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Recession Looms for Mexico With Trump Threatening New Tariffs

A surprise tariff threat couldn’t have come at a worse time for Mexico’s already shrinking economy.

Recession Looms for Mexico With Trump Threatening New Tariffs
Demonstrators hold an effigy of U.S. President Donald Trump and a Mexican flag in front of the U.S. embassy during a protest against Trump in Mexico City, Mexico. (Photographer: Yael Martinez/Bloomberg)

(Bloomberg) -- A surprise tariff threat couldn’t have come at a worse time for Mexico’s already shrinking economy.

The move could tip Mexico into recession, and at the same time force the central bank to boost interest rates to rein in inflation. In a country highly dependent on exports, it’s no surprise that U.S. President Donald Trump’s plans to slap tariffs as high as 25% on all imports by October sent shockwaves through Mexican business and political circles.

“Tariffs on Mexican goods increase the possibility of a recession in Mexico,” said Bloomberg’s economist Felipe Hernandez. “The economy, on the heels of a first-quarter contraction, has high exposure to trade with the U.S., and high inflation and fiscal constraints limit the room for counter-cyclical policy.”

Recession Looms for Mexico With Trump Threatening New Tariffs

Monica de Bolle, senior fellow at the Peterson Institute for International Economics, anticipates the economy taking a “big hit” if Trump’s plan goes ahead. “You’ll see GDP falling, inflation accelerating. It’s going to be a mess for Mexico.”

Latin America’s second-largest economy unexpectedly shrank 0.2% in the first quarter amid a contraction in service and industrial sectors, as well as budget cuts ordered by President Andres Manuel Lopez Obrador. The data led economists to trim their growth forecast for this year, and the central bank to consider the possibility of the economy growing as little as 0.8% in 2019, which would be its worst performance in a decade.

And all that before the tariffs.

Mexican exports as a percentage of GDP are the largest of any major Latin American country, according to the World Bank, and about 80% of them go to the U.S. Across-the-board tariffs would create havoc in an economic system that over the years grew ever more intertwined.

Industry Disaster

The 1994 Nafta free-trade agreement between the U.S., Mexico and Canada enabled factories to draw close links across national borders as a means to reduce costs. A single capacitor, for example, hopscotches the U.S. border with Mexico four times before finally reaching Canada. That interdependence means enacting tariffs is all the more worrisome, according to Eduardo Suarez, an economist at Scotiabank.

“Given this is a tariff, and not a VAT tax, it would be applied every time a good or part crosses the border, which for a supply chain as integrated as North America’s, could be disastrous,” Suarez wrote in a note. “Given the high uncertainty, we expect volatility to remain high.”

Inflation Boost

The impact will be felt on prices, too. Before Trump’s announcement, economists surveyed by Bloomberg expected policy makers to keep its benchmark rate on hold at 8.25% through the third quarter. Implementation of tariffs could instead prompt tightening, according to Carlos Capistran, head of Mexico and Canada economic research at Bank of America Merrill Lynch.

“The central bank of Mexico would likely respond by increasing rates to fight higher risk premium, higher domestic prices and a peso depreciation, despite a weaker economy," Capistran said in an email.

Tariffs would start at 5% on June 10 and rise incrementally to 25% by October unless Mexico stops immigrants from entering the U.S. illegally, Trump said. Peterson’s de Bolle said that while the initial tariff level could be absorbed by companies’ profit margins, effects would be quickly visible soon after it reaches 10%.

To contact the reporters on this story: David Biller in Rio de Janeiro at dbiller1@bloomberg.net;Eric Martin in Mexico City at emartin21@bloomberg.net

To contact the editors responsible for this story: Juan Pablo Spinetto at jspinetto@bloomberg.net, Walter Brandimarte

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