How a new infrastructure plan could help build Mexico’s future.

LATINVEX SPECIAL
Knowledge@Wharton

Over the past decade, Mexico’s manufacturing output has steadily increased, especially in the automotive, auto parts and electronic sectors. According to AMIA, the association of Mexican automotive producers, Mexico has become the world’s seventh-largest automotive manufacturer in the world, and the fourth-largest vehicle exporter. Mexico’s output and exports will continue to expand as manufacturers from around the world — including Daimler, BMW, Hyundai/Kia and Nissan — flock to build new plants in the country. From January through June 2015, the number of vehicles assembled in Mexico grew by 21.9 percent, from the same period in 2014.

And yet Mexico currently ranks 64 of 148 countries in terms of infrastructure, according to the Global Competitiveness Index of the World Economic Forum. Economists agree that Mexico’s prospects for becoming a truly industrial economy will remain limited unless the country accelerates its construction of the roads, railroads, ports, energy plants and other physical infrastructure essential in any modern industrial economy. According to Barbara Kotschwar, research fellow at the Peterson Institute for International Economics in Washington: “Now is the moment for Mexico to get serious about its infrastructure. Latin America is woefully underfunded in terms of its infrastructure, and studies cite its infrastructure weakness as a major reason for Latin American underdevelopment.”

With that goal in mind, the Mexican government last year published its National Infrastructure Program for 2014-2018, a comprehensive array of projects that would cost the public and private sectors a combined total of about $600 billion. Under the umbrella of the program, Mexico expects to upgrade not only its transportation sector, but also its communications networks, along with its energy sector — including power, oil and gas — water; health care; urban development and housing, and the infrastructure for tourism.

What are the prospects that implementation of the program might wind up falling short of its ambitious goals? Observers note that with oil prices continuing to weaken, Mexico’s public sector may not be able to adequately fund key elements of the program. Also, they question whether the country has the organizational capacity to pull off such an ambitious plan.

But others see the plan as having enormous potential. According to a report by Mexico-based researchers at the law firm Baker and McKenzie, “There is no doubt [about] the relevance and the deep and long-term impact of the program. The development of infrastructure is a key element to increase the quality of life and, at the same time, an essential ingredient to achieve economic growth.” Based on the 743 investment programs and projects that are being contemplated, and an estimated investment of $594 billion between the public and private sectors, “the program is the most ambitious ever launched in Mexico,” the report noted.

As a means of boosting Mexico’s global competitiveness, the federal government announced recently that it is investing an additional $5 billion in its network of 117 ports, including the construction of four new terminals in Veracruz. Guillermo Ruiz de Teresa, coordinator of Mexico’s agency for ports and merchant marine, said that the new investments reflect “our conviction that a system of total distribution, with each logistical chain of a high level, both within the country and beyond our borders, is the best way of functioning.”

A CRITICAL STAGE

The potential impact of upgrading Mexico’s transportation and logistics infrastructure is huge, says Walter Kemmsies, chief economist at Moffatt & Nichol, an international port infrastructure consultancy. Long isolated by geography and poverty from the major currents of global trade and development, Mexico has entered a crucial stage in its development, in which the country is now at the center of several, long-term positive trends. On the one hand, Mexico’s workforce has become relatively skilled, and its labor costs are now lower than those in many locations in China. Nowadays, Mexican exports also benefit from the country’s participation in NAFTA and its numerous other bilateral and regional trade pacts. Wharton management professor Mauro Guillen, who is also director of The Lauder Institute, notes that Mexico’s participation in NAFTA undoubtedly provides the country with strategic benefits. Mexico entered NAFTA in 1993, throwing in its lot with the U.S., “which makes all the sense in the world [for Mexico],” says Guillen. “The advantages [of taking such an approach] are clear.”

Just as crucial, Mexico’s geographical position gives the country what Kemmsies calls “optionality,” which means that from a Mexican location, corporate exporters “can send goods to anywhere in the world,” from either the country’s Gulf coast — positioned close to the Panama Canal — or via the Pacific Ocean to a growing list of markets in Asia.

On the import side, Mexico’s “optionality” implies, for example, that if iron ore from Brazil gets too expensive for a Mexican manufacturer, rather than import that iron ore from Brazil via the Panama Canal and then via the Gulf port of Veracruz, that Mexican manufacturer might decide to switch its sourcing to Australia or China if those countries offer competitive ore prices. “Mexico is not tied to any one location” when it comes to sourcing imports, or shipping exports, says Kemmsies. Unlike other countries in Latin America, Mexico not only has ports on both the Gulf and the Pacific, but “Mexico is right next door” to the newly expanded Panama Canal, “where all kinds of world trade flows. Just as in real estate, it’s all about about “location, location, location,” according to the report by Baker and McKenzie.

In terms of manufacturing capacity, Mexico is in a stronger position now to export goods than it has been historically. Unlike Brazil, “which relied on China’s commodity boom and is now suffering the consequences of being unable to diversify” from its reliance on the Chinese market, notes Kotschwar, “Mexico really suffered from the rise of China” initially. However, the country has since rebounded from that experience to produce higher value-added goods for its export markets. “Five years ago, Brazil seemed like the winner” in the race for ascendance among emerging nations in Latin America, “but now, it is not clear” whether Brazil or Mexico will pull ahead. Mexico could be the winner, “particularly if it tackles the corruption problem,” she adds.

CAPACITY SHORTAGE

Michelle Karavias, global head of infrastructure at BMI Research, notes that Mexico’s performance in the first months of the mammoth program has revealed the country’s shortage of “institutional capacity” when it comes to the entire process of tendering, planning and executing infrastructure projects. In short, there aren’t enough people in the right places who have the right sorts of knowledge about regulatory procedures and permitting. “It is an ambitious plan, and they need to build a lot more capacity in order to realize it.”

Nowhere has this been more apparent than in the tendering of an ambitious project to build Mexico’s first high-speed inter-city railway. In BMI’s latest report, Karavias writes, “Mexico presents significant potential for railway development,” but “we continue to hold reservations related to the tendering environment. The Mexico City-Queretaro high speed rail line is one of a number of projects supporting our positive outlook,” but “the lack of a competitive bidding process and subsequent contract cancellation reinforces our concerns over the tendering environment for major infrastructure projects.”

With a significant pipeline of attractive projects on the way, BMI Research forecasts average real growth rates of 11.3 percent between 2015 and 2019 in the value of the sector, “but our key concern remains delays and challenges at the tendering phase.” A flagship initiative aimed at reviving passenger traffic in Mexico, the Mexico City-Queretaro project will be the first high-speed rail line in Latin America, traveling at 300 km/hour (180 mph) and linking the capital city with the industrial city of Queretaro in about one hour. The contract was structured on a turnkey basis — to design, build, operate and maintain (for five years) the line with a project cost of US$3.75 billion — including both infrastructure and rolling stock.

In November 2014, the contract was awarded to the only bidder — a consortium of Chinese and Mexican firms that included, among others, China Railway Construction Corporation, Constructor y Edificadora Gia+A (Mexico), and Promotora y Desarrolladora Mexicana. However, less than a week after that announcement, Mexico’s SCT — the Ministry of Transport and Communications — annulled the contract award. At first, the government said that its intention was to re-tender the project, but in January 2015, the secretary of finance announced the “indefinite suspension” of work on the railway in response to federal budget cutbacks (worth 0.7 percent in GDP) resulting from the rapidly falling price of crude oil. Last May, the Chinese company that headed the consortium, China Railway Construction, was compensated by the Mexican government with an award of $1.31 million after threatening a lawsuit. Days later, in a further embarrassment, it was revealed that the wife of President Enrique Pena Nieto was in the process of acquiring a house from one of the Mexican firms in the railway consortium.

Nevertheless, Karavias notes, “The backlash to the contract award surrounded the lack of a competitive bidding process … which raised questions over the country’s ability to successfully tender major projects.” Prior to the tender, 16 companies had expressed interest in the contract, yet only one bid — that of the above consortium — was actually offered. At stake is not just the project itself, notes Karavias. “A successful resolution to the Mexico City-Queretaro project will be crucial in order to continue to attract major international players to bid on forthcoming projects.” Several key projects have yet to be tendered. Upcoming on the agenda are the extension of Mexico City’s Public Transport System (STC), the largest metro in Latin America. This would include adding about eight miles of track to link Chalco with La Paz and eight new stations serving an estimated 314,000 passengers a day. An institutional tender for 34 new train cars, at a likely cost of about $700 million, will only be awarded to a company after an extensive market study. Likely bidders for that contract include Alstom, Bombardier and CAF, according to executives at STC.

In some respects, however, the infrastructure plan may turn out to be insufficient, even if it achieves its near-term targets. Some observers have voiced doubts that growth in Mexican manufacturing exports will be forced to slow as a result of congestion in the country’s ports even if the ambitious port-infrastructure goals of the plan are ultimately realized. According to Carlos Serrano, chief economist of Mexico-based BBVA Bancomer, “Until now, Mexico has managed to attract more [foreign] investment” despite the weakness in its ports, railroads and highways. “But it will reach a point at which, if the infrastructure does not improve, people will start to think that Mexico’s steady progress is at risk.”

Horacio Saldivar, head of purchasing for Nissan in Mexico, said recently that by 2020, bottlenecks at the ports of Veracruz and Lazaro Cardenas could delay as much as one-fourth of that company’s planned maritime shipments out of Mexico to the United States, Europe and the Near East, even if existing expansion plans for the ports proceed as scheduled. In response to such qualms, government port coordinator Ruiz de Teresa told the Mexican press that plans are moving along “on schedule” to cover the growing industry’s needs. “I have guaranteed the auto producing companies that there will be enough port space [for them] to grow.”

THE IMPACT OF LOW OIL PRICES

The postponement of the Mexico City Metro extension reflects the fact that Mexico “suffers from a dependence on public sector funding, which is seeing a squeeze on infrastructure investment” as Mexico’s “fiscal capacity is reduced in light of low oil prices,” notes a report by BMI. Unfortunately, Mexico has a “largely undeveloped project finance market, with limited access to commercial credit, ranking fourth out of 15 countries on BMI’s Project Risk Index for Latin America.”

For 2015 and 2016, at least, public spending in Mexico’s transportation sector will be in decline. A notable exception is the ambitious plan to build Latin America’s largest — and most dazzling — airport in Mexico City. Scheduled to open in 2019 or 2020, at a cost now estimated at $11.3 billion, it will have capacity for 120 million passengers per year and feature six runways after completion of its second phase. Most of the funding is expected to come from the public sector.

In July 2015, Mexico’s SCT, the transport ministry, began the process for 21 tender packages regarding the construction of the Mexico City airport. Secretary Gerardo Ruiz Esparza, who heads the SCT, announced, “The scheme of packaging bids will mean we receive proposals from contractors with proven experience … resulting in the highest quality and speed of execution possible.” During the second half of 2015, tenders for preliminary works — including drainage, foundation laying, electricity supply works, the control tower and three runways — will be launched. It won’t be until 2017 that tender offers are made for such components as a multi-modal transportation center, operations facilities and general parking areas.

Although observers agree that Mexico has one of the region’s most advanced and transparent public-private partnership laws, private investors are contributing only 37 percent of total spending for infrastructure projects, at last count. “That’s a low figure,” notes Karavias, imposing a burden for the public sector at a time when the private sector is being counted on to take advantage of the “huge opportunity” of investing in some of the more attractive projects. Karavias points out that “we have seen a lot of private sector capital coming into Mexico” in such projects as the Mexico City bypass, water projects and toll roads. However, “there have not been a lot of public-private partnerships so far.”

‘COMMON PRACTIVCE’ VS BRIBERY

In another infrastructure-development case that has attracted a great deal of attention, OHL Mexico, a subsidiary of Spanish construction firm OHL, has been widely accused of corruption ever since video recordings were leaked in late April that revealed one OHL executive saying that the construction firm had received information about government tenders before they were made public. One recording purported to show former OHL Mexico executive Pablo Wallentin, who resigned after the first scandal, telling company chairman Jose Andres de Oteyza that a Transport Ministry official had given him CDs with information about two highway project bids.

According to a leak posted online, the taped conversations were from February and March. Wallentin resigned in May. In response, Mexico’s Transport Ministry said in a statement that it had given OHL Mexico and other contractors some information about one of the projects, but that it had merely been following “common practice” in that case. In a separate conversation in the same leaked recording, OHL Mexico executive Wallentin also appeared to suggest to a secretary that the company pay for a vacation for Transport Minister Gerardo Ruiz Esparza. Ruiz Esparza “categorically” denied that this had occurred.

How can newcomers to Mexico’s infrastructure sector succeed under such circumstances? According to Karavias, “People need to be aware that partnering with a local company is a key to navigating the Mexican market, [as is the case] in all emerging markets.”

Republished with permission from http://www.knowledge.wharton.upenn.edu -- the online research and business analysis journal of the Wharton School of the University of Pennsylvania.

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