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Corridors of Power: China’s Latin American Linkage

China’s slowing economic growth has implications that extend far beyond its domestic borders. Key trading partners in particular seem vulnerable to the knock-on effects of reductions in imports or exports. In the case of Brazil and Chile, however, concerns about potential economic disruption seem misplaced.

China’s trade with Latin America has flourished over the past decade, hitting $261.2 billion in 20121 — up from $100 billion in 2009 and just $10 billion in 2000 (see graph 1).2 Flows between the two are projected to hit $400 billion by 2017,3 as the Middle Kingdom fuels its growth with Latin America’s abundant raw materials. Thanks partly to tightened belts in the U.S. and Europe, and more importantly to their vast reserves of energy and commodities, Brazil and Chile now count China as their largest export destination (see graph 2).4

While it’s roundly agreed that China’s era of dazzling economic growth is coming to an end, raising concerns that trade with the two countries will slow down, former World Bank chief economist Justin Yifu Lin predicts that the Asian giant should still be able to grow by around 8% a year for the next 20 years — a still-enviable pace.5 This year, J.P. Morgan pegs the country’s GDP growth at 7.6%.6

Graph 1: Trade Growth between
LATAM and China (2000-2012)

Graph 2: China’s Growing Role as a
Key Trading Partner (Brazil and Chile

Cautious Optimism for Continued Trade Growth

In the short term, the economic outlook for China is not as bullish as early last year as we are now seeing slowing exports, sluggish recovery in the U.S. and EU markets, and much less infrastructure spending domestically,” points out Benjamin Lam, J.P. Morgan’s head of Global Trade for China. “This undoubtedly will affect China’s demand for natural resources, especially for hard commodities. In the longer term, however, I am still optimistic about the trade with Chile and Brazil as China continues to grow its economy, albeit at a slightly lower rate.”

In a recent research report, Boston University’s Kevin P. Gallagher, author of “The Dragon in the Room: China and the Future of Latin American Industrialization,” said that although in the long run China's appetite for Latin American commodities will decline, we are still in a China “super-cycle” — an increase in commodity prices attributed to Chinese growth — that should benefit Latin America for the foreseeable future.7

Unexpectedly upbeat official PMI (Purchasing Managers’ Index) figures also lend support, after the index rose to 50.3 in July from 50.1 in June, besting the 49.9 shown by a Reuters poll of analyst estimates.8 The key 50 threshold demarcates expansion from contraction.

Building BRICs

Brazil, as Latin America’s largest economy, is crucial for China as both a source of raw materials and as a market for Chinese goods. Trade between the two countries has almost tripled in value between 2011 and 2012, jumping from $44 billion to $125 billion in that period alone, according to Oxford Economics analysts. Ernst & Young says the three sectors experiencing the largest increases in volume will be metals, crude oil (ex fuels) and mineral fuels.9

Macau, a Special Administrative Region of China whose Portuguese past was once seen as little more than a colonial hangover, has now developed into a useful business tool, linking the mainland with the world’s 260 million Lusophones, the majority of whom live in Brazil.

“Trade growth between Brazil and China is coming from the increasing importance of both countries within the international marketplace,” explains Claeiber Abreu, J.P. Morgan’s VP for Traditional Trade in Brazil. He also highlights “improving purchase power, not only from the middle class, but also from the working classes in both countries and the ensuing increased demand for consumer goods, the greater importance of the Renminbi, which is set to become the third most-traded currency within the next two-three years, and the continuing investments in Brazil for infrastructure supporting the World Cup, Olympic Games, and oil and gas development.”

Brazil’s agricultural sector has seen increasing investment from China as it works to ensure food security for its vast population. According to China Customs figures, total agricultural trade between Brazil and China hit $19.4 billion in 2012, up 19% from the previous year, with the main commodities including soybeans, soybean oil, and cane sugar.10

The flows go both ways: China’s agricultural exports to Brazil increased by more than 7% year on year to $734 million, helped in no small part by the fact that 53% of Brazilians — 104 million people — are now part of the middle class, according to the Brazil Presidential Office of Strategic Affairs Study September 2012.11 Chinese automotive manufacturers, such as Chery, are targeting this growing consumer segment by building new assembly plants in Brazil, while Chinese motorcycles, electric bicycles, accessories and parts are increasingly being exported to the country.12

Vast amounts of energy are required to literally fuel China’s growth. Sinopec and the China Development Bank inked a loan pact with parastatal Petrobras in 2009 to secure the supply of oil.

In a bid to reduce dependence on the U.S. dollar and the euro, Brazil and China signed an agreement in March to denominate $30 billion of trade in their own currencies.13

“For banks it represents an option to offer finance solutions like traditional import finance and pre-export loans in Renminbi, which sometimes has a more attractive cost when compared to U.S. dollars,” says Abreu. “For the exporter, this enables them to access more attractive credit lines and ultimately may reduce receivables days outstanding, as there is no need for a correspondent bank in the U.S.”

However, as neither side currently has a large pool of the other’s currency, this could lead to potential availability and volatility issues.14

The notorious “Brazil cost” — the increased operational costs associated with doing business in the country — is still an issue. Placed 156th out of 180 countries in the World Bank’s Doing Business (Paying Taxes) ranking, sandwiched uncomfortably between Nigeria and Burkina Faso, Brazil’s high tax burden and complicated fiscal structure provides a distinct disincentive for investors.15 Rather than take the tax hit when they repatriate profits, some foreign companies choose to reinvest that money locally, often setting up production facilities.

On the trade finance front, in a bid to staunch the appreciation of the real, Brazil's Central Bank had imposed a 6% tax on all foreign trade finance loans over a year long, which had the effect of slashing capital inflows to the country. However, in June 2013 the Bank cut the tax to zero to “reflect the regularization of the market,” according to finance minister Guido Mantega. Some analysts predict that this sudden reduction of the tax will lead to a sharp increase in liquidity.16

As Lam explains, unlike the U.S. or EU markets which have been dealing with China for a much longer time, the trading history between China and Latin America is shorter and the shipping distance is also longer. “Therefore, risk mitigation on counterparties and financing over the shipment period is more important,” he says. “The most typical and still the most effective trade instrument is still a letter of credit. This can allow the exporter to offload their counterparty risk and obtain financing after shipment. When a longer trading history is built, I would expect some of this trade be changed to open account basis, and receivable purchase on the exporter side would be another effective method of risk mitigation as well as financing.”

Abreu reports that some exporters are starting to conduct trade finance via the new bank payment obligation (BPO) channel — which provides an efficient, automated framework for transactions and is generally seen as somewhere between the letter of credit and open account in terms of risk.

Focus: Bank Payment Obligation

  • A bank-to-bank obligation
  • Combines the risk mitigation and liquidity benefits of a Letter of Credit with the cost benefits and operational efficiency of Open Account
  • Can bring efficiency to a paper-intensive process
  • URBPO — uniform rules for bank payment obligation

From Copper to Cabernet

For its part, Chile was the first non-Asian country to negotiate a free trade agreement with China in 2005,17 and aims for its trade with China to hit $60 billion by 2015.18 China surpassed the U.S. as Chile’s main trading partner in 2007, the first year that the Chile-China free trade agreement came into force.19

Copper represents about half of Chile’s total exports,20 and China buys about 40% of the world’s copper.21 Despite jitters among Chilean miners as China’s boom slows down — leading to copper supply outstripping demand — Regina Bruni, J.P. Morgan’s head of Global Trade for Chile, points out that an increase in the value and volume of other products might reduce the impact of a drop in exports of the red metal.

New opportunities for Chile include wood pulp, paper and other processed wood products, and one of the government’s priorities is to promote Chilean lobster in China, where its salmon already has a foothold. Chile’s food exports are expected to top $20 billion in 2015, placing Chile among the top-ten food-producing countries.22 Its wine industry, already a regular medal-winner at the China Wine and Spirits Awards, is well on its way to realizing plans to increase export revenues to $3 billion by 2020.23 “Exports of bottled wine to China increased almost 83% in 2012, which made China the third largest wine import market in volume and value,” says Bruni.

Fisheries and aquaculture also represent a key sector. In 2012, China imported from Chile 94,000 tonnes of these products, worth $169 million, an increase of 5% over 2011. China has shown interest in increasing imports of fishmeal, as it is a necessary feed for eel aquaculture, and the country has proposed a bilateral Memorandum of Understanding with the aim of facilitating the exchange of information and promoting chilled salmon imports.24

China is investing heavily in Chile’s agriculture and viniculture sectors, while over $1 billion of investment by Hong Kong-based Sky Solar into photovoltaics has just been approved by the Chilean Foreign Investment Committee (CIEC),25 which has recently translated its website and publications into Chinese and created a China desk with Chinese staff.26

“While Chile is a strategic partner for China for its commodity assets, China is also keen on Chile’s consumer appetite for manufactured goods,” added Bruni.

Chile does not apply any anti-dumping or countervailing measures on its imports from the Chinese mainland or Hong Kong,27 which make up 18% of the country’s total, coming second only to the U.S. As a result, China now provides around three-quarters of Chile’s imported computers and over half of its cell phones, while according to Mercopress the most-imported products include digital cameras, liquid crystal display monitors, shirts, sweaters and shoes. Meanwhile, the inventively-named Great Wall Motors recently celebrated the sale of its 30,000th unit in the country.

To finance this trade, Bruni notes that retailers are shifting from traditional trade finance instruments, such as letters of credit to open account solutions including supplier financing. Chile is a major importer of consumer goods, and larger retailers are interested in standardizing and extending payments terms without increasing the cost to the supply chain, and at the same time allowing Chinese suppliers to accelerate cash flows by early discounting receivables.28

A Bright Future

As China Construction Bank eyes acquisition targets and expansion opportunities throughout the region, and while the Export-Import Bank of China talks with the Inter-American Development Bank about setting up a fund to provide up to $1 billion worth of Renminbi funding for infrastructure projects, the future looks positive for flows between China and its two biggest Latin American trading partners.

“It’s a virtuous cycle,” says Lam. “Through increasing exports to China, the economies of these two countries are growing, increasing the general income level, which drives the demand for more industrial and consumer products from China.”

Despite a slight deceleration in China’s breakneck growth, it remains keen to enlarge its political interests — with trade as a key factor — as well as safeguard food and energy security through cooperation in agricultural production and natural resource exploitation — which means that these three very different nations are likely to benefit from their trade ties for years to come.

  1. Xinhua News, China-Latin America economic cooperation gains momentum: MOC, May 2013
  2. Katherine Koleski, Backgrounder: China in Latin America, U.S.–China Economic and Security Review Commission. May 2011.
  3. China Daily, Xi's trip new chapter for China-Latin American ties, June 2013
  4. Trading Economics, Chile / Brazil Balance of Trade, July 2013
  5. China Real Time Report Blog, The Wall Street Journal, China is Going to Be Just Fine, Say Justin Lin, July 2013
  6. J.P. Morgan Chase & Co Emerging Market Research., China Outlook 2014, June 2013
  7. Global Development and Environment Institute at Tufts University, Capitalizing on the China Cycle: Time is Running out For Latin America, December 2012
  8. Thomson Reuters News, Activity picks up at big China factories, smaller firms struggle, August 2013
  9. Ernst & Young, Time to tune in — Latin American companies turn up the volume on global growth, May 2013
  10. Global Agricultural Information Network, China Agricultural Trade Report in 2012, February 2013
  11. The Rio Times, Brazil Says Over 50% in Middle Class: Daily, August 2013
  12. China Daily, Chery: Brazil supply chain to aid local production, April 2012
  13. Bloomberg News, China, Brazil Sign $30 Billion Swap Accord to Bolster BRICS, March 2013
  14. Benjamin Lam, J.P. Morgan Chase, Personal Interview, July 2013
  15. International Finance Corporation, Doing Business — Measuring Business Regulations: Brazil, 2013
  16. The Financial Times, Brazil slashes financial transactions tax, June 2013
  17. Bloomberg Businessweek, China and Chile: South America is Watching, November 2005
  18. International Maritime Information Website, China expects to double trade with Chile to US$60 billion by 2015, July 2012
  19. Policymic, The Resource Curse Haunts Chile-China Trade, August 2011
  20. Trading Economics, Chile Exports, July 2013
  21. Bloomberg Businessweek, China Consumes 40% of the World's Copper, June 2013
  22. Regina Bruni, J.P. Morgan Chase, Personal Interview, July 2013
  23. Business Chile Magazine, Chile's Wine Industry: A Premium on Quality, August 2012
  24. FIS, China shows interest in importing more Chilean fishery products, July 2013
  25. PV-Tech, Chile approves US $1.1 billion investment in PV sector, July 2013
  26. Xinhua News, Xi's visit expected to bvoost Chinese investment in Child: Chilean official, June 2011
  27. HKTDC Research, Chile: Market Profile, January 2013
  28. Regina Bruni, J.P. Morgan Chase, Personal Interview, July 2013

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