A looming slowdown in the Chinese economy promises trouble for China's economic partners in Latin America, especially commodity exporters. The growing relationship between China and Latin America is on display this week as Chinese Foreign Minister Wang Yi tours the region in a trip that will wrap up April 26. Wang is visiting Cuba, Venezuela, Brazil and Argentina to discuss bilateral financing and trade deals.
China's slowing economy and potential for domestic economic instability threatens to sharply lower demand for key commodities exported by Latin American countries. Particularly vulnerable are countries such as Brazil, Peru and Chile that have seen China rise in importance as an export destination.
When the 2008 financial crisis seized international trade and sent the European Union and the United States into recession, the immediate effects on Latin America were surprisingly muted. Bouncing back strongly, Argentina and Brazil saw gross domestic product growth rates of 9.2 percent and 7.5 percent, respectively, in 2010. While the recovery was brief in both cases, Chinese demand for South American commodities was an important factor. For a range of countries, Chinese demand has been an important external driver of growth. Brazil, Chile and Peru have all seen China rise to become the top customer, particularly for metals.
Soybeans, Copper and Iron
The primary driver of Chinese demand has been a boom in construction, which has consumed Peruvian and Chilean copper as well as Brazilian iron as building materials. At the same time, population growth and rising wealth have driven demand for soybeans in China. China is the biggest national importer of soybeans, consuming more than 40 percent of the globally traded supply. Brazil, Uruguay, Paraguay and Argentina are home to some of the world's best soybean cropland outside of North America, and together they supply about 26 percent of the market.
Particularly for Brazil, the rising demand for commodities has played a crucial role in buoying growth. At the same time, however, demand for Brazilian value-added products from the United States and Argentina stagnated as U.S. consumers recovered from the financial crisis and Argentina put up trade barriers in an effort to deal with its own balance of payments problem. This has created domestic challenges for the government of Brazilian President Dilma Rousseff, whose administration is seeking to support industrial production. It has also helped to keep the value of the Brazilian real relatively high, stimulating domestic demand for imported goods and encouraging Brazilian tourists to go abroad. This has eaten away at Brazil's trade and current account balances, posing long-term risks to Brazil's financial stability.
The primary driver of Chinese demand has been a boom in construction, which has consumed Peruvian and Chilean copper as well as Brazilian iron as building materials. At the same time, population growth and rising wealth have driven demand for soybeans in China. China is the biggest national importer of soybeans, consuming more than 40 percent of the globally traded supply. Brazil, Uruguay, Paraguay and Argentina are home to some of the world's best soybean cropland outside of North America, and together they supply about 26 percent of the market.
Particularly for Brazil, the rising demand for commodities has played a crucial role in buoying growth. At the same time, however, demand for Brazilian value-added products from the United States and Argentina stagnated as U.S. consumers recovered from the financial crisis and Argentina put up trade barriers in an effort to deal with its own balance of payments problem. This has created domestic challenges for the government of Brazilian President Dilma Rousseff, whose administration is seeking to support industrial production. It has also helped to keep the value of the Brazilian real relatively high, stimulating domestic demand for imported goods and encouraging Brazilian tourists to go abroad. This has eaten away at Brazil's trade and current account balances, posing long-term risks to Brazil's financial stability.
Financing as a Political Tool
China has also played a direct role in supporting Venezuela in the wake of the nation's alienation from foreign investors. China's willingness to provide financing to Venezuela in exchange for oil has been a mutually beneficial arrangement. China gained access to energy supplies critical to its strategic interests at favorable rates, and the financing helped to stabilize a government dependent on social spending for stability and popularity. The situation in Venezuela has shifted, however, with the death of Venezuelan President Hugo Chavez. While the health of the oil sector continues to decline, protests and currency instability are plaguing the new government of President Nicolas Maduro.
Wang's visit this week is thus an important reminder of the role that China has played in supporting the Venezuelans and is an opportunity for Venezuela to push for additional assistance on key projects ranging from social programs to energy development. The Cubans also have an interest in greater Chinese involvement in Venezuela, which continues to supply Cuba with billions of dollars worth of subsidized energy every year. The Cuban government will almost certainly use the visit of the Chinese delegation to push for greater assistance to Venezuela.
China has also played a direct role in supporting Venezuela in the wake of the nation's alienation from foreign investors. China's willingness to provide financing to Venezuela in exchange for oil has been a mutually beneficial arrangement. China gained access to energy supplies critical to its strategic interests at favorable rates, and the financing helped to stabilize a government dependent on social spending for stability and popularity. The situation in Venezuela has shifted, however, with the death of Venezuelan President Hugo Chavez. While the health of the oil sector continues to decline, protests and currency instability are plaguing the new government of President Nicolas Maduro.
Wang's visit this week is thus an important reminder of the role that China has played in supporting the Venezuelans and is an opportunity for Venezuela to push for additional assistance on key projects ranging from social programs to energy development. The Cubans also have an interest in greater Chinese involvement in Venezuela, which continues to supply Cuba with billions of dollars worth of subsidized energy every year. The Cuban government will almost certainly use the visit of the Chinese delegation to push for greater assistance to Venezuela.
The Question of Chinese Instability
In the shorter term, potential for instability in China's economy poses serious questions for Latin America. China's growth has begun to slow, and while still high at around 7.4 percent year-on-year for the first quarter of 2014, the economy is visibly changing. Recent reports of bankruptcies or near-bankruptcies in the real estate sector underline the fragility and potential for instability in the one sector that has been driving demand for copper from Chile and Peru and iron from Brazil. More broadly, a slowdown could affect a range of activities, from shipbuilding to infrastructure development, that also consumes Latin American iron and copper.
The Chinese government would immediately and strongly address any slowdown or crash in the real estate sector. Furthermore, China's accelerated urbanization push, particularly in the interior, seems unlikely to halt entirely and should continue to support demand for copper and iron even as the coastal economy slows down. But even a short-term contraction associated with the changing composition of China's economy could rapidly erode the value and even volume of commodity trade, leaving these Latin American countries particularly vulnerable to balance of payments shocks in the short run, and in the long run to lower growth prospects. And of course, anything that threatens Chinese financial stability poses a direct threat to the country's willingness or ability to provide financing deals to countries such as Venezuela or Ecuador. Still, given the overall size, wealth and interconnectedness of the Chinese economy, a slowdown in outward investment would likely be temporary.
Besides copper and iron, soybean exports will remain important for South American countries. Although China has made significant progress in developing efficient, widely mechanized agriculture, it remains reliant on foreign markets for a range of agricultural products, particularly soybeans. This is especially true since rapid urbanization continues to compete with agriculture for fertile zones. Additionally, rising incomes in China mean that more people can afford to eat meat, for which soybean products are an important feedstock. And while China's population growth has slowed significantly and is projected to start decreasing in 2030, demand for soybeans can be expected to continue to climb for at least the next few decades.
A slowdown in metals exports presents the biggest risk to Brazil, along with Peru and Chile, of a sharp reduction in export revenues. Iron exports have already slowed, but should that become an extended decline, it will cause long-term harm to growth prospects. But there are mitigating factors. All three countries have significant foreign currency reserves that will help to mitigate the negative effects of a downturn. For Brazil, which has been struggling with the high value of the real, this could actually provide some relief, albeit on a longer-term basis. A lower-valued real would help to discourage imports -- including cheap imports from China that are out-competing domestic producers -- and help to alleviate Brazil's falling trade surplus. In short, a decline in commodity imports could actually help Brazil boost its manufacturing base.
Furthermore, while a slowdown in China would potentially be costly for Latin America, substantial business links between the two over the past decade will also provide opportunities for Chinese businesses to diversify with operations in Latin America. Diversification into Latin American assets will be a boon for Chinese companies in that same way that Latin American investments help Spanish companies survive the slowdown.
In the shorter term, potential for instability in China's economy poses serious questions for Latin America. China's growth has begun to slow, and while still high at around 7.4 percent year-on-year for the first quarter of 2014, the economy is visibly changing. Recent reports of bankruptcies or near-bankruptcies in the real estate sector underline the fragility and potential for instability in the one sector that has been driving demand for copper from Chile and Peru and iron from Brazil. More broadly, a slowdown could affect a range of activities, from shipbuilding to infrastructure development, that also consumes Latin American iron and copper.
The Chinese government would immediately and strongly address any slowdown or crash in the real estate sector. Furthermore, China's accelerated urbanization push, particularly in the interior, seems unlikely to halt entirely and should continue to support demand for copper and iron even as the coastal economy slows down. But even a short-term contraction associated with the changing composition of China's economy could rapidly erode the value and even volume of commodity trade, leaving these Latin American countries particularly vulnerable to balance of payments shocks in the short run, and in the long run to lower growth prospects. And of course, anything that threatens Chinese financial stability poses a direct threat to the country's willingness or ability to provide financing deals to countries such as Venezuela or Ecuador. Still, given the overall size, wealth and interconnectedness of the Chinese economy, a slowdown in outward investment would likely be temporary.
Besides copper and iron, soybean exports will remain important for South American countries. Although China has made significant progress in developing efficient, widely mechanized agriculture, it remains reliant on foreign markets for a range of agricultural products, particularly soybeans. This is especially true since rapid urbanization continues to compete with agriculture for fertile zones. Additionally, rising incomes in China mean that more people can afford to eat meat, for which soybean products are an important feedstock. And while China's population growth has slowed significantly and is projected to start decreasing in 2030, demand for soybeans can be expected to continue to climb for at least the next few decades.
A slowdown in metals exports presents the biggest risk to Brazil, along with Peru and Chile, of a sharp reduction in export revenues. Iron exports have already slowed, but should that become an extended decline, it will cause long-term harm to growth prospects. But there are mitigating factors. All three countries have significant foreign currency reserves that will help to mitigate the negative effects of a downturn. For Brazil, which has been struggling with the high value of the real, this could actually provide some relief, albeit on a longer-term basis. A lower-valued real would help to discourage imports -- including cheap imports from China that are out-competing domestic producers -- and help to alleviate Brazil's falling trade surplus. In short, a decline in commodity imports could actually help Brazil boost its manufacturing base.
Furthermore, while a slowdown in China would potentially be costly for Latin America, substantial business links between the two over the past decade will also provide opportunities for Chinese businesses to diversify with operations in Latin America. Diversification into Latin American assets will be a boon for Chinese companies in that same way that Latin American investments help Spanish companies survive the slowdown.
Courtesy : Stratfor (www.stratfor.com)
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