RESEARCH SEMINAR IN FINANCEPROFESSORS: NORMA A. HERNÁNDEZ, PH.D

AND ROBERTO SANTILLÁN, PH.D.

Investment Environment in

Mexico

Content

SWOT Analysis for Investors in Mexico

Economic Environment

Legal Framework

Mexico’s Enterprises Data

Entrepreneurship

Conclusions

SWOT Analysis

Strengths

Mexico is one of the more attractive developing economies to foreign direct investment worldwide, with an annual average 22.5 billion of direct investments income (2001-2008).

Mexico has 16 international sea ports, 85 airports, 123, 000 km of paved roads and 27,000 km of rail.

Mexico has a large export base (one of the world's 15 largest exporters).

Mexico has a comparative advantage in production costs of 20.5% over 12 U.S. industries including construction, land, rental, labor and tax.

Recent studies by international consultants, show that manufacturing costs in Mexico are lower than those in Brazil, China and India.

Mexico is an interesting destination for foreigners seeking second homes; due to its attractive beaches, pleasant climate, biodiversity, cultural heritage, excellent services, economic infrastructure and historical sites, as well as the comparatively low cost of real estate.

Weaknesses

The most important source of foreign currency is through exports of oil, which has a highly volatile price.

The second source of hard-currency for the country is the remittances from Mexican workers in the United States to their families.

There is a complex taxation system.

There are serious problems associated with too much government bureaucracy, corruption, lack of infrastructure, insecurity, labor and tax regulation.

SWOT Analysis

Opportunities

Technological development of the primary sector to reinforce food production independence.

Increase the literacy rate in rural and marginalized urban areas.

The regional centers are located north and west of the country, where there is significant development of manufacturing industries, especially in the technology area.

Strategic industries for investment in Mexico include: aerospace, automotive, food, medical instruments and devices, surgery, dentistry, veterinary medicine, electronics, renewable energy, creative industries, fashion, habitat, tourism, professional services, software and information technologies.

SWOT Analysis

Threats

The high economic dependence of the country's

main trading partner (United States).

Lack of important structural reform (energy, fiscal,

labor).

Prevalence of an insecure climate.

SWOT Analysis

Economic Environment

Current Account Deficit and Direct

Foreign Investment in Mexico

Source: Banxico with forecasts of Index

A lower current account deficit is

not necessarily good news for an

economy as open as Mexico’s. This

could mean little economic

dynamism, especially in

consumption and capital investment.

The opportunity for México is to

reach the 2008 FDI investment

levels of more than 25 billion USD.

Gross Domestic Product

The most severe economic decline was observed during 2009; during the second quarter of 2009, the GDP decreased by around 7.0% annualized.

The manufacturing sector led the economic recovery; in industries known as "countercyclical“, like food, drink transport equipment, basic metals and metal products.

It will take a couple of years for the economy to return to the activity levels observed during the third quarter of 2008.

GDP

2009 downturn of

6.2%.

Positive forecast for

2010, 4.0%. – 4.5%

Reach previous levels

of activity in a couple

of years.

Similar evolution to

other Latin American

countries.

Source: CONSENUSUS FORECASTS /

BLOOMBERG, 2009

Gross Domestic Product

During the recent months

there has been a significant

appreciation of the Mexican

peso against the USD, which

was also observed for other

emerging currencies.

Low volatility of the

exchange rate due to stable

oil revenues, important

international reserves, and a

low trade deficit.

Mexico. Exchange rate vs. Emerging currencies.

(August 2008 = 100)

Exchange Rate

Source: BLOOMBERG & SANTANDER, 2010

Inflation

There was a short-lived inflationary bubble during 2008; explained by a temporarily weakened currency exchange.

For 2010, a one-time inflationary effect is expected as a consequence of the 1% increase of the Value Added Tax.

The 3% Central Bank Goal is still expected for the 4th quarter of 2011.

Mexico has similar levels to Brazil historically, without Brazil’s more dynamic inflationary tendencies.

Bloomberg, 2009

Country Risk

Reduction of country risk:

Recovery of industrial activity in the US means increasing demand for products made in México.

As the US industrial economic activity improves, investment in Mexico grows.

There was a reduction of the Country Risk Premium from levels of 360 bp in December of 2008 to only 167 bp in February 2010.

Country Risk - EMBI (Emerging Markets Bond Index)

(Base Points)

Source: BLOOMBERG & SANTANDER, 2010

Legal Framework

Main Laws Regulating

Investment in Mexico

Ley de Inversion Extranjera (Foreign Investment Law)

Opens the possibility for foreign investors to invest in various economic activities

that were previously restricted.

Ley del Mercado de Valores (Securities Market Law).

It shows a new legal structure, the Sociedad Promotora de Inversión or SAPI

(Investment Promotion Society)

Features:

1) Registration without the obligations to reach a public offer.

2) Leaves open the possibility to repurchase own shares.

3) Offers protection to minority interests.

4) Favors an institutionalization process through corporate governance mechanisms.

NAFTA

Its implementation eliminates most tariff and nontariff barriers to trade between

the USA, Mexico and Canada.

Ley de Inversión Extranjera Directa

(Foreign Investment Law) reform of 2008

According to the Mexican United States

Constitution, this law defines 11 economic

activities that are exclusively reserved to

the Mexican government due to their

strategic nature:

• Oil and hydrocarbons

• Basic petrochemicals

• Electricity

• Nuclear Power Generation

• Radioactive minerals

• Telegraphs

• Radiotelegraphs

• Postal service

• Coinage

• Control of seaports, airports and heliports

• Some utilities

Also restricts participation in certain

economic activities exclusively for

Mexicans and Mexican companies whose

act of incorporation includes a foreign

ownership exclusion clause, specifically in:

• Land passenger transportation, tourism and

freight; not including courier services.

• Retail distribution of gasoline and liquefied

petroleum gas.

• Broadcasting and other radio and

television services, including cable television.

• Development banking, in terms of the

relevant legislation.

• Providing professional and technical

services, as expressly provided by the law.

The aim of the law is to promote that a company will be transformed into a SAB (SociedadAnónima Bursátil).

The Securities Market Law includes increasingly sophisticated legal and financial regimes; the more stock the company sells and the more commitment it has with the investing public, financing becomes cheaper and available in greater quantities.

Relationship Between Legal Structure (according to the

Securities Market Law of 2006) and Financing Issues

Source: Un análisis de la ley del mercado

de valores, EGADE 2007.

Tax Framework

Special laws for specific taxes.

LISR: Federal taxes and obligations.

Basic laws that are related to fiscal management:

Código Fiscal Federal: Contains the procedures

that guide fiscal policy (including tax definitions),

residence status and exceptions, and those who are

considered contributors.

Tax Framework

Tax Reform 2009

Source: Diario Oficial de la Federación, 2009

Mexican Firms Data

Results of the 2009 Mexican Firms’

Census (INEGI)

According to INEGI (with results from the 2009 Mexican Firms’

Census) data, there are approximately 5,194,000 economic

units (firms) in México (in the main and rural cities).

4,300,934 firms were registered individually and 3,955,975

opened before 2009.

95.6% are micro-firms with less than 10 employees.

The states with greater rates of enterprise growth are: Edo.

De México, 12.3%; D.F, 9.6%; Jalisco, 6.9%; Veracruz, 6.2%;

and Puebla, 5.8%.

Number of firms in Mexico, by size

(Preliminary data)

With data of Mexican census 2004 and Preliminary Census Results 2009;

The number of Big firms 2009 and the GDP contribution estimation is from

Economy SME´s Sub -Secretary , 2008.

Egade own estimations

Firm Type 1999 2004 2009

Approx. Cont

GDP

% change

(04-09)

Micro 2,722,365 4,075,602 4,966,239 15 21.85%

Small 88,112 167,314 179,786 15 7.45%

Medium 25,320 38,610 40,885 23 5.89%

Big 8,474 8,580 7,900 48 (7.93%)

Total 2,844,271 4,290,106 5,194,810 101 21.09%

Facts

There was an increase of 21.1% in the number of firms during 2004-2009, i.e., an

annual growth rate of 3.9%; growth rates above the average correspond to the

micro, small and medium sized firms segments.

The 21.8 % increase in Micro-firm category doesn’t represent a substantial

contribution to GDP, but is important due to the number of jobs created (46.6% of a

total 27,748,583 jobs; or approximately 13 million).

New policies to promote the growth of medium sized firms could be important to:

a) Support the growth of small firms which are their suppliers in most cases.

b) Stop the drop in the number of big firms, which are critically important due to

their contribution to GDP. In great measure, the medium sized enterprise is a

supplier to big companies (especially in the manufacturing sector).

c) Enhance the performance of medium sized firms by focusing in economic sectors

characterized by high growth, as is the case in: IT, electronics, medical devices, etc.

This category of firms is important due to their significant economic contribution to

GDP and also because they pay good salaries to their employees.

Manufacturing 435,436

Commerce 1,869,120

Services (Excluding financial services) 1,351,477

Firms of the Private and Government Sector

that Started Operations Before 2009

Source: Elaborated with data from the 2009 Census, INEGI

Stratification of SMEs in Mexico

Enterprises are categorized according to the number of workers multiplied by

10%, plus the value of sales multiplied by 90%. The index obtained must be

equal or less to the maximum combined of each category. It goes from 4.6 for

small businesses, to 250 for medium sized businesses.

According to the results of the INEGI’s Economic Census, there were 4,300,934

economic units (without considering the data obtained by sampling in rural

areas). Out of 4,300,934 units, 3,955,975 units (92%) started operations

before 2009, and 344,959 (8%) opened during 2009.

Distribution of Enterprises by Sector

Source: 2009 INEGI Census,

Distribution of Companies that Opened Existing Before

2009; by Sector

Annual Sales

There are important

differences between

categories in terms of the

revenues obtained by a

firm. The mode of micro

firms is less than

US$50,000; small firms

are between US$50,000

and US$200,000; finally,

medium sized firms are

between

US$200,000 and

US$5,000,000.

Source: Nielsen, 2008

4 6 5 15

46

7 5 2

16

30

8 10 8

25

20

21 17 18

31

4

60 62 67

13

Region México Micro Small Medium

Less than US $50,000

Between US $50,000 to $100,000

Between US $100,000 to $200,000

Between US $200,000 to US $1,000,000

Between US $1,000,000 to US $5,000,000

Funding Sources

In the case of Mexico, low

economic growth affects

micro-enterprises first, which

have fewer resources to

continue their business.

Midsized companies are

major users of bank credit,

with a significant increase in

the use of bank issued credit

cards for that purpose. The

supply of business credit

cards by banks is

concentrated in that segment.

Another credit source

frequently used by SMEs is

suppliers’ credit.

Source: Nielsen, 2008

Distribution of Investments in 2009

Of a total 1,417.5 million dollars of new foreign direct investments notified from January

to December 2009, manufacturing activities received 42.3%; financial services ,22.6%;

other services, 16.1%; commercial activities, 10.4% , and other sectors, 8.6%.

Source: Data reported to the registration of foreign direct investment, 2009.

High-Growth Sectors in Mexico

Automotive - In 2007 Mexico ranked as the 11th largest

automobile producer in the world. In the commercial vehicle

segment Mexico ranks 6th worldwide, with 900 thousand vehicles.

That year, Mexico exported vehicles and parts worth 41.9 billion

USD. Such products’ exports have observed an average annual

growth rate of 11% in the last four years.

Electrical and electronics - In Mexico, the electronics industry is a

pillar of the manufacturing industry. Its main sectors are: consumer

electronics, personal computers, and telecommunications

equipment. In 2007 the exports value of industrial electrical and

electronic equipment represented 72 billion USD, and comprised

the main component of manufactured exports.

Information Technology (IT) - In Mexico there are 2,095 companies that

have boosted the growth of IT industry, with average annual growth rates

of 9%. In 2007 the IT industry generated revenues of 1.8 billion dollars.

The Secretaria de Economia recently launched a Program for the

Development of the Software Industry (Prosoft), which aims to raise the

level of spending in information and communication technologies (ICT).

There are over 500 thousand professionals in the industry, with 65 thousand

new professionals added to the jobs market each year.

Aerospace - There are 150 aerospace companies employing over 16

thousand workers, and seeking to capitalize on the opportunities the country

offers. The aerospace industry is supplied with skilled human capital

including approximately 65 thousand newly graduated engineers every

year.

High-Growth Sectors in Mexico

Tourism. The World Tourism Organization placed Mexico as the eighth most important destination worldwide, with an annual uptake of 21.4 million tourists.

During 2007, foreign tourists spent12.9 billion USD, 6% higher than in 2006.

Mexico has a rich culture, important historical locations and wonderful natural scenery. There are 173 archaeological sites open to the public, and 55 thousand monuments of historical value. Mexico ranks first among all the Latin American countries in terms of the number of sites declared “World Heritage” by the UNESCO.

High-Growth Sectors in Mexico

A New Culture of Entrepreneurship

Entrepreneurship

• What is it: The people that can transform an idea into a project, a business or a social organization.

• Benefits: It is the main element that contributes to industry growth, innovation, economic development and job development.

• How to measure it? : Number of enterprises created each year or Job creation, by state.

The states which had the best and worst job creation rates, relative to their population were:

Source: INEGI, 2009

Sectors Where Jobs Were Produced

The sectors with more invested resources were manufacturing, construction

and services. This graphic does not show technology-based industries, which

it is considered an area of opportunity for the country and for Venture

Capital Funds to invest.

Ways to Improve Entrepreneurship

Improvement practices:

Facilitate business opening

Facilitate contracts’ compliance

Improve property registration procedures

Expedite construction permissions

Improvement areas

Process simplification

Internet use

Processes standarization

Eliminate unnecesary requirements

CONCLUSIONS

The majority of SMEs which began operations before 2009 are commercial companies. It is necessary to promote technology based industries (electronics, aerospace, IT, medical devices), which have a major contribution to wealth creation.

Other strategic sectors with growth expectations that can be supported by the right public policies include the food industry and tourism.

An increment of 21.1% in the number of firms during the 2004-2009 period, represented an annual average growth rate of 3.9%.

The increment of 21.8 % in the number of Micro-sized enterprises doesn’t generate a significant contribution to the country’s GDP, but is important due to the number of jobs provided ( 46.6%, or 13 million, out of a total of 27,748,583 jobs).

New policies that support growth in the medium-sized firms’ segment could be important for the integration of production chains. This will create a multiplier effect on the growth of small companies, as well as reverse the fall in the number of big firms.

Although Mexico is beginning to experience an

economic recovery, growth is still incipient. This is

mainly due to the high dependence of the country

with respect to the US economy.

It is absolutely necessary to stop insecurity problems

in Northern Mexico in order to maintain its industrial

development.

CONCLUSIONS

References

Banco de México. (2010). Estadísticas del Banxico. Recuperado el 25 de Marzo de 2010, del sitio Web del

Banco de México http://www.banxico.org.mx/tipo/estadisticas/index.html

Deloitte. (2009). Latin American Private Equity Confidence Survey. Londres, Reino Unido: Arbor Square

Associates.

Instituto Ncional de Estadística y Geografía. (2009). Resultados Oportunos Cifras Preliminares Censos

Económicos 2009. Recuperado el 24 de Marzo de 2010, del sitio Web del INEGI

http://www.inegi.org.mx/inegi/default.aspx

KPMG. (2007). Investment in Mexico 2007. Ciudad de Mexico, Mexico: KPMG Cárdenas Dosal, S.C.

Nielsen. (2008). Perspectivas de las Pymes Mexico 2008. Ciudad de Mexico, Mexico: The Nielsen Company.

PROMÉXICO (2009). Inversión y Comercio. Recuperado el 24 de Marzo de 2010, del sitio Web de

PROMEXICO http://www.promexico.gob.mx/

Secretaría de Economía. (2010). Estadísticas. Recuperado el 22 de Marzo de 2010, del sitio Web de SE

http://www.economiasnci.gob.mx/sphp_pages/estadisticas/cuad_resumen/impmx_e.htm

Consulted laws:

Código Fiscal de la Federación (2009)

Diario Oficial de la Federación

Ley de Inversión Extranjera Directa (2008)

Ley del Mercado de Valores (2006)

Ley del Impuesto sobre la renta (2002)