Profile of Mexico details industry’s restructuring as country reacts to domestic growth in demand, and lowering of trade borders under NAFTA

Containerboard industry in transition as trade, competition increases

Mexico: A profile. Mexico is the second largest country in Latin America in terms of population and GDP, ranking behind Brazil. It has a surface area of almost two million square kilometers (0.8 million square miles), with forest, jungle and other natural vegetation occupying about 72% of the country. Mexico’s population, estimated at 93 million in 1997, is currently growing at only about 1.7% annually, much lower than in previous decades.

In 1997, Mexico’s Gross Domestic Product (GDP) was US$ 402 billion, and per capita GDP was US $ 4,345. Compared with its North American neighbors, this level of per capita income is low, meaning Mexico has a tremendous potential for growth in both absolute value of the economy as well as in per capital income. Principal sectors of Mexico’s economy are services, commerce and manufacturing. Pulp and paper, part of the manufacturing sector, accounts for 2.2% of manufacturing activity and 0.5% of GDP.

Economic growth in Mexico has varied in recent years, as shown in Fig. 1.

FIGURE 1: GDP growth has varied widely in the last decade.

The largest change was in 1995, when a recession occurred, which also coincided with a change in Presidential Administrations. The country is trying to avoid this erratic economic behavior, and high sustained growth is the goal. In 1996 and 1997 this was accomplished, as growth was over 5% each year. In 1998, growth will also be good. However, for 1999 and 2000, it will be more difficult to maintain high and sustained growth.

Inflation has been one of the major problems affecting the economy of Mexico for over a decade. Inflation peaked in 1987 at 160%, but since has plummeted and appeared to be under control by 1992. In 1993 and 1994, inflation had been reduced to single digit levels, however, in 1995 it soared to 52%. This reversal was principally a result of the peso’s devaluation on December 20, 1994. In 1996 and 1997, the inflation rate was again reduced substantially. For 1998 the government targeted a 12% rate, which should be exceeded.

FIGURE 2: Mexico’s currency was devalued in 1994.

The peso’s exchange rate has generally followed the trend in inflation. However, in the 1991-94 period, the currency’s devaluation was negligible, and the peso became over-valued. Consequently, there was 38% devaluation in 1994, with the major impact occurring in the last ten days of the year. During this period it dropped from 29 cents to 20 cents per peso, or 3.5 to 5 pesos per US dollar. In 1995, the currency’s volatility was intensified by political turmoil and lost confidence. With the financial help received from outside sources, especially the United States, the peso become more stable, floating around 8 pesos per US dollar (12 to 13 cents to the peso) form late 1995 to early 1998. By mid-1998, the rate had become unstable again.

With this background on the major trends in the general economy, and the pulp and paper industry as an example, let’s review how Mexico’s economy changed from a closed economy emphasizing import substitution, to an open economy with international trade. Following this will be a review of how the country’s international trade grew, especially in maquiladoras, and in turn the impact of these changes on the country’s containerboard industry, and paper industry in general.

Apertura or opening of the economy. In 1985, high import duties of 40% to 45% existed on imports of all paper products, and import permits were the norm. In 1986, Mexico started the process of “apertura”—or opening of the economy—upon joining the General Agreement on Tariffs and Trade. Trade barriers such as import permits disappeared and duties were reduced. The end of the 1980s eliminated all import duties on pulp and wastepaper, with the exception of a 5% duty on wastepaper for newsprint production. Import duties on all imported paper were reduced to 10%, except newsprint with was reduced to 15%.

NAFTA Duty Schedule. The opening of the economy finally culminated in the trilateral North American Free Trade Agreement among Canada, the United States and Mexico. NAFTA went into effect on January 1, 1994, and as a consequence, the import duties to Mexico of all paper products from North America will continue to drop until reaching zero (Figure 3).

Tariffs on corrugating medium will drop 1% per year from 5% in 1998 to zero in 2003. Unbleached kraft liner duties were 7% in 1998 and will be eliminated in 1999. Corrugated boxes are currently at 5% and will continue at this level through 2000, but in 2001, this duty will be eliminated. These duties are applicable to Mexico’s North American trading partners, and not to others, where the duties remain at 10%.

As the economy became more open, the magnitude of foreign trade increased. Oil related exports decreased in relative importance to only about 10% of the total in 1997. The maquiladoras grew in importance, now representing almost half of all manufactured products exported.

From deficits in 1993 and 1994, Mexico’s balance of trade changed to a surplus of US$ 7.1 billion in 1995. This was to a great extent the result of the devaluation and recession of 1995. The balance of trade continued positively in the first semester of 1997, but turned to a deficit in the second semester.

FIGURE 3: Tariffs on Mexico’s imports are falling under NAFTA.

Maquiladoras. Maquiladora refers to any partial assembly, manufacture or packaging done by a party other than the original manufacturer. A special duty-free treatment applies to these kinds of operations, but with the disappearance of duties, the maquiladora concept would no longer apply. Consequently, it doesn’t apply to North American trading, but it continues for other countries. In total there were 3950 maquiladoras as of mid-1998 providing jobs for 1 million workers. Of this total over 2600 are located in the 6 states closest to the US border. However, there are maquiladoras spread around the country, and thus no single area defines them. Nevertheless, there is a greater concentration due to the convenience of proximity, along the US border. .

Mexico’s Paper and Board Industry. In terms of the overall pulp and paper industry, 1997 production of paper and board in Mexico was 3.5 million metric tons. Within a North American framework, this compares to output of 86 million metric tons in the US and 19 million metric tons in Canada. Relative per capita consumption values are similar, with Mexico at 46 kg per capita (101 lb./capita), vs. 335 (738 lb.) and 227 (500 lb.) per capita in the US and Canada, respectively. This lower level of use per person suggests a large potential for growth as Mexico’s economy grows.

Containerboard Industry. Containerboard is a big sector of Mexico’s pulp and paper industry, accounting for about half of output and nearly 50% of consumption of paper and board. In the 1987-97 period, consumption doubled, reaching 1.7 million tons in 1997 vs. only 830,000 tons in 1987. It is quite evident that apertura has resulted in increased trade in both directions and that economic factors such as growth, inflation and devaluation effect these trends. The bulk of imports have been kraft liner, and practically all containerboard exports have been recycled medium.

In general I believe this trend can be expected to continue; however, the amounts of imports and exports will be influenced by macroeconomics factors such as economic growth, inflation and exchange rate. Furthermore they will be affected by industry structural changes that occur such as the Smurfit Stone merger in the US, the Durango Group’s purchase of McKinley and the establishment of new competitors in Mexico.

FIGURE 4: Containerboard output and trade expanded with economic growth.

Producers of Containerboard. Of the approximate 1.4 million tons produced in 1997 (the most recent full year data available), only 20,000 tons were exported. The biggest share of production came from three principal integrated participants that comprise over 60% of the production of both containerboard and corrugated containers. The major containerboard producers are the Durango Group and the Smurfit Group. The Gondi Group is a large local company, which is family owned. The Estrella Group is worth highlighting because it is in the process of installing a 200,000-tpy-linerboard machine this year. The group is also a local integrated family owned company. With this additional new capacity, the company will become a major factor in the market, although the domestic market will take time to absorb all of this capacity.

Containerboard capacity with the new machine will reach about 2 million tons by late 1999. It was originally projected to be only about 1.8 million tons in 1999, rising to 2 million in 2000 and 2.1 million in 2001, but the new the startup date for the Estrella machine was moved from 2000 to 1999.

TABLE 1: There are three major containerboard producers in Mexico.

Changing Environment. In reviewing all of these data, one can understand why the Government emphasizes the goal of “high and sustained growth” with low inflation. The erratic behavior of growth, inflation, devaluation and other related factors such as volatile interest rates must be stabilized to achieve potential economic growth. As the world economy has become globalized, Mexico has participated proactively with the trend. Consequently, both local factors as well as global influences now affect the country.

In an open economy, competition has increased, and new participants have entered into the market. These include national and international players, which may be integrated companies or independent converters. In addition, there has been movement towards mergers and acquisitions that would result in increased competition across country borders. The Mexican containerboard and shipping container industries are a good example of this economic environment in transition. Imports and exports now represent a substantial part of the market, reflecting the impact of globalization. Furthermore, the NAFTA agreement is transforming the N.A. region into one market place. It is composed of different countries with different cultures, but in essence it is only one market. Consequently, the performance of this market is influenced by the behavior of all players within this common marketplace.

Finally there are common issues facing the containerboard and shipping container industries that must be addressed in this changing environment. These include:

a) International supply contracts, sometimes with the intent of obtaining common packaging standards, but usually directed to reducing packaging costs,

b) new paper grades and packaging designs, e.g. “mini flutes made with light weight boards,”

c) and all other perennial issues such as ecology, alternative packaging materials, greater information demands and so on.

Key issues. Within this context of the Mexican container industry within a changing environment, certain issues challenge the future of our industry.

First of all, since the Mexican economic environment has yet to reach the type of stability and size that characterizes developed economies, the cost of capital is greater and financial risks are higher. In an emerging economy, this should be compensated for with better margins than in mature economies. Therefore, profitability should be greater to create economic value. However, the new large international players coming into Mexico often seem to neglect this economic fact. The economic health of this industry will depend on how these players will operate in Mexico.

Second, since Mexico is part of one North American market, the consequences of competitors’ behavior will affect to different degrees the whole market. In particular, unfair trade practices will be destructive.

Dumping is a common behavior pattern that many large containerboard producers practice in down cycles to the export market. With globalization, this unfair trade practice will eventually affect all of us.

Transfer pricing between related companies at different values than market is a fiscal violation as well as an unfair trade practice. This has been a common practice that some new international players perform with their containerboard supply to their converting plants in Mexico. I know of at least two cases, which are being audited for this.

Other destructive trade practices include the shipment of odd lots and seconds, which are sometimes invoiced as wastepaper. This disruption will backfire in a single open market.

Conclusion. There is a sign on the wall of a small car repair garage near Mexico City that states: “NO LE TEMAS A LA COMPETENCIA, TEMELE A LA INCOMPETENCIA.” This means, “Fear not competition; fear incompetence.” I really love that sign and think its message is very applicable to our industry. The Mexican containerboard industry is on the threshold of a new and different situation. Beginning in 1999, the import duty from NAFTA countries disappeared for the most important containerboard grade, unbleached kraft liner. Other grades will follow. In spite of this, Mexico has not created other non-tariff to avoid free trade.

Mr. Sacal is with Smurfit Carton Y Pape De Mexico. This article is based on a presentation given at the 8th International Containerboard Conference, Sept. 17-18, 1998, in New Orleans, La.