CHINA-LATAM: Chasing the dragon

A massive inflow of Chinese investment into South America last year has brought significant short-term benefits, but could worsen the region’s addiction to commodity exports

  • By Matthew Plowright
  • 28 Mar 2011
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When China’s two largest state-owned oil and gas majors, China National Petroleum Corp (PetroChina) and Sinopec, agreed separate deals totalling almost $5 billion for oil and gas assets in Argentina within 10 days of each other last December, they capped a remarkable year for the Asian nation in Latin America.

Chinese investment in the region surged in 2010, led by state-owned resource companies acquiring direct-equity stakes in local energy companies, offering loans in return for guarantees of oil, gas and industrial commodities, or exploration rights for future projects.

According to Washington, DC-based think-tank the Heritage Foundation’s widely followed China Investment Tracker, Chinese companies pumped more than $32 billion last year into Latin American ventures, accounting for 36% of global Chinese non-bond investment, up from $4.5 billion (6% of overall investment) in 2009. The vast majority of the deals were by Chinese state-owned energy and commodity firms.

China’s Ministry of Commerce has yet to release its own figures for overall foreign direct investment (FDI) in Latin America in 2010, but it says FDI in Brazil alone was $12 billion last year, more than 20% of the total for the region and up from just $116 million in 2009. Brazil’s central bank estimates Chinese FDI in Brazil hit $17 billion in 2010, around 35% of overall FDI in the country last year, up from less than $300 million in 2009.

The logic behind the investment drive is clear: China is a net commodity importer with vast foreign reserves looking to diversify its resource supply and to secure upstream and downstream ownership stakes where necessary. Moreover, many South American countries have abundant natural resources but lack investment capital, and are keen to cultivate new investment and trade partners, not least to break a long-standing dependence on the US.

But the implications of this sudden influx of Chinese capital are less obvious. Although the inflows have served as a major short-term boost to regional economies, they could exacerbate long-term overreliance on commodity exports and hinder diversification. What’s more, growing Chinese trade and investment in the region is likely to shift the economic centre of gravity of the region further away from the US, and increasingly towards emerging Asia, and China in particular.

WHY 2010?

Chinese trade flows with Latin America have been growing for much of the past decade, but until last year direct investment remained muted. “The Chinese have been promising for years that investment would flow into Latin America, but until last year we had seen very, very little of it,” says Mauricio Mesquita Moreira, senior trade economist at the IDB.

To some extent, the Chinese investment boom last year was a natural consequence of a decade of deepening trade ties between the regions. According to Chinese customs data, imports from Latin America increased by 1,800% between January 2000 and January 2010, while exports rose 1,153% over the same period. Having solidified its trade relationship with the region, the natural next step was for China to have its state-owned firms invest in it, thereby gaining access to the region’s strategic resources and a foothold in rapidly growing markets.

But most observers agree the catalyst for last year’s sudden surge in Chinese investment was the global recession, which followed an oil and commodity price spike in mid-2008, and led, in turn, to a commodities slump.

Derek Scissors, a research fellow at the Heritage Foundation who has tracked Chinese foreign investment flows for over a decade, says record global commodity prices in the run-up to the global financial crisis threw Chinese concerns over energy security into sharp relief. The collapse in commodity prices that followed in late 2008 and 2009 created a buying opportunity which grew more urgent as prices began to rebound.

Latin America – with its abundant resource pool and thirst for investment dollars to kick-start its economic recovery – was an obvious destination, especially considering an ever more saturated investment landscape in Africa, another resource-rich region where China has already made substantial inroads.

DOMESTIC IMPETUS

Investment in Latin American resources also represents a shrewd way of diversifying Chinese assets, says Michal Meidan, a China energy expert at Eurasia Group. As a result of the global financial crisis, Beijing had also begun to rethink its policy of holding a large chunk of its foreign exchange reserves in US dollars, given its fears over a possible loss in their value.

“The Chinese took dollars that were losing their value and turned them into a valuable asset, while enhancing supply security,” says Meidan.

 
Beijing’s drive to create globally competitive Chinese multinationals is another motivation: the bulk of its Latin ventures have been led by three state-owned oil and gas companies, PetroChina, Sinopec and China National Offshore Oil and Gas Corporation (CNOOC), which the government is keen to transform into vertically integrated global energy majors. By buying direct equity stakes in the region’s energy companies and partnering with them on exploration projects, Chinese companies are also acquiring managerial and technical know-how, as well as assets and expertise outside of their specialist sectors, Meidan notes.

Sinopec’s $2.5 billion purchase of Occidental Petroleum’s upstream Argentine assets last December is a clear example of this, as Sinopec has traditionally focused on downstream production and buys more than three-quarters of the crude it refines.

SHORT-TERM BENEFITS

So far China’s new engagement with Latin America has been a tremendous boon for the region. Its investment in and demand for natural resources has boosted current account balances and diversified the region’s export markets, while also pushing up global commodity prices. “For the Conosur [Southern Cone] in particular, Chinese investment has had a huge benefit in terms of foreign exchange and promoting growth,” Moreira says.

Kevin Gallagher, an associate professor of international relations at Boston University, notes that the terms of Chinese commodity investment and trade in South America is not overwhelmingly weighted in the buyer’s favour: China is paying competitive prices. “Latin American exporters are getting a better global price for iron ore and copper because of China.”

“It’s important not to oversimplify and think that the new investment winds in South America are giving the region away to China,” says Guillermo Mondino, head of Latin American research at Barclays Capital. “It’s a natural development, part of China’s new role in the global economy as an increasingly large economic player.”

Says Scissors: “The Chinese will pay you properly. The one-way investment flow is because South America has what China wants, and they’re willing to pay for it.”

LONG-TERM RISKS

But a failure by Latin authorities to reinvest capital wisely could aggravate structural economic imbalances and further the region’s overreliance on commodity exports.

Brazilian commodity exports outstripped manufacturing exports for the first time last year, Gallagher points out. And a renewed emphasis on primary commodities production in Latin America could exacerbate the region’s “resource curse”, he says.

“China is a great opportunity for the region, but Latin American nations can’t sit there and let things happen,” says Gallagher. “South America has to weigh the benefits of a massive export market for their commodities versus the cost of import and global manufacturing competition and an over-dependence on commodities. The question is whether or not it can capitalize on the benefits to mitigate the costs.”

Chile’s copper stabilization fund is an example of a sensible way of ensuring that China’s investment drive has longer-term benefits, says Gallagher. South American nations must look to develop stabilization funds, sovereign wealth funds and development banks to channel the investment windfalls efficiently and to create a buffer against future commodity price shocks or a possible drop-off in Chinese investment, he says.

LONG VIEW

Most experts say Chinese demand for South America’s raw materials is unlikely to fade anytime soon – even if China’s economy slows moderately. But whether today’s benign investment and trade relationship can continue indefinitely is another question.

Gallagher’s back-of-the-envelope calculations suggest that Chinese per-capita commodity consumption has at least another 30 years left to expand, provided incomes grow at current levels. But this does not rule out the prospect in the meanwhile of heightened economic and political tensions with the region or the possibility that China looks to invest further afield instead.

“Latin America has to try and look beyond the short-term money and have a more long-term view of its relationship with China,” says Moreira. “Look at the type of barriers that the Chinese impose, or the scale of their trade surplus with Central America, yet there is silence on the part of the governments in the region.”

“There comes a point where the political economy gets so complicated that in order to avoid a major backlash, you need to start investing and making, not just exporting goods to these countries.”

But while there have been isolated examples of Chinese manufacturing investments in the region – such as last year’s $700 million investment by the private Chinese automaker Chery in a manufacturing plant in Jacareí, Brazil – Chinese manufacturing investment in the region would in any event continue to be dwarfed by commodities for the foreseeable future, Moreira acknowledges.

Scissors predicts that Chinese investment in South America will likely “crest” later this year, before moderating in the coming years as Chinese state-owned enterprises look to alternative commodity and investment destinations, such as Canada.

“Latin America has a pretty narrow time-window to use this money wisely,” he says. “This is the big jump, the big initial lottery payment, and they will continue to receive smaller payments over time. But the region has to make this investment income work for generations. It mustn’t think that it will last forever. It must think about what happens after the wave crashes.”

 
ECONOMIC ROLE

What’s clear is that Chinese trade and investment has already reshaped Latin America’s economic landscape – a trend that’s unlikely to reverse given the odds of continued strong trade flows.

Many experts now agree that Beijing has displaced Washington as South America’s primary economic driver, although the US remains the predominant economic force in Central America. “South America is clearly not the US’ economic backyard in the way that it used to be,” says Barcap’s Mondino. “China is now a more important economic determinant of Latin America’s fate than the US.”

A number of South American leaders, most notably Venezuela’s Hugo Chavez and Ecuador’s Rafael Correa, have hailed closer economic ties with China as the realization of much-vaunted “south-south” ties that signal the end of US political and economic hegemony over the region.

Yet most analysts remain sceptical about reading too much political significance into the trend. “I don’t think there’s any political motivation from the Chinese to try and improve south-south relations – it’s purely economic,” says Moreira.

While Chavez may paint Chinese oil investment in Venezuela in an ideological light, the Chinese simply see it as a good trade deal, says Eurasia Group’s Meidan.

Still, Gallagher believes the combination of increased Chinese commerce in the region and US foreign policy preoccupation elsewhere has undermined Washington’s influence across much of South America – a perception that US president Barack Obama will no doubt have been trying to dispel during his recent tour of the region.

“We’ve looked the other way for the past 10 years, and, boy, other folks haven’t,” he says. “What we have to offer really needs to change if we want to compete. Brazil won’t touch a US trade agreement with a 10-foot pole. This has got to be a wake-up call for US foreign economic policy in the region.”

MULTILATERAL INFLUENCE

According to Gallagher, Beijing’s long-term strategic concerns will often trump short-term commercial logic and could even pose a challenge to development finance institutions.

“The Chinese will lend to you if it’s strategic, regardless of what your bond rating is,” Boston University’s Gallagher says. “They don’t care if you default on your multilateral debt repayments or if your currency collapses, so long as you keep providing them with commodities. It’s a form of barter-based financing.”

He cites as evidence the fact that China agreed a $1 billion loans-for-oil deal with Ecuador in mid-2009, just six months after it had defaulted on $3.6 billion in bonds.

But Moreira says if such a dynamic is a concern, it’s only so in the region’s less liberal-reform-minded states, such as Venezuela or Ecuador.

“Since the Chinese invest with no strings attached, clearly you reduce the clout of [multilateral development] organizations to try and push reforms. This might be an issue in terms of not giving the right incentives or the right type of development model,” he says.

“At least so far, I don’t think that the Chinese have changed anything in terms of the course of development of those countries. They might have reinforced trends that were already there, but they haven’t changed it.” But should Chinese investment continue to pour into the region at last year’s rates, this could change.

Says Moreira: “This might become a real issue in the future.

  • By Matthew Plowright
  • 28 Mar 2011

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 15 Aug 2016
1 JPMorgan 243,624.78 967 8.68%
2 Citi 218,715.75 783 7.79%
3 Barclays 205,766.70 643 7.33%
4 Bank of America Merrill Lynch 202,029.46 695 7.19%
5 HSBC 173,256.62 692 6.17%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 23 Aug 2016
1 BNP Paribas 23,543.21 101 6.75%
2 UniCredit 23,360.96 107 6.69%
3 JPMorgan 23,076.45 41 6.61%
4 HSBC 19,192.10 94 5.50%
5 ING 16,697.84 101 4.78%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • 23 Aug 2016
1 JPMorgan 9,747.52 55 9.59%
2 Goldman Sachs 8,816.07 50 8.67%
3 Citi 6,911.91 36 6.80%
4 Morgan Stanley 6,504.18 35 6.40%
5 UBS 6,126.84 31 6.03%