Peso Fall Hurts Business (en anglais seulement)

Peter Godsoe has a warm spot for Mexico. The chairman and chief executive of the Bank of Nova Scotia and his wife honeymooned there in 1963. In 1992, the bank invested $102 million for a five-per-cent stake in the country's fourth-largest bank, 370-branch Grupo Financiero Inverlat. That deal looked golden in the warm afterglow of last year's North American Free Trade Agreement. But last week, Godsoe estimated that Mexico's recent bout of financial and political instability had knocked as much as 65 per cent from the value of the Inverlat holding. After Mexico devalued its peso in late December, Godsoe travelled to Mexico to discuss the situation with his colleagues and partners there. And last week, a team of six Scotia bankers visited Inverlat's Mexico City head office to prepare a detailed follow-up report for the chairman. By this fall, he says, Scotiabank will choose between building on its current Mexican investment - or writing off the Inverlat stake altogether. But Godsoe, who managed to keep three bank branches open in Haiti through last year's political turmoil, insists that he is upbeat about Mexico's prospects. "Our history has been to stick around through thick and thin. If you go in and out of a market with each hiccup, you soon have no operations left," he said.

That same choice is facing other Canadian executives and investors exposed to Mexico through direct holdings, stock or mutual fund assets. The recent turmoil marks the first major setback in a swelling two-way trade relationship. Mexicans exported $4.5 billion worth of goods to Canada in 1994, up from $1.7 billion in 1990. In turn, Canadian businesses shipped $1 billion worth of goods south last year, up from exports of $643 million in 1990. But that flourishing relationship may have suffered a substantial setback. For one thing, Mexican companies and consumers now have far less money with which to buy imported goods. Prior to the devaluation in December, it took 3.47 pesos to buy one U.S. dollar. Now, the exchange is seven pesos to the dollar.

Meanwhile, the Mexican government's austerity program - a combination of wage and price controls, international financial aid and higher interest rates put in place since early January - has pushed domestic interest rates up to 80 per cent from around 15 per cent. Godsoe now projects that Mexico's gross domestic product will shrink by about two per cent in 1995. That is a sharp turnaround from the sunny projections of five-per-cent economic growth less than six months ago. Mexican President Ernesto Zedillo's financial woes are further compounded by continued battles between government forces and Zapatista rebels, as well as the shock waves generated by criminal allegations against relatives of former Mexican president Carlos Salinas de Gortari. Rosalind Wilson, a partner in Kitchener, Ont.-based Latitudes Consulting, which advises Canadian companies doing business in Mexico, says the turmoil of the past two months has "shaken out the companies that aren't committed to the market."

The chaos in Mexico has already damaged Canadian balance sheets. Brewer John Labatt Ltd. of Toronto paid $720 million last July for a 22-per-cent stake in Femsa Cerveza, Mexico's second-largest beer producer. When it wrote down the Femsa investment by $272 million earlier this month, Labatt admitted that it paid too much for its stake in the maker of the popular Dos Equis beer. The fallout continued when Canadian Bond Rating Service downgraded its opinion of Labatt's corporate debt to negative from stable; a full credit-rating cut may soon follow. Still, Labatt has an option to buy an additional eight per cent of the Mexican brewery over the next three years. The company's executive vice-president for public affairs, Sharon Paul, says it has not decided whether to increase the stake: "We were disappointed by the peso devaluation, but we are still working with our Mexican partners to develop our relationship."

The Mexican financial crisis has also created a hurdle for a financial comeback attempt by the once powerful Reichmann family of Toronto. In June, 1994, Reichmann International lp, a real estate partnership backed by Paul Reichmann and billionaire currency speculator George Soros of New York City, announced plans for three separate Mexican projects worth a total of $1.7 billion. Those plans included a 50-storey office tower in Mexico City's financial district and a $700-million, 14-building redevelopment of the Mexican capital's Sante Fe neighborhood, which was devastated by an earthquake in 1985. Those ventures would have marked Reichmann's first major return to the real estate sector following the 1992 failure of his family's Olympia & York Developments Ltd. of Toronto.

Although Reichmann International's Mexican plans are now on hold, the firm is not pulling out of the country, according to Vinay Kapoor, the firm's executive vice-president for Mexico. While investments in land, design and permits stand idle, Reichmann is trying to find tenants for its Sante Fe project, although Kapoor says few companies are willing to make firm leasing commitments. "The biggest problem is that you can't plan," Kapoor says. "You can make plans, but they might not be valid the next day." To avoid that element of uncertainty, Laidlaw Waste Systems Inc. of Burlington, Ont., has put on hold its bid for a solid-waste disposal contract in the Mexican state of Morelos. But according to Ron Poland, Laidlaw's vice-president for strategic planning and analysis, the company is still bullish on Mexico's long-term prospects, and despite the peso devaluation will continue to pursue opportunities in the country.

Extended financial uncertainty is also changing the way Mexican companies do business, and those shifts are affecting their Canadian partners and suppliers. Husky Injection Molding Systems Ltd. of Toronto sold millions of dollars' worth of machinery, moulds and robots in Mexico last year, but the peso's dramatic tumble has made its products twice as expensive for Mexican buyers - at the same time as their cost of credit has soared. With the exception of service contracts and parts sales, Husky's business in Mexico has now come to a standstill. "We haven't closed any new deals this year," says Husky's Mexico area manager, Francisco Gonzalez. For his part, Northern Telecom marketing executive Douglas Clark says there have been some "immediate delays" in his company's Mexican projects, although no contracts have been cancelled in the wake of the peso's devaluation. Most of Northern Telecom's largest clients, Clark says, have access to international financing and will not be permanently set back by Mexico's exorbitant interest rates and devalued currency. Bank of Nova Scotia's Godsoe adds that Mexican companies have made a swift adjustment to buying supplies in Mexico with pesos, while focusing on sales outside the country that generate foreign currency.

For Canadian investors, who may hold Mexican stocks and bonds through Latin American or emerging-market mutual funds, however, Mexico's financial collapse has certainly hit hard. International equity mutual funds sold in Canada have dropped an average of 11 per cent in the past six months - when Asian markets were also in a tailspin - while the nine funds that invest in Latin American stocks have dropped 27 per cent. Richard Whiting, who runs the $295-million Americas Fund for Trimark Investment Management Inc. of Toronto, says: "The lesson that investors should learn from Mexico is to have diversity in their emerging-market holdings." But he adds that Canadian investors seem to understand that volatility is inevitable. So far, Trimark has seen almost no redemptions in its Americas Fund, which has seen its Mexican assets fall from 12 per cent of the fund in late December to just six per cent by last week.

Professional investors are also adapting to new conditions, moving their Mexican stock exposure over the past three months to companies with assets in U.S. dollars. Trimark's Whiting is holding Mexican steel companies and hotel chains, which profit from a boom in tourism. Very little new mutual fund money, however, is being directed at the Mexican market. Instead, most fund managers are on the sidelines waiting for a few months of relative stability before risking their capital. According to Fred Pye, senior vice-president at Fidelity Investments Canada Ltd. of Toronto: "The big risk in pulling out of emerging markets completely is that you miss any rebounds. Investors may need to take a longer outlook on these funds than they originally expected, and they should have been looking at a five-year time frame."

Last month, Mexico's short-term financial crunch was met with $70 billion of loan guarantees from the United States, Canada and international financial organizations. In the long run, the $10-trillion North American market, with its population of 380 million consumers, is tied together with trade bonds that were cemented by NAFTA. And it is this partnership that keeps financiers like the Bank of Nova Scotia's Godsoe on track. "While Mexico's troubles are serious, there's a professional group of technocrats working at it. If they succeed, they'll be an example to countries everywhere that tariff barriers must fall."

Maclean's April 3, 1995