Even if the renegotiation of the North American Free Trade Agreement, or NAFTA, ends well for Mexico, the country will remain plagued by "significant, long-term structural impediments to growth," Moody's warned.
In a sector report, the rating agency said NAFTA has improved Mexico's export competitiveness, production complexity and integration with the U.S. economy. However, Mexico's economic growth remained weak despite opening up its economy and it is still hounded by low productivity and wage growth.
Mexico's widened productivity and wage gaps with the U.S. are driven by uneven regional growth opportunities and a high informal economy, Moody's noted. "[Mexico] has an outwardly oriented, cutting-edge manufacturing sector, but a far larger informal sector made up of inefficient, small firms that are disconnected from the formal economy and credit markets."
"For the income gap [with the U.S.] to shrink, Mexico will have to consistently grow at least 1.5 percentage points above the rate of the U.S., or above 3.5% on average," the rating agency said, noting that failure to improve productivity growth would lead to a growth rate that is constrained and "much lower than what would be required to close the income and productivity gaps with the U.S."
However, Mexico has been able to maintain fiscal sustainability due to its "strong policy framework and willingness to implement measures to maintain a healthy government balance sheet," Moody's said. This serves as an important factor in the creditworthiness of the country, the rating agency added.
Separately, the country's structural reforms agenda which pushes for the creation of special economic zones and the introduction of unemployment insurance "would in part address some challenges with respect to regional disparity and employment informality," Moody's said. However, the extent and timeline of the reforms' impact remain to be seen, it noted.
Meanwhile, Moody's expects that NAFTA will likely be preserved with minor changes in areas including rules of origin, environmental standards, labor standards, intellectual property and the dispute resolution process. Mexico's large wage differential with the U.S. also serves as a cushion against any possible changes in the free trade pact.