Ram pickup made in Mexico City is in big demand by U.S. buyers.
“Our U.S. dealers are happy to get each one of these,” Donlon said.
GM and Ford stressed that it is too early to make changes in strategy.
James F. Connor, executive director of Ford’s North American marketing operations, said the greatest need is for a return to stability and restoration of consumer, business and investor confidence.
“(In effect) we are losing money on stuff we are building now,” he said, “but you can’t run a large corporation and close down things so fast that you hurt your entire distribution system and customer base.”
The predicament is complex. While exporting to Mexico is clearly much more expensive than before the devaluation, exporting from Mexico may not be as advantageous as one might think. A lot depends on the vehicles and the source of the parts. A vehicle made in Mexico with more costly imported parts is not as attractive to export as one with more local content.
So Ford is trying to determine how best to balance its operations. If the Mexican market falls 35% as it expects, the company must determine whether it can use the extra capacity to serve the U.S. market, Connor said.
It must also weigh the U.S. political impact of such a step. The auto industry, perhaps more than any other sector, reflects both the most bearish and most bullish views of NAFTA in the United States.
Although there are parallels between the current turmoil and Mexico’s devaluations and economic crises of the 1980s, the big difference lies in the existence of NAFTA. Some say the economic ties it has fostered will hasten a recovery in Mexico and that investment will return sooner than it would have otherwise. Others say the peso crisis exposes the false promise of the free-trade accord for the United States, and that the movement of auto industry jobs will prove it.
Moving production south to keep Mexican factories running would fulfill the darkest prophecies of NAFTA’s opponents in Congress and in organized labor. The United Auto Workers union was bitterly opposed to NAFTA. It said companies would exploit the pact to move more production to Mexico, where wages are about one-tenth UAW levels.
Detroit’s Big Three went to great pains during the NAFTA debate to demonstrate that its passage would benefit workers in all three countries. When Ford announced that it would make the Contour and Mystique sedans at Cuautitlan as well as at a U.S. site, the auto maker also said it would create 1,000 jobs in the United States and Canada by building other vehicles for export to Mexico.
With demand for exports to Mexico now in jeopardy, Ford officials still maintain that no U.S. or Canadian jobs will be lost. But industry experts are less certain.
“You can see American jobs being lost because we can’t export,” said David Eisenhart, partner in the Coopers & Lybrand accounting firm. He said 23,000 jobs in Michigan alone, most auto-related, are tied to exports to Mexico.
UAW officials are even more suspicious, saying the Big Three could exploit the peso crisis to build up permanent operations in Mexico that ultimately could eliminate union jobs in the United States. They note that, although vehicle exports to Mexico have surged since NAFTA, Detroit auto makers imported 300,000 vehicles from Mexico last year, five times the number they exported.
“We expect substantial new investment in equipment and plants in Mexico,” said Steve Beckman, international economist for UAW. “This was not the promise of NAFTA. The integration of the Mexican and U.S. economies was supposed to offer greater stability and to make everybody better off. It hasn’t.”
Others predict that auto makers will not risk souring relations with the UAW at a time when the U.S. market is strong and additional foreign investment into Mexico remains a high-risk undertaking. Still, if the peso remains weak for a significant period of time, the pressure of economics might well lead the companies to move more manufacturing to Mexico.
“In the long run, if the dollar remains strong against the peso, it may entice some of the Big Three to move more manufacturing south of the border,” said William Wilson, economist for Comerica Bank in Detroit.
From the perspective of Mexican unions, though, the prospect of higher production doesn’t automatically mean more jobs. Auto firms have been slashing the labor content of their products to compete with more efficient importers. In the meantime, slowed production will eliminate jobs.
“If the assembly plants shut down all the suppliers will have to shut down too,” said Benedicto Martinez, a member of the executive council of the Authentic Workers Front, the largest Mexican labor federation not affiliated with the ruling political party.
Many of Mexico’s parts makers cannot survive temporary plant closures, he said. They need revenue to pay off loans they took on to modernize their factories. Now, those loan payments--made in dollars because the loans were used to buy imported equipment--will cost them 30% to 40% more.
Plants that have not modernized are in even worse shape. The devaluation was a sort of watershed for suppliers: Those who bought new equipment may survive; those who didn’t upgrade facilities no longer can do so because of the weak peso, and the have little chance of remaining competitive or even in business.
“Only the companies that can compete will survive,” Martinez said.
U.S. auto makers are less worried about survival than about the impact of the still relatively tiny Mexican market on their bottom lines. Though Mexico represents less than 3% of Detroit’s vehicle sales worldwide, the companies may have to take write-downs to reflect the weaker peso and reduced value of plants and property in Mexico.
Most important to the auto makers is stability. They would like to see the government achieve the target level of 4.5 pesos to the dollar, but they say the number is less important than having confidence that a value will hold steady. In the long run, auto makers say, Mexico’s remains a fundamentally sound economy that still promises good growth.
“There is nothing that has changed my mind about this,” said J. Michael Losh, GM’s chief financial officer.
Darling reported from Mexico City, Nauss from Detroit.
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Mexico: A Major Auto Manufacturing Center
The Big Three, Nissan and Volkswagen dominant Mexico’s auto industry, though other world carmakers have plans to begin assemblying vehicles in Mexico as well. Besides assembly plants, there is a big parts industry centered in the maquila district along the U.S. border.
MEXICAN AUTO PLANTS:
1. Toluca-- Chrysler Neon, Cirrus/Stratus, GM engines
2. Mexico City--Chrysler Dodge Ram pickup, GM C/K pickup, Suburban
3. Saltillo-- Chrysler engines, assembly plant under construction
4. Cuautitlan--Ford Contour/Mystique, F-series pickup
5. Hermosillo--Ford Escort/Tracer
6. Chihauhau--Ford engines
7. Silao--GM assembly plant under constructon
8. Ramos Arizpe--GM Chevrolet Cavalier, Buick Century
9. Guadalajara--Honda Accord plant under construction
10. Aguascalientes--Nissan Sentra, small cargo vans
11. Cuernavaca--Nissan pickup trucks
12. Puebla--Volkswagen Beetle, Golf, Jetta
Source: Auto companies
NO VA
The sluggish Mexican economy has slowed domestic auto sales in the last two years, and the devaluation of the peso is likely to result in a further drop of at least 30% in 1995, industry officials and analysts say.
BORDER CROSSINGS
In the year since NAFTA took effect, the Big Three have increased both exports of cars and trucks to Mexico from U.S. and Canadian plants and imports from Mexico into the United States and Canada.
