Latin America expects to get some benefit from the relationship with China

(InfoAmericas (Pan Regional))A year ago, China's President Hu Jintao made a historic diplomatic journey to four Latin American markets in search of deeper economic and political ties. China promisedmassive investment in the region, a growing shopping list for commodities and increased political support at the UN and the WTO. In return for these bold promises, China wanted recognition as a market economy, especially from Brazil and Argentina, which together represent a huge potential consumer market. Jintao's road show was an unqualified success and the Chinese got what they came for.

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But twelve months later, the South Americans are still not sure if the Chinese promise is real, and they wonder out loud if they were dealt a losing hand. China's economic impact in Latin America over the next five-to-ten years will vary significantly from market to market. This article will help business thinkers to understand how each market in the region is likely to play its own strategic "China card" as well as the most likely outcomes. .Latin America as a Source of Raw Materials

In 2004, Latin America achieved strong GDP growth thanks to an 18% surge in exports. Most of that increase was driven by an appreciation in commodity prices. China's massive consumption of raw materials to feed its industry and consumers drove radical increases in the price of cement, steel, oil, iron ore, copper, tin, soybeans and other base commodities. Although China does not source the bulk of its commodity inputs from South America, it is responsible for creating a scarcity of supply in global markets, thereby driving up prices, much to the benefit of Latin America, especially South America.

While China needs to source raw materials for its factories, it also must contend with the growing global pressure to float its currency. The concerted undervaluation of the currency has generated massive trade surpluses as well as $800 billion in reserves. China is reluctant to float its currency because any loss of price competitiveness could lead to job cuts. In a country where 500 million rural poor are expected to migrate to the cities over the next 5-to-10 years, sustained job creation is the foundation of Chinese political stability.

One of China's strategies is to use its burgeoning dollar reserves to resolve its sourcing issues by acquiring commodity-producing companies abroad. That was the focus of Jintao's political junket to South America last year. But while China is clearly a potential investor in the region, it is unlikely that all of its promises will come to fruition. The opportunities and risks are different for each of the three categories of potential investment.

Acquiring Commodity ProducersThe purchase of Latin American extractor/exporters of raw materials would help to guarantee China's future supply of certain primary resources that its labor-intensive industries need but cannot supply. For example, in 2004, the Chinese state oil company Sinopec invested US$1 billion in a joint venture with Petrobras, the Brazilian state oil firm, for the construction of a gas pipeline linking southern and northeastern Brazil. And Codelco, Chile's state copper company, has entered into a partnership with China's Minmetals to develop a mine to supply China with copper for the next two decades. China's recent investment in Ecuador's oil sector via the purchase of a Canadian firm with Ecuadorian assets is another example. Nonetheless, Chinese investors are very wary of Latin America's weak corporate governance.

Building InfrastructureSecond, China's vertical integration strategy may also include the purchase of infrastructure to modernize its supply chain. This means investing in infrastructure to extract and export raw materials. For example, building a pipeline to transport Bolivian gas to the pacific coast makes sense if it helps China to supply itself more efficiently and securely. Nonetheless, China is not likely to invest in infrastructure that brings product to markets that do not generate hard currency, such as Bolivian gas to Brazil, or to competing markets like Bolivian gas to the US.

Cognizant of their own infrastructure deficit, South American leaders were intrigued by the possibility that China might invest in new roads, rail and other basic infrastructure. Such promises are likely to prove empty. To begin with, domestic infrastructure projects generate local currency, exposing the investor to currency risk. Further, they do more to help the recipient country than to improve China's supply chain. China has too many of its own domestic infrastructure problems to worry about solving similar deficiencies in Latin America.

Mexico might be an exception to this conclusion, because China faces a strong business backlash there against aggressive Chinese competition that has taken 300,000 Mexican jobs in light assembly. Road building may be one way for China to improve its image in the country. Moreover, Mexico has perhaps the most stable currency in the region (outside of Puerto Rico and Panama) and is therefore a relatively viable investment target.

Other possible exceptions are Chile and Argentina. Trade talks between China and Chile are progressing rapidly and China has lifted the ban on Argentinean beef, promising to make its standards more flexible if Argentina agrees to improve the quality of its soy oil. One possibility is Chinese investment to provide an alternative to the Cristo Redentor Pass between Argentina and Chile, which is forced to close for part of every year due to snow buildup. Last June, the closure of this road caused losses of more than US$4 million to Argentina's economy alone. Years of discussion between the two governments have failed to yield a solution because of the lack of financial resources, but sources say that China is interested in participating as a partner. This would be China's first investment in the southern cone.

Low-interest LoansLatin America has long counted on its northern neighbor for investment, but the funds coming into the region from the US have decreased substantially since they last peaked in 2000, while Chinese investment grows at a rapid pace. On the other hand, many Latin American economists point out that a lot of the promised investments are actually low-interest loans that generally fund activities by Chinese companies backed by sovereign assets from the borrowing country. In today's highly-liquid international capital markets, Latin America can shop for debt from multiple markets. Even Ecuador recently returned to international debt markets.

Stripping away the hyperbole of the Jintao visits, we anticipate that actual Chinese investment in Latin America is not likely to exceed $25 billion over the next ten years.

The Threat to Consumer Goods ProducersChina is a threat to any country that competes on the strength of the price competitiveness of its labor pool. This is particularly true for textiles/clothing and consumer electronics. They are for the most part light products where assembly labor is a critical cost component, because parts and finished products can be shipped around the world to find the cheapest labor pool. Heavier products like automobiles, refrigerators, and central air conditioners are less vulnerable because it costs too much to ship them over long distances between suppliers and consumer markets.

In particular, China is a serious threat to Latin American electronics and textile/clothing exports to the US, especially from Central America and the Caribbean. China has gradually cornered the consumer electronics market over the years, in part because of easy access to parts sourced in Taiwan, Korea and Japan.

In the case of textiles and clothing, the multi-fiber agreement, which was finally phased out at the end of 2004, helped to delay the inevitable shakeout in terms of servicing US and European markets. Chinese exports of clothing to the US jumped by 90%, primarily due to stealing US share from less efficient suppliers who enjoyed market-manipulating quotas like Canada, Hong Kong, and Dubai, among other wealthy nations. China is also a real threat to Latin American producers in their own markets. For example, Mexican producers no longer dominate their own market for toys and some clothing products.

On the other hand, there are some mitigating factors that may soften the Chinese of threat to Latin America:US trade actions vs. China. In response to the meteoric rise of Chinese textile exports to the US in the first quarter of 2005, the US played its trump card the option to manage (limit) Chinese imports until China completes its introductory phase of WTO membership in 2008. This will take effect in January 2006, leaving market share taken in 2005 in Chinese hands. Still, Central America and parts of the Caribbean can breathe a sigh of relief. . The Central American clothing producers that survive will be those that make fashion-driven lines of clothing, need a short supply chain to cope with volatile demand. Proximity to market will help Central American producers, while those in Colombia and Mexico will gain competitiveness from transport bottlenecks facing Chinese imports via US west coast ports. To survive, other producers will need to shift towards fashion clothing and away from clothing commodities like undergarments and t-shirts.. In electronics, Central America and Mexico can compete in heavy goods where transport costs are key (especially helpful for Mexico) as well as in seasonal and trend-oriented electronics. For example, certain electronic toys achieve as much as 80% of annual sales during the Christmas holiday season. Retailers want a guaranteed supply and will favor producers with short supply times and healthy inventory streams. The Caribbean ConnectionDuring the depths of the Cold War in the 1960s, the US did not diplomatically recognize China, a communist country that it had fought in the Korean war. Instead, the US recognized Taiwan as the legitimate seat of Chinese government. As the largest aid donor, military ally and trading partner to all of Central America and Caribbean, the US looked to its neighbors for additional recognition of the "breakaway island province of Formosa" as the "country" of Taiwan.

In 1972, the Nixon government played its China card to try to neutralize that country as a threat, ending diplomatic recognition of Taiwan and embracing Beijing as the sole legitimate government of the middle kingdom. But to satisfy conservatives in its own country, the US continued to pressure its western hemisphere cousins to keep recognizing Taiwan.

When the Berlin wall fell, the US ended its policy of giving aid to any nation that declared itself anti-communist, including some of the most incompetent and dangerous despots in Latin America. This helped democracy to flourish in Latin America, but it also took away any incentive to keep recognizing Taiwan, since this was no longer an essential anti-communist credential for aid recipients. Taiwan responded by filling the gap with aid to small nations in Central America and the Caribbean.

With the cold war ended, China has increased its pressure on Taiwan to rejoin the fold. Chinese diplomats know that one way to delegitimize Taiwan as an independent country is to convince the remaining holdouts to recognize the PRC as the one true China. So the country has entered a bidding war with Taiwan, promising aid and investment to achieve its diplomatic goal. For example the island nation of Dominica accepted a $200 million aid package (more than its GDP) in return for full recognition of the PRC. Others are likely to follow.

The Impact of Chinese Contraband The inability of Latin American governments to collect income tax from citizens and corporations makes them dependent on sales taxes (VAT) and import duties. This is especially true of smaller nations that lack economies of scale for building efficient infrastructure. They are therefore threatened by free trade agreements that would lower import tariffs. Only Mexico and Chile have succeeded in lowering tariffs over a significant number of products and trading partners. The rest of the region continues to impose substantial tariffs, in addition to value added taxes ranging between 15 and 20%. This provides plenty of incentives for a thriving grey and black market for imported goods.

Latin American consumers, squeezed in terms of disposable income, flock to markets that sell illegally imported consumer goods for cash, at prices that can be 30%-to-60% less than the same goods sold through formal channels. In some product categories such as consumer electronics, clothing, and products based on intellectual property, black and grey markets are often the dominant distribution channels.

China is a major supplier to Latin America's grey and black markets for a number of reasons, starting with the fact that it is the low-cost producer of many of the goods that flourish in these markets. Also, Chinese exports bound officially to open markets like the US are often re-routed in transit to Latin American black markets, so China has little official knowledge of where its exports land.

Policy makers in Latin America argue that illegal Chinese products are destructive to their economies, robbing them of competitiveness and tax revenue. Free traders argue that the cost savings that they represent provide badly needed purchasing power to working class Latin Americans. What politicians across the region all desire is a China that moves beyond its traditional black market role to become a significant trade and investment partner. 2005 NoticiasFinancieras - InfoAmericas - All rights reserved
Latin America expects to get some benefit from the relationship ...