Canada will have to join the US-Mexico deal for carmakers to carry on business as usual — although the market seems upbeat about the accord.Picture: Reuters
Canada will have to join the US-Mexico deal for carmakers to carry on business as usual — although the market seems upbeat about the accord.Picture: Reuters

Judging from the increase in General Motors (GM) and Ford Motor shares, the market thinks President Donald Trump’s accord with Mexico to replace the North American Free Trade Agreement (Nafta) will enable US carmakers to carry on business as usual.

This could be right, with one big caveat: the companies are going to need Canada to join the deal, too.

The preliminary agreement announced on Monday allows carmakers to import vehicles duty-free if 75% of the content is made in the US and Mexico.

That is up from the 62.5% minimum under Nafta. Under the US-Mexico deal, as much as 45% of parts will also have to be made by workers who are paid more than $16 an hour, according to US trade representative Robert Lighthizer.

"The vast majority of vehicles made in the US, Mexico and Canada are above the requirements," said Kristin Dziczek, vice-president of industry, labour and economics at the Center for Automotive Research in Michigan. "If Canada doesn’t sign on, it’s a problem."

To meet the proposed rules, carmakers would need to be able to count the Canadian content on some of their current models, Dziczek said.

THE NEW AGREEMENT WILL PUSH PRODUCTION COSTS HIGHER ON MEXICAN PRODUCTS — PARTS AND VEHICLES

Prior to Monday’s announcement, the Trump administration had been threatening tariffs of as much as 25% on vehicles imported from any country.

That would hit carmakers hard, including GM, Fiat Chrysler and Toyota Motor. The three are the only carmakers that researcher LMC Automotive expects to sell more than 1 million imported vehicles in the US in 2018.

In addition to dodging that bullet, the agreement marks a significant backtrack from some of the initial proposals the Trump administration floated in Nafta negotiations, including an 85% Nafta-sourced parts content requirement and a 50% US-sourced provision.

GM and Fiat Chrysler shares each rose 4.8% on Monday in New York trading, while Ford finished up 3.2%, the stock’s biggest advance since February.

If Canada signs on, all but a handful of cars would meet the requirements or come close, Dziczek said. Most of those that would not hit the targets would be imported by European and Asian carmakers, including Volkswagen and Nissan Motor, she said.

BMW said it welcomed a "modernisation" of the trade accord, adding that any final decision must ensure duty-free trade between the partners can continue. The new preliminary threshold on content to qualify for tariff-free access was "ambitious", the carmaker said.

BMW produces sport utility vehicles at its biggest plant in Spartanburg, South Carolina and is set to start making sedans at a factory in Mexico from 2019. The luxury carmaker rose 2.4% to €85.15 and was 2% higher in morning trade in Frankfurt. Volkswagen gained 2.1% and the Stoxx 600 Automobiles & Parts Index rose 1.2%.

If vehicles do not meet the requirements, they will be hit with a 2.5% tariff, the same levy faced by countries that have most-favoured nation status under the World Trade Organization. That is not going to be enough of a tax to get companies to move an assembly plant to the US from Mexico, but it will raise the price of vehicles, said Michelle Krebs, a senior analyst with AutoTrader.

"We think car prices will rise. The new agreement will push production costs higher on Mexican products — parts and vehicles — which will eventually be paid for by American consumers," she said.

The good news for carmakers is that Canada will likely sign on to a similar agreement, said Mark Wakefield, head of the auto practice at consultant AlixPartners. So long as a Nafta replacement does not penalise Canada’s agriculture industry, it should be easy to get a deal.

"I don’t see why Canada wouldn’t be OK with the terms," Wakefield said. "At the moment, it looks positive."

Bloomberg