MEXICAN AUTO INDUSTRY HIT HARD BY U.S. RECESSION BUT EXPECTS

UNCLAS SECTION 01 OF 03 MONTERREY 000206 SENSITIVE SIPDIS DEPARTMENT PLEASE PASS TO USTR E.O. 12958: N/A TAGS: ECON ELTN ETRD EFIN ELAB PGOV MX SUBJECT: MEXICAN AUTO INDUSTRY HIT HARD BY U.S. RECESSION BUT EXPECTS TO REBOUND REF: 2008 MONTERREY 504 MONTERREY 00000206 001.2 OF 003 ¶1. (U) Summary. The deep U.S. recession has dramatically reduced demand in the Mexican auto industry, a key source of industrial production and exports. Mexican auto producers are in an ornery mood, strongly criticizing the importation of used U.S. cars and their government's lack of support during the economic crisis. Despite the GM and Chrysler bankruptcies, Mexican auto and auto parts producers are cautiously optimistic in the long run that their modern and low cost manufacturing industry will thrive. End Summary. Importance of the Mexican Automotive Industry ¶2. (U) The Mexican automotive assembly and auto parts industries are critical to Mexican manufacturing. Speaking at the May 18 Auto Show in Saltillo, Eduardo Solis, President of the Mexican Automotive Association, stated that the Mexican auto industry provides 1 million jobs, and constitutes 17% of Mexico's manufacturing GDP, 13% of Mexico's industrial employment, and 21% of its manufacturing exports. The Mexican automotive industry is primarily geared toward exports, as they export 80% of their car production, including 71% to the United States. The auto industry is particularly strong in the Northern states such as Nuevo Leon, Coahuila and San Luis Potosi. The Mexican auto parts industry is also important, accounting by itself for $18 billion in sales. Finally, Solis emphasized how the auto industry has been a key magnet for attracting foreign direct investment, delivering $20 billion USD in FDI between 2000 and 2006, including $3.5 billion USD in research and development. Deep U.S. Recession Hits Mexican Auto Producers ¶3. (U) An historic decline in U.S. car sales has led to a dramatic drop in Mexican production of cars and auto parts. In recent years Americans purchased 17 million new cars each year, but auto parts giant Nemak expects car sales to decline to 9.5 million units in 2009, and then recover slowly to 11.5 million in 2010, 12.5 million in 2011 and 14.5 million units by 2012. These projections are far below Nemak's forecast last October, when they expected U.S. car sales to total 13.9 million (see reftel). As a resulting of falling demand, Solis expects auto production to drop by 29% in 2009. The Mexican auto parts industry is also hard hit, because 63% of their sales are the U.S. Big 3 automakers. Agustin Rios, Executive President of the Mexican Automotive Parts Manufacturing Association, expects a 20% drop in Mexican auto parts production. The situation in Nuevo Leon is worse. Manuel Montoya, director of the Nuevo Leon Automotive Cluster, stated that the Nuevo Leon automotive industry is only operating at 40% capacity, and that the industry has shed 15% of its jobs in the last seven months. Interestingly, the industry lost 6,500 jobs in the last four months of 2008, but the pace of job losses has slowed, with only an additional 1,000 jobs lost in the first quarter of 2009. ¶4. (SBU) Mexican auto producers must cut production even below the abysmal car sale figures to reduce the overhang of inventory. Automobile analysts confirm that companies such as GM and Chrysler have 100 days of inventory of new cars waiting on the car lots. Due to the bankruptcy of Chrysler, auto production and auto parts suppliers have shut down production for 2-3 months. The same is true for many other brands, as many companies throughout the supply chain have slowed or stopped production. For instance, Nemak, a Tier 1 worldwide supplier of cylinder heads and engine block, coped with a 40% decline in sales and ballooning inventory by reducing production by 54% in the first quarter of 2009. Nemak also fired 3,500 employees, or 22% of their work force, and they have reduced their capital investment by 50%. Nemak is a division of the large Alfa company, which has other successful divisions such as the Sigma group (processed food) to rely upon. The situation is much more dire for many other smaller producers in the supply chain, particularly those focusing exclusively on auto parts. MONTERREY 00000206 002.2 OF 003 Fallings Sales in Mexican National Market ¶5. (U) The Mexican auto industry is not going to be bailed out by domestic car demand, because Mexican car sales have also fallen substantially. According to the industry magazine Mexico Now, Mexican auto sales will fall from 1.02 million in 2008 to 779,000 in 2009 (a 24% reduction),and the Mexican market will not recover to 1 million new car sales until ¶2015. Subsequently, the April data shows that Mexican sales of new cars fell by 38%, so the Mexico Now forecast may turn out to be optimistic. Curiously, Mexico's auto industry only supplies 38% of local sales, while the remaining new cars are imported (albeit many with Mexican auto parts). ¶6. (SBU) Industry leaders blame the depressed market on two factors besides the recession: lack of credit and imported used cars. Financing has become increasingly important for new car sales, as the percentage of buyers who receive financing has risen from 30% in 2000 to 70% in 2008. In the Coahuila auto show, Luis Gomez of Chrysler agreed that declining credit had had a dramatic impact in reducing sales of new cars, a point also made by several other contacts. According to an analysis by the leading newspaper El Norte, new car credits fell by an average of 25% in the first quarter of 2009, including reductions by GMAC (-42%) , Ford Credit (-39%) and Chrysler Services (-71.5%). Car loans from local banks fell at a much lower rate. Katia Calderon, the head of GMAC, disagreed by noting that GMAC financing was available and GMAC had taken over financing for Chrysler cars. Calderon did not think that lack of financing was an impediment to new car sales, although she acknowledged that a deterioration of the borrowers' credit worthiness (due to the deep recession) had led to higher credit standards. ¶7. (U) The real bugaboo for Mexican car producers is the importation of U.S. used cars, which they claim has substantially reduced Mexican new car sales. According to industry association head Solis, if not for used car imports, Mexicans would have bought 1.7 million new cars in 2008, instead of the 1.02 million which were purchased. In the Coahuila auto show, speaker after speaker thundered against used car imports, claiming that they were old junkers which did not meet U.S. safety or emission standards, and demanded that the GOM enact new rules to greatly reduce used car imports. The GOM decreed in December 2008 that all imported used cars must prove that 62.5% of the car or truck's content was made in the NAFTA region, or the car is subject to a 10% tax. In addition, there is an additional tax imposed on cars imported into the border area. These standards are extremely difficult to meet for an older car, especially if it has had several owners. Mexican car producers fully support the decree, and want even more protection based on safety and emissions tests. If pressed, the car producers claim that these rules are NAFTA compliant, but the issue was rarely addressed in front of Mexican auto trade audiences. Complaints that the GOM has Failed to Support the Auto Industry ¶8. (U) Almost every industry contact complained to econoff that the GOM has done little to support the Mexican auto industry during this difficult time. The GOM has a pro-employment program to support industries with temporary plant shutdowns. However, El Norte reported that by late May the GOM program to preserve employment in the automotive and electronic industries had only spent 25% of its 2 billion peso budget ($154 million USD). Moreover, the program had only supported 230,000 workers, less than half of its goal of 500,000 workers. Of the supported workers, 73% were in the automotive or automotive parts industries, and 27% were in electronics or machinery. Auto industry leaders have repeatedly complained that the GOM program had too many requirements and red tape to be effective. For example, Tier 1 producer Metalsa kept paying its workers even though they were not working, but kept track of their hours, and Metalsa plans to recoup these hours from its workers when production ramps up. However, since the workers were being paid, we understand that Metalsa was not eligible for MONTERREY 00000206 003.2 OF 003 the GOM program. The GOM agreed on May 28 to create more flexible regulations so that more companies would subscribe. Industry association head Solis demanded even more support, such as lines of credit and loan guarantees for new car purchases, the GOM should renovate its car fleet by buying new cars; the GOM should maintain the December 2008 decree on used cars; and the GOM should initiate common safety and emissions regulations for U.S. and Mexican cars. Solis and others also compared the GOM unfavorably to Germany, which they claim provides a 2,500 Euro credit for new car sales, a Brazilian program to provide consumer credit, and the U.S. programs to help the U.S. automakers. Impact of GM and Chrysler Bankruptcies ¶9. (U) Industry leaders are cautiously optimistic that the bankruptcies of GM and Chrysler will not substantially disrupt Mexico's industry because Mexican plants are modern and cost efficient. This issue is critical for Mexico, not just for final assembly, but the Mexican auto parts industry supplies 63% of its production to GM, Ford and Chrysler. However, the economic fundamentals point to Mexico overcoming the crisis. Several observers concurred that Mexico's plants are newer and more efficient than those in the U.S., and combined with Mexico's substantially lower labor costs, meant that a purely business decision would be to send auto production to Mexico. For example, Garcia of Chrysler assured the Coahuila audience that Chrysler planned to continue operating all of its Mexican car production plants. The Mexicans' primary concern is that GM and Chrysler will face political restrictions on their ability to out-source production. El Norte reported on May 30 that GM agreed with the United Auto Workers union (UAW) to produce a subcompact car in the U.S., instead of sending the production to Mexico or China. Michele Compton, an American lawyer from Detroit, said that the new Ford agreement with the UAW requires Ford to notify the UAW if it plans to ship production to Mexico, but the UAW does not have veto power over Ford's plans. Compton explained that any restrictions on auto production are likely to affect final auto assembly and Tier 1 suppliers, so there may be more opportunities for Tier 2 suppliers and others lower in the supply chain. ¶10. (U) Mexico should also benefit from the approximately 30% depreciation of the peso, which has made its auto industry more competitive. Garcia commented that labor constitutes 9% of Chrysler's total costs, so Mexican production has become even more competitive. Tier 1 supplier Nemak also considers the peso depreciation a great benefit, because like all tier one suppliers their sales are denominated in dollars and euros, while labor and some other costs are in pesos. Mexico would also greatly benefit if it develops more second and third tier automotive suppliers. Trade magazine Mexico Now estimates that Mexico could reap an additional $5 billion USD through producing additional products for the supply chain. ¶11. (U) Comment. Mexico still has a significant cost advantage, which has only grown with the shrinking peso, and it could grow further if Mexican industry continues to develop more auto components. Therefore, in the long run, the future still looks bright for the Mexican auto industry. However, unless U.S. auto demand quickly ramps up after the recession, the short term will be difficult, especially for smaller auto parts suppliers with little financial capacity to weather the storm. End Comment. WILLIAMSON