On Feb. 1, the U.S. government announced an across-the-board 25% tariff on imports from Mexico as well as tariffs on Canada and China. After Mexico and Canada unveiled some border security measures, the White House delayed the tariffs on Mexico and Canada to March 4. Our expectation is that Mexican officials will be pragmatic in their negotiations with U.S. officials--in an effort to avoid tariffs or, if tariffs materialize, to shorten their duration.

However, if tariffs were to take effect and stay in place through this year, the impact on the Mexican economy would be significant. Here, S&P Global Ratings discusses the potential impact of such a scenario on rated entities across the sovereign, corporate, infrastructure, financial services, structured finance, and local and regional government sectors.

Our Alternate Scenario

S&P Global Ratings Economics' forecasts for Mexico don't currently incorporate the tariffs. Our economists' base-case expectation is that the Mexican economy will grow 1.2% this year.

In our alternate scenario--in which tariffs take effect and stay in place for some time--Mexico's GDP would contract 0.5% in 2025. The depreciation of the Mexican peso, which we assume would be, on average, 10% weaker than our baseline, would partially absorb the higher costs associated with the tariff increase and would lead to a significant decline in imports.

These are our first-order approximations and do not necessarily capture all interactions between macroeconomic variables. We did not run this alternate scenario through our macro model. Rather, we generated it using the expertise of our regional chief economists.

In the alternate scenario, we have assumed:

• The U.S. imposes a 25% tariff on all imported goods from Canada and Mexico starting in March 2025 and remaining in place through the end of the year. Canada responds with a 25% tariff on all U.S. imports. Mexico imposes a 25% tariff on all nonmanufacturing U.S. imports.
• The tariffs decline to 10% at the beginning of 2026, when the renegotiation of the United States-Mexico-Canada Agreement (USMCA) is likely to begin.
• USMCA is ratified in the middle of 2026, at which point tariffs between the U.S., Canada, and Mexico would return to the near-zero regime established under the trade agreement.
• Tariffs to China remain in place through 2025-2026.
• Uncertainty around tariffs does not fully disappear even if an agreement is reached in USMCA. Therefore, the estimated effects of the tariffs are not automatically unwound.

On prices, we assume the tariffs are almost fully passed through to home country consumers. This is in line with empirical evidence. While the tariffs are paid by the importing companies to the home country treasury, the burden of the tariffs can be different. Specifically, the burden can fall on foreign country exporters or home country importers through lowering margins in an attempt to preserve market share. While these outcomes are possible, they do not play a large role, in our view.

Even if home country consumers bear the ultimate cost of tariffs, there can be offsets. The government could rebate the full amount of the tariff revenue back to households. However, this is unlikely to be perfectly calibrated to the tariff incidence, so there will be distributional effects. In addition, the rebates may come later than the tariff-related higher household outlays.

The largest drag on GDP would come through consumption and investment. These would decline significantly due to the uncertainty that would likely prevail regarding the future of trade relations between the U.S. and Mexico. Inflation would be higher in 2025 due to the high content of imported goods on consumption and the sizable pass-through of a weaker exchange rate on prices. This would, in our view, prompt the central bank to pause its current rate-cutting cycle through the rest of 2025.

For more details, see "Macro Effects Of Proposed U.S. Tariffs Are Negative All-Around," published Feb. 6, 2025.

Sovereign: Recent U.S. Policies Could Pose Challenges To The Mexican Economy

The Trump administration's recent policies, combined with Mexico's existing economic vulnerabilities, are posing risks to the sovereign credit rating trajectory for Mexico. Our foreign currency sovereign credit ratings on Mexico (BBB/Stable/A-2) reflect our expectation that cautious macroeconomic management, including prudent monetary policy and a return to low fiscal deficits, will stabilize public finances and the sovereign's debt burden over the next two years.

The Mexican economy is highly open and integrated with the U.S. Mexican exports are around 36% of GDP, and 80% of exports go to the U.S. (see chart)--the highest of any country in Latin America. In addition, remittance inflows, mostly from the U.S., have averaged 3%-4% of GDP in recent years, an important source of domestic consumption. (However, these levels are lower than in Central America, where remittances account for 10%-25% of GDP.)

The U.S. imports more from Mexico than from any other country, and its bilateral trade deficit with Mexico is the third largest, after China and the EU.

The external challenges compound Mexico's existing domestic issues with economic growth and public finances. We could lower our sovereign rating on Mexico if failure to reduce the high fiscal deficit in a timely manner leads to a higher-than-expected general government debt and interest burden. Weaker public finances, combined with the potential for a need to provide extraordinary support to state-owned companies Petroleos Mexicanos (Pemex; foreign currency: BBB/Stable/--; local currency: BBB+/Stable/--; national scale: mxAAA/Stable/mxA-1+) and Comision Federal de Electricidad (foreign currency: BBB/Stable/--; local currency: BBB+/Stable/--; national scale: mxAAA/Stable/--), could lead to a downgrade over the next two years.

We assume that the Mexican government will manage disputes with the U.S. in a manner that sustains economic stability and maintains the deep economic integration of the two countries. Economic compulsions may lead the Mexican administration to pursue more pragmatic policies, especially in key sectors such as electricity, to attract more foreign investment and boost Mexico's weak GDP growth.

Corporates: Vulnerabilities Of Auto Suppliers, Metals And Mining, And Oil And Gas To Potential Tariffs

The 25% tariff would represent a challenge to corporate credit quality in Mexico, and, should it be enforced, we would incorporate the effects in our analysis. Specifically, if the tariff became a reality, we think the most exposed rated corporate sectors in Mexico would be auto suppliers, metals and mining, oil and gas, agribusiness, durable goods, and alcoholic beverages.

However, some rated companies are insulated from a tariff shock by credit buffers, vertical integration of their U.S. operations, and the possibility of negotiating strategies with their trading partners to pass through costs to customers.

Auto suppliers

Given the auto sector's substantial integration in North America, Mexican auto suppliers are highly exposed to a potential 25% tariff. Most exports from companies we rate are completed directly by the original equipment manufacturers (OEMs), which would carry the direct exposure to tariffs.

But we believe the tariff could elevate vehicle sales prices, which could, in turn, reduce volumes for the industry and constrain profitability for most of the supply chain. In addition, President Trump has mentioned in tariff remarks that some production facilities could relocate from Mexico to the U.S.

However, the Mexican auto suppliers we rate have solid competitive positions, given the specialization of their products. For instance, they hold the largest market shares for their products in North America among the types of models they supply, which would give them some advantage when negotiating the pass-through of costs with OEMs.

Additionally, Mexico's competitive labor costs, skilled labor, and already installed capacity would provide economic incentives to maintain the current industry integration, since the required investments to transfer production to the U.S. would take a few years.

Metals and mining

On Feb. 10, President Trump announced 25% tariffs on imports of steel and aluminum to the U.S. This round of tariffs is more broad-based than during the first Trump administration.

Rated Mexican mining companies have high exposure to the U.S. market because exports account for 10%-40% to the U.S. Thus, a potential 25% tariff would likely reduce demand for base metals like zinc, copper, and lead--as U.S. buyers seek alternative sources to avoid higher costs--and, to a lesser extent, precious metals such as gold and silver.

Lower volumes sold, coupled with potential higher costs as companies allocate products to likely less profitable markets, would hurt companies' margins. However, we believe mining companies could negotiate more favorable conditions, given the scarcity of final mining products in the U.S.

Oil and gas

We believe the oil and gas sector would be highly exposed to the suggested tariff, since Pemex is a major supplier of crude oil to the U.S. The company exports around 25% of its total sales to the U.S.--474,000 barrels a day as of third-quarter 2024.

However, refineries located on the northern coast (Costa Norte) of the Gulf of Mexico use Mexican crude oil to run their operations. The supply of this crude is very limited--with Mexico and Venezuela as the main providers--thus providing some leeway for Pemex.

For more details, see "A 25% Tariff Would Create New Trade Challenges For Mexican Corporations," published Feb. 3, 2025.

Infrastructure: Tariffs Could Lead To Traffic Declines--And Weakening Performance For Toll Road Projects

The increased share of heavy vehicles in Mexican toll road traffic means volumes could be rapidly hampered by various policy measures President Trump has referenced. In recent years, most of the projects we rate benefited from high industrial activity, mainly supported by the free trade agreement with the U.S. and Canada. Therefore, if the U.S. enacts tariffs on imports from Mexico, this could weaken projects' performance--particularly for heavy vehicles--and consequently debt service coverage ratios (DSCRs).

The credit effects of any potential traffic decline from these policies would not be uniform across the road projects we rate, since they would depend on asset-specific features and each project's financials, structure, and liquidity cushion.

However, we believe subordinated debt will be most affected because lock-up tests may be triggered--meaning those series receive lower or no distributions from senior debt. In our view, projects' senior debt would be more resilient because of higher coverage cushions to start, with average DSCRs above 1.5x for the next 12-24 months.

For further details on infrastructure, see "From Tariffs To Traffic Volumes: Potential Economic Effects On Mexican Toll Roads," published Feb. 5, 2025.

Financial Institutions And Insurance: Demand For Credit And Insurance Products Could Suffer Amid A Weakening Economy And Business Environment

In our view, if the 25% tariffs take effect and remain beyond the end of 2025, the impact on the Mexican economy and business environment would be significant, and demand for credit and insurance products would suffer as a result. In this scenario, we think banks would tighten their lending policies even further, focusing on high-quality credit clients and secured credit products.

Our growth projections for credit and premiums in 2025 are 8% and 25%, respectively. However, the potential implementation of a 25% tariff on goods produced in Mexico could lead to modest growth prospects for the banking and insurance sectors in the next two years.

Furthermore, with President Trump's decision to declare drug cartels as terrorist organizations, we expect heightened scrutiny from U.S. authorities and sanctions against cartel collaborators. As a result, banks and insurers could take stricter measures to prevent servicing clients that supply weapons and services to these cartels. This situation could hinder the growth of credit and premiums.

A scenario of a weakening economy in 2025-2026 could lead to increased inflation and interest rates, as well as a deterioration of the labor market and weaker local currency. Consequently, banks may experience a rise in nonperforming assets, while insurers could face higher claims costs, which would challenge their operating performance.

Furthermore, a 25% tariff would negatively affect the northern and central states, which are heavily reliant on export activities. Historically, these states have been significant growth engines for the country and account for a substantial share of credit and premiums nationwide. We will closely monitor the additional pressure this situation may place on banks' asset quality and insurers' operating performance.

We also expect the profitability of banks and insurers to weaken in a 25% tariff scenario, but investment-related income--in an environment where high interest rates persist--would help cushion the pressure on profitability.

Structured Finance: More Adverse Economic Conditions Could Lead To Increased Delinquencies For Some Transactions

In our opinion, the proposed tariffs will mainly hamper investor confidence, which could affect the already low volumes of structured finance issuance. A more adverse economic environment could lead to an increase in delinquencies in some of the transactions we rate. This could lead us to adjust our base-case loss assumptions, depending on the magnitude and duration of the impact on securitized portfolios' performance.

However, the transactions have credit enhancement, mainly in the form of overcollateralization and excess margin, which would allow them to absorb additional losses without affecting the cash flows to investors.

Also, the portfolios backing the asset-backed securities we currently rate show adequate diversification by economic activity. According to information provided by the managers, these portfolios are primarily exposed to the transportation sector (15%); manufacturing (13%); professional, scientific, and technical services (13%); and wholesale trade (12%).

Additionally, most of the transactions we rate include geographic and industry concentration limits, which, in our opinion, would somewhat mitigate the potential impact of the tariff measures.

In the case of residential mortgage-backed securities, we believe tariffs could ultimately erode households' disposable income, which, combined with adverse economic conditions, could lead to increased delinquencies and defaults. However, we anticipate a limited impact on collateral performance, given the current seasoning of the securitized portfolios and their solid levels of credit enhancement.

Local And Regional Governments: States That Rely On Export-Oriented Manufacturing Are Most Vulnerable To Potentially Lower Growth At The National Level

Mexican states that rely on export-oriented manufacturing--which are generally in the northern and central parts of the country--appear to us to be the most vulnerable to a direct economic hit. Even if it's implemented, the across-the-board tariff wouldn't necessarily lead to rating changes associated with weaker economic assessments. Our ratings on nine of the 13 Mexican states that we rate already incorporate some of these vulnerabilities--such as limited economic growth prospects, in line with the sovereign.

In addition, potentially weaker economic growth at the national level could indirectly lead to lower federal transfers to local governments. This would erode the budgetary performance and the liquidity position of the subnational system as a whole.

Revenue for Mexican states mostly comes from federal transfers--they account for about 90% of Mexican states' total revenue. Therefore, how a tariff-induced shock affects the overall Mexican economy and, in particular, the distributable federal income would be key to financial performance at the subnational level.

As uncertainty remains high, we'll continue to monitor Mexico's relationship with the U.S. and the potential effects of U.S. policies on Mexican entities' credit quality.