May 30, 2000
M E M O R A N D U M
TO:	Clients and Friends of the Firm
FROM:	John M. Peterson, Michael K. Tomenga and Julia Padierna-Peralta
RE:	Mexico's Sectoral Programs

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I.     INTRODUCTION
     To ease the transition towards a new era in Mexican manufacturing¹ Mexico's Secretaria de Comercio y Fomento Industrial (SECOFI) is establishing "Sectoral Development Programs" (Programas de Promoción Sectorial, or PPS by their Spanish acronym). These Programs [hereinafter "Sectoral Programs"] will allow participating companies to import eligible non-NAFTA inputs at reduced fixed duty rates for the manufacturing of specific end-products. The Programs coincide with the elimination of NAFTA duty drawback on January 1, 2001. Mexico's Sectoral Programs will impact business decisions with respect to sourcing and manufacturing in Mexico. The Sectoral Programs are not to be ignored by companies operating in Mexico, particularly those established under a maquila or pitex program.

     This memorandum highlights the key features of Mexico's Sectoral Programs: their origin, what they are, how they work and who can participate in the Programs. We also explain what the Firm can do to assist your company to reap the benefits of the Programs.

II.     ORIGINS OF MEXICO'S SECTORAL PROGRAMS
     Mexico's Sectoral Programs can only be understood in the context of NAFTA duty drawback.

A.     Elimination of NAFTA Duty Drawback: One Side of the Coin

     The waiver or deferral of import duties, commonly known as "duty drawback," has been a prime feature of Mexico maquiladora operations. For over three decades, companies operating under Mexico's maquiladora regime have benefited from the in-bond, duty free importation of materials, parts and components for manufacturing of finished products for export. This special customs regime has led to the establishment of over 4,500 maquiladora plants across Mexico as of December 1999. About 54% of maquiladora plants are owned by U.S. or other non-Mexican interests. Beginning January 1, 2001, however, maquiladoras will no longer enjoy duty drawback treatment on non-NAFTA originating inputs used to manufacture products for export to the U.S. or Canada.

     Elimination of duty drawback is mandated by Article 303 of the North American Free Trade Agreement (NAFTA). Drawback on U.S.-Canada trade was eliminated in 1996 and Mexico will eliminate it with respect to trade with the U.S. and Canada in 2001.

     Why is Mexico's elimination of NAFTA duty drawback significant?

     NAFTA duty drawback elimination would mean that maquiladoras using non-NAFTA originating inputs - whether parts, components, packing materials or machinery - to produced goods for export to the U.S. or Canada would start facing Mexico's general external tariffs or most favored nation (MFN) rates as of January 1, 2001. Mexico's MFN import duty rates can be as high as 30%. This could disadvantage maquiladora plants heavily dependent on non-regional inputs since they would have to pay duties on such inputs, while inputs from the U.S. and Canada would still be allowed to enter Mexico duty free. Duty drawback will still be permitted on inputs exported outside the NAFTA region.

B.     Mexico's Sectoral Programs: The Other Side of the Coin

     Mexico has not remained idle at the crucial changes of 2001. To ease the transition towards a new era in manufacturing and to bolster the competitiveness of key industries in Mexico, the Mexican government is in the process of establishing "Sectoral Programs." These Programs, to be administered by SECOFI, will allow participating companies to import eligible foreign inputs at reduced fixed duty rates to be used in certain industries. The Programs promise to reduce the effects and uncertainty associated with the implementation of the "drawback sunset" provisions of the NAFTA, which will result in the termination of many benefits currently provided to maquiladora manufacturers.

     By regulation, the Programs are scheduled to go into effect on November 1, 2000,² and by law on January 1, 2001.³

III.     WHAT MEXICO'S SECTORAL PROGRAMS ENTAIL
     On November 14, 1998, SECOFI published a Sectoral Programs Decree establishing the first two Sectoral Programs. These Programs are geared to benefit inputs and components used in the Electricity and Electronics industries. Each of these Programs identified over 3,700 qualifying HTS tariff items to be used in manufacturing over 50 qualifying finished products.

     On May 9, 2000, SECOFI published a second Sectoral Programs Decree that superseded the prior Decree to include, in addition to some changes to the Electricity and Electronics Programs, the following industries:

• Furniture
• Toys and Games
• Footwear
• Mineral and Metals
• Capital Goods
• Photographic Goods
• Agricultural Machinery
• Miscellaneous

     The ten Sectoral Programs established so far provide a duty rate reduction on over 10,900 tariff items affecting the manufacturing of hundreds of finished goods. About 72% of the listed inputs belong to the Electricity and Electronics industries.

MEXICO'S SECTORAL PROGRAMS

Sectoral Program	Number of Qualifying Inputs
Electricity Industry	3,771
Electronics Industry	4,135
Furniture Industry	888
Toys and Games Industry	641
Footwear Industry	146
Mineral and Metals Industry	693
Capital Goods Industry	229
Photographic Goods Industry	110
Agricultural Machinery Industry	194
Miscellaneous Industries4	104
Total No. of Qualifying Inputs	10,911

     SECOFI is currently evaluating petitions from other industrial sectors - including autos, textiles, chemicals and steel - with an eye towards launching similar Programs in the near future.

     The Mexican government expects about 10,000 companies to register in the Sectoral Programs. To keep up with the timely processing of applications, SECOFI would have to review about 150 applications a day.⁵

IV.     MEXICO'S SECTORAL PROGRAMS AT WORK
     Mexico's Sectoral Programs provide for the importation of qualifying non-NAFTA originating inputs - whether parts, components, packing materials or machinery - at a reduced duty rate of 5% or 0%. Participating manufacturers will be able to import non-NAFTA originating inputs that are classified in one of the listed qualifying Mexican Tariff Schedule (HTS) numbers with the ad valorem tariff indicated in the specific Sectoral Program. Each Program lists certain end-products and inputs by HTS number. If both the end-product and the non-NAFTA inputs to manufacture such end-product are listed, the non-NAFTA inputs may be imported at a 5% or 0% import duty rate, as specified in the particular Program.

     The Sectoral Programs promise to benefit hundreds of manufacturing plants, particularly those heavily dependent on non-NAFTA originating inputs that will face the new restrictions on duty relief mandated by the NAFTA. These companies, however, will not be on an equal footing with those that source materials and components from NAFTA parties.

     Consider the following scenario: By 2001, most NAFTA inputs imported into Mexico and most finished goods entering the U.S. or Canada will be duty free both under NAFTA. At the same time, the January 1, 2001 changes in NAFTA duty drawback and duty deferral rules, will make non-NAFTA inputs entering into Mexico subject to Mexico's MFN duty rates. Under the new rules, the Mexican government may only waive import duties on inputs equal to the lower of two amounts:

     (1)     the amount of import duties paid or owed on the inputs imported into Mexico; or

     (2)     the amount of import duties paid or owed on the end-product subsequently exported to the U.S. or Canada.

     No Mexican import duties would have to be paid on the inputs when imported into Mexico, but only when the end-product is exported to one of the other NAFTA countries.

     Let's assume that a maquiladora plant imports a non-NAFTA input to manufacture an end-product for export to either the U.S. or Canada. Let's further assume that the end-product qualifies for a NAFTA preferential duty rate (meets the NAFTA rules of origin) and that the NAFTA duty rate is zero. If, for example, the applicable MFN duty rate on the non-NAFTA input when imported into Mexico as of January 2001 is 18%, no waiver or refund may be claimed on its exportation after processing because the duty rate on the end-product, when exported to one of the other NAFTA countries, would be zero. (0% would be the lower amount of the two: 18% and 0%). So the maquiladora importer would have to pay the full amount of import duties (18%) on the input at the time the end-product is exported to either the U.S. or Canada. However, if the non-NAFTA input qualifies under a Mexican Sectoral Program, the input would likely be assessed a much lower Mexican import duty rate (0% or 5%) than the applicable MFN rate. When the end-product is exported to either the U.S. or Canada, the maquiladora importer would not receive a full duty waiver or refund, but it would still benefit from having to pay a much lower import duty rate (0% or 5%) on the imported component than the applicable MFN rate.

     The changes in NAFTA duty drawback will only apply to products for export to the U.S. or Canada. If the end-product is exporter to countries outside North America, a waiver or refund of Mexican import duties on imported inputs will generally continue to be available for companies operating under a maquila and pitex programs.

     Scenarios like the above highlight the importance of Mexico's Sectoral Programs and the changes due to transform Mexico's manufacturing landscape.

V.     WHO CAN PARTICIPATE IN MEXICO'S SECTORAL PROGRAMS
     Any company with manufacturing operations in Mexico, whether foreign-owned or not, may qualify to participate in Mexico's Sectoral Programs. The imported qualifying inputs must be used in the production of the finished goods specified in the particular Program. The finished products, however, do not need to be exported, even if the company operates under a maquila or pitex program.

     Interestingly, the elimination of NAFTA duty drawback and the establishment of Mexico's Sectoral Programs coincide with Mexico's total opening of its domestic market to maquiladora sales, beginning January 2001.⁶ Unrestricted access to the Mexican market will likely lead to increased competition among maquiladoras and domestic producers. It will also create a greater need for companies to seek the benefits of Mexico's Sectoral Programs.

VI.     HOW Neville Peterson LLP MAY ASSIST YOU
     Clients and Friends of the Firm with manufacturing operations in Mexico, particularly those that source inputs from outside the NAFTA region, should be aware of Mexico's Sectoral Programs. The Programs create a new legal framework for manufacturing plants seeking to remain competitive in light of the elimination of NAFTA duty drawback. These developments will undoubtedly impact business decisions with respect to sourcing, manufacturing and selling in Mexico.

     We strongly recommend companies with operations in Mexico or those who plan to operate in Mexico to become familiar with the Sectoral Programs. The Firm stands ready to assist companies in reviewing the coverage of the various Programs to determine whether there are any products of importance to their Mexican operations that are or are not provided for thereunder. If certain products are not included, the Firm can approach SECOFI on behalf of clients, to request the inclusion of specific products in any of the established Sectoral Programs or those to be announced later this year (autos, textiles, chemicals and steel industries).

     Companies wishing to participate in the Sectoral Programs must submit an application to SECOFI indicating, among other things: the program(s) in which they wish to participate, and the products they will be manufacturing under those Programs. There are other requirements and procedures involving Sectoral Programs submissions to SECOFI.

     The timely submission of applications to SECOFI is critical, considering that thousands of companies are expected to seek the benefits of the Programs.

     We stand ready to furnish any additional information or assistance which may be required regarding Mexico's Sectoral Programs and their impact on your company.

     Copies of Mexico's current Sectoral Programs Decree are available from NP&W by e-mail request.

1.     A new manufacturing era in Mexico will begin with the elimination of "duty drawback" on exports to the United States or Canada as of January 1, 2001. Duty drawback has essentially allowed duties paid on imports to be waived or refunded by the Mexican government when the finished product is exported under a maquila or pitex program.

2.     Although NAFTA's "drawback sunset" provisions are effective January 1, 2001, the new Sectoral Programs are timed to begin two months earlier, based on the 60-day "lead times" for duty-free imports of goods under the maquila and pitex bond programs. See, Decreto por el que se establecen diversos Programas de Promocion Sectorial (Sectoral Programs Decree), Transitory, Third, D.O., May 9, 2000. Also, the Mexican government has decided to set this date in order to initiate the implementation of the Programs before the current Administration of President Zedillo leaves office.

3.     Sectoral Programs Decree, Transitory, First, D.O., May 9, 2000.

4.     The miscellaneous products covered by the Decree include miscellaneous plastic articles, luggage with outer surface of plastics, notebooks and binders, interchangeable tools for handtools, certain internal combustion engines, miscellaneous single function machines, watches and clocks.

5.     Government prepares non-Nafta tariffs, The Journal of Commerce, May 26, 2000, at 13.

6.     Under Mexico's Maquiladora Decree, all restrictions regarding maquiladora sales to the domestic market shall cease to exist as of January 1, 2001. See, Art. 16 of Decreto para el fomento y operaci—n de la Industria Maquiladora de Exportación (Mexico's Decree for the Development and Operation of the Maquiladora Industry for Exports), D.O. June 1, 1998.

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