Chinese FDI in Latin America: Likely to remain resilient
Even if problems in China's shadow finance system lead to a sharp slowing of its growth - and adverse consequences for the global economy - foreign direct investment (FDI) from China to Latin America will likely remain resilient over the coming years.
The fragility of growth in China is no secret. On 22 May 2014, HSBC noted that its flash purchasing manager's index (PMI) for China's manufacturing sector rose from 48.1 in April to a five month high of 49.7 in May. This indicates that overall activity is still contracting, albeit marginally. HSBC believes that output, new orders and output prices are rising. Hongbin Qu, HSBC’s Chief Economist for China, suggests that the government's recent mini-stimulus, and lower financing costs, have had some impact: however, HSBC research suggests that conditions in China's labour markets have continued to deteriorate in recent weeks.
In its latest review of the economies of Latin America, the Spanish multinational banking group BBVA is looking for regional growth of 2.3% in 2014 and 2.5% in 2015. Aside from the softness in China's economy, BBVA considers that the region also faces challenges from two other quarters: slippage in the prices of raw materials, of which Latin America is a large exporter, and the tapering of asset purchases by the US Federal Reserve (which will reduce the funds that would otherwise be available to emerging markets).
BBVA's base case is that the Chinese economy will be able to maintain an economic growth rate of at least 7% per annum. However, BBVA recognises the possibility of a hard landing in China over the next year or so. It defines this as a fall in real GDP growth to around 6% per annum from H2 14 to H2 15, slippage in consumption growth from a little above 8% per annum to a little over 7%; and a slump in investment growth from the current 8% or so to 5% or less.
Such a hard landing would affect the region through various channels: through lower commodity prices, through reduced exports, through damage to household and business confidence in Latin America and most crucially, in our view, through a reduction in the general appetite of global investors for emerging markets risk. Although exports of minerals from the Andean countries (Chile, Peru and Colombia) would be hit hard under this scenario, BBVA notes that in all three countries the governments have ample scope to run counter-cyclical and expansionary policies. The biggest negative impact would be on Brazil: BBVA believes that economic growth in 2014 and 2015 would be 1.3% lower than otherwise, thanks to the hit to export revenues and the lack of scope for the authorities to ease policies. Argentina's soft commodity exports would also suffer, but the overall impact on that economy would be limited. Thanks to its proximity to the (now) steadily growing US, Mexico would be largely unaffected.
As BBVA notes, the most obvious catalyst for such a hard landing is a major crisis in China's sprawling shadow finance system. Unusually for a senior official at one of the world's most important central banks, Bank of England (BOE) Governor Mark Carney specifically alluded to 'downside risks from the consequences of the rapid growth of shadow banking in China' in his introduction to the BOE's latest inflation report on 14 May 2014. We believe that the likelihood of a crisis emanating from China's shadow finance system before the end of this year is at least 50%: it is possible that we are more bearish in this respect than BBVA (or the BOE).
An obvious question, therefore, is what the impact of such a hard landing might be on foreign direct investment (FDI) flows from China to Latin America. Latin America governments take varying positions towards neo-liberal orthodoxy, free trade and the importance of relations with the US. Nonetheless almost all welcome FDI from China. From the point of view of Chinese businesses (often, but not always, large state-owned enterprises), Latin America offers access to raw materials that are scarce at home and other market opportunities.
According to China's Ministry of Commerce (MOFCOM), Asia received 71% of the stock of China’s outwards FDI at the end of 2011. A similar percentage of the Chinese entities making this investment (but a lower percentage of the money involved) were manufacturing entities. The reasonable conclusion is that much of China’s FDI involves investment in more cost effective operations in nearby (and culturally familiar) countries in (mainly) South East Asia. MOFCOM suggests that 13% of the stock of outwards FDI was destined for Latin America and the Caribbean. However, this figure includes investment that was channelled through regional offshore financial centres such as the British Virgin Islands (BVI) and the Cayman Islands. Conversely, it does not include (significant) investment into Latin American countries through offshore financial centres in other parts of the world (such as Luxembourg) [Chart 1].
Chart 1: Stock of outward FDI from China, by region, end-2011 (%)
In a working paper published in November 2013, 'Chinese foreign direct investment in Latin America', the United Nations' Economic Commission for Latin America and the Caribbean (ECLAC) noted that the overall stock of Chinese FDI in Latin America had risen from around US$6bn at the end of 2009 to approximately US$40bn. Relative to its size within the global economy, Latin America has been the recipient of a large amount of FDI from China. However, in the overall context of all inwards FDI received by Latin America, China is a fairly unimportant source in normal terms, whether or not the money is channelled through offshore financial centres. By analysing transactions that have been reported, and using non-official sources, ECLAC produced figures indicating that China accounted for a little over 5% of FDI in Latin America in each of the years 2011 and 2012. The corresponding figure was 11% in 2010, the first year of significant FDI from China to the region. (By contrast, China’s total FDI in Latin America between 1990 and 2009 was less that the region received in calendar 2009 [chart 2]).
Chart 2: Chinese FDI as portion of total to Latin America
ECLAC highlights a number of important features of Chinese FDI in Latin America. A major theme has been participation in energy projects by the 'big four' state owned oil companies (China National Petroleum Corporation [CNPC], Sinopec, Sinochem and China National Offshore Oil Corporation [CNOOC]) and other Chinese energy companies. Chinese groups are present in every country in Latin America that exports oil and gas, bar Bolivia and Mexico (where foreign investment in the energy sector is prohibited [although new reforms aim to change that]).
By contrast, Chinese mining companies have concentrated on projects in just two countries - Peru and Brazil. In part because of the unfamiliarity for the Chinese of business practices in Latin America, many of these mining investments are still at an early stage of development. Manufacturers have established operations to serve large local markets (especially Brazil), relying to the maximum extent possible on components that are sourced from China. As appears to be the case with outwards FDI from China generally, the numbers of investments by Chinese manufacturers are relatively large, but small in size. Since 2010, Brazil has accounted for well over half of all Chinese FDI into Latin America; Mexico and Chile for virtually none.
ECLAC's conclusions provide a useful framework within which recent developments involving (actual or potential) investment from China into Latin America can be assessed [chart 3], as follows:
- The IMF's remarks underline the widespread consensus that slower than anticipated growth in China and lower commodity prices is the main source of risk to Latin American as a region over the coming year or so.
- The rise in the number of Chinese companies in Peru indicates that companies in China's energy and mining sector are, collectively, comfortable with the business environment in a country that is unfamiliar and, often, difficult. China Minmetals, Guoxin International Investment Corporation and Citic Metal are, as a consortium, buying the Las Bambas copper project in Peru from the multinational Glencore X-Strata for US$5.85bn. Glencore X-Strata is looking to reduce the gearing on its balance sheet. It describes Las Bambas as 'a long-life copper development project with prospective exploration options...which is at an advanced stage of construction and is scheduled to commence production in 2015.' The project, located in Cotabambas, in Peru's Apurimac region, had gross assets of US$4.42bn at the end of 2013. Jinzhao Mining is proceeding slowly with the Pampa de Pongo iron ore project.
- Two observers, Jeremy Martin at the Institute of the Americas of the University of California at San Diego (UCSD) and ProMéxico Executive Director Marco Espinosa, have alluded to the possibility of a sharp increase in Chinese FDI into Mexico, targeting the energy and manufacturing sectors respectively. Once new laws actually open up the energy sector to inwards FDI, we would expect Chinese players to buy assets in Mexico, given their enthusiasm for the region as a whole. Such purchases may involve JVs with Pemex or with other foreign multinationals also keen to take advantage of the liberalisation of Mexico's energy sector. We are far less convinced that China's manufacturers will be keen to relocate to Mexico. Although Mexico provides ready access to the US market, it is also characterised by competition from world-class and often multi-national businesses: China's manufacturers would be facing companies with established brands and distribution channels, as well as a deep understanding of what is (for the Chinese) an unfamiliar business environment; and (much) greater access to global capital markets. The Chinese manufacturers that have set up operations in Brazil have, to some extent, been shielded by that country's protectionist trade barriers.
- Huawei's expansion in Argentina (and other countries in the region) is a classic example of how Chinese manufacturers approach Latin America. The manufacturing operations support the import of Chinese-made components and know-how. We presume that Huawei receives substantial tax breaks to operate from Tierra del Fuego.
- The mid-April deal between China Minmetals on one hand and Venezuela's Venalum and Sidor on the other is a good example of how the agencies of the government of Venezuela can usefully provide access to large-scale funding through unorthodox sources (in this case, apparently, in order to boost production by the above units of the state-owned minerals conglomerate CVG): in return, Chinese influence with the Venezuelan government is increased.
| Chart 3: Chinese FDI into Latin America: selected recent developments | |
| 10-Feb-14 | Gong Bencai, the head of the association representing Chinese firms in Peru says that the number of Chinese companies operating there rose from 100 in 2012 to 120 in 2013. |
| 12-Feb-14 | Mexico's investment agency Promexico calls for upgrading of transport and communications infrastructure in order to attract FDI from multi-nationals in Asia. Promexico Executive Director Marco Espinosa claims that 50% of companies with over US$10bn in revenue have considered moving part of their factories in Asia to North America. |
| 26-Feb-14 | Jinzhao Mining announces plans to submit an environmental impact study for the US$1.5bn Pampa de Pongo iron ore project to the government of Peru by mid-year. |
| 19-Mar-14 | IMF Western Hemisphere department director Alejandro Werner says that slower than anticipated growth in China and lower commodity prices are the two main external risks for Latin America's economies in 2014-16. |
| 10-Apr-14 | Huawei opens new HQ in Argentina, which will also oversee operations in neighbouring countries and Peru. Huawei looks to double production of smartphones in Tierra del Fuego to 320,000 units this year. |
| 16-Apr-14 | Glencore XStrata agrees to sell Las Bambas copper project in Peru to China Minmetals/ Guoxin IIC/ Citic Metal consortium for US$5.85mn. |
| 17-Apr-14 | Venalum and Sidor, elements of Venezuelan state-owned conglomerate CVG sign US$750mn agreement with China Minmetals |
| 20-May-14 | Institute of the Americas (IOA) energy program director Jeremy Martin cites CNH Commissioner Edgar Rangel, who notes that energy reform could bring US$30bn in investment and create 2mn jobs in Mexico. |
| Source: Business News Americas | |
In short, Chinese FDI into Latin America is driven largely by strategic issues relating to the particular industries in question. Whether or not a crisis in China's shadow finance sector produces a sharp slowdown in Chinese economic growth remains to be seen. In any event though, we would expect Chinese FDI in Latin America to remain resilient. In an environment of weaker commodity prices, it is possible that inwards FDI in the minerals and energy sectors could actually increase following a crisis - simply because assets would be for sale at lower prices than would otherwise have been the case. Conversely, as BBVA has noted, a crisis that is 'made in China' would have an adverse impact on Brazil, the largest regional economy, where on balance, it is more likely that inwards FDI from Chinese manufacturers would fall.