(This article was covered by Jeannete Leyva in El Financiero)
Mexico’s unique economic structure makes it particularly susceptible to the impact of COVID-19
According to INEGI (the National Institute for Statistics and Geography), small to medium-sized businesses (PYMES) make up the vast majority (95%) of companies in Mexico. PYMES employ 78% of the working population and contribute 43% of the country’s GDP. Most of them run on very thin margins with little or no emergency reserve capital. At the same time, their ability to borrow operating capital is extremely limited – with 77% having no access to commercial credit. Most banks simply aren’t interested – preferring instead to focus their lending on the very largest of companies. In addition, the speed at which this crisis unfolded left almost no time to adjust or prepare. While, of course, no one could have anticipated a crisis of this magnitude, Mexico’s overall economy is left in a particularly precarious spot.
The Inter-American Development Bank responds
The Inter-American Development Bank (the “BID”) responded quickly by announcing a program to inject capital into the system. One of the tools they intend to use is subsidized invoice financing.
The approach they selected is called “Reverse Factoring”. This mechanism allows suppliers to sell their accounts receivable, at a bit of a discount, to an investor in exchange for cash today. Then, when the payment is due, the buyer simply redirects to the supplier’s payment to the investor. Everybody wins: the supplier gets the immediate capital they need to buy raw materials, make payroll, and continue to run the company, the lender makes a margin on the loan, and the buyer has a healthy and happy supply chain. Given that the loan is secured by the buyers’ agreement to pay (the invoice), it’s also a pretty safe investment.
In the announced program, BID is acting as the investor and is offering money at very low rates (somewhere in the neighborhood of 8%). They are relying on Consejo Mexicano de Negocios (CMN), a consortium of wealthy business owners, to administer the program. A key component of the program, however, is that it’s limited to 50 of the largest companies and their networks of suppliers.
Great idea but most local and state economic ecosystems are left out in the cold
The BID’s approach is the right one and undoubtedly will help in keeping Mexico’s economic gears turning. Unfortunately, the centralized nature of it may leave most of the economy (in terms of the number of companies and number of jobs) out in the cold. Those lucky 50 companies and their network of suppliers are primarily concentrated in and around Mexico City. What happens to state and local market ecosystems that aren’t part of this club? They are already struggling to compete with larger, better-capitalized companies. We could see a period of regional economic starvation while a small number of large Mexico City-based mega-companies thrive through access to cheap money.
State and local governments will need to help themselves
Cities, states, and various chambers already see the writing on the wall. There is and will be, very little help coming from Mexico City. If they hope to shield their local economies from the damage they’ll need to do it themselves. Both public and private sector groups are now scrambling to identify and implement some sort of safety net to address the specific needs of their local economies.
The obvious but flawed approach – payments or loans directly to PYMES
Many states are discussing programs whereby payments or loans are to be made directly to PYMES to keep them afloat. It’s an admirable goal, but, in and of itself, it’s unlikely to have the desired outcome for several reasons. First, the systems and processes required to administer a program like this don’t currently exist and by the time they could be implemented, it would be too late. Second, there simply is not enough money available to have a substantial impact.
A better alternative? Unlock the power of the private sector to provide liquidity
Rather than a direct, 1-to-1 assistance approach, the public sector could provide a combination of co-investment and partial loan guarantees to encourage private investors to inject the required liquidity in the form of reverse factoring.
This allows public funds to act as a multiplier – for every 20 pesos of public funding, private sector investors could contribute 80 pesos. This exponential factor will allow the public funds to go much further while, at the same time, building a healthy market ecosystem that will continue to operate even when the government funds run out. The private funds needed to keep Mexico’s supply chaining working are out there – they are mostly just parked on the sidelines. The public sector should act quickly and decisively to reduce risk and increase the incentive to get that capital back in the game.
We don’t have time to create new infrastructure and processes to distribute assistance
Hosted factoring platforms already exist today that have automated the process of invoice factoring (disclosure: my fund is an investor in one). It’s a complex business with (at least) three participants (buyer, supplier, and investor), risk analysis, agreements, vendor and invoice approval, invoice submission and validation, payment process, reporting while all systems need to be reliable, auditable, and available 24/7. With this current economic crisis, time is critical. Every day spent building new systems and processes puts us farther behind. Instead, funds could be distributed using systems that are already in the market, are proven, and are ready to be put to work. In addition to stimulating the overall economy, the startup ecosystem – critical to the long-term transformation and health of the economy – would be strengthened.
Direct distribution of payments may cause more problems than it solves.
The public sector does not have the skills and experience to accurately assess credit risk. Obviously, not all companies will be able to pay back the loans. What happens to public finances when, 6 months from now, 40% of the loans default? How does the treasury recover? By working with existing platforms and companies, the public sector can leverage pre-existing skills, systems, and experience in risk analysis and debt portfolio management. This will minimize a downstream default problem that would only extend or deepen the financial crisis.
What happens when the money runs out – a built-in transition strategy.
Eventually, the public funds will be depleted and, although those funds have solved the short-term problem, they’ve not addressed the core problem and perhaps created a dangerous dependency. If instead, the private sector has been mobilized to invest in pursuit of reasonable rates of return, the public sector can slowly reduce its participation, allowing rates to move marginally higher, while more investors move in to take their place.
The current economic crisis is severe and without decisive action on the part of the public sector to limit the damage, the negative effects may accelerate quickly and take years to recover from. Corporate handouts will come too late, too little, and ultimately may do more damage than good. For the most part, capital hasn’t disappeared – it’s simply locked up because of fear of what might happen. If the public sector can reduce that fear through partial loan guarantees and co-investment, the private sector can do what it does best and keep the economy moving.