More Than Mining
China has traditionally looked to Latin America as a region that could feed its seemingly insatiable appetite for natural resources. Chinese resource extraction operations remain strong there, but in recent years Chinese companies and investors have broadened their interests in Latin America by investing in a wide range of sectors in at least 10 different Latin American countries.
The region has seen some large scale investment: Eight of China’s top 30 companies have invested in Latin America in the past seven years, including investments like State Grid’s US$1 billion purchase of seven power transmission companies in 2010.
But smaller non-state enterprises such as Chery Auto have also started operations in Latin America. Even at the individual investor level, there are opportunities such as real estate investment.
“The predominant focus is on resources, energy and transportation-related investments,” said Margaret Myers, director of the China and Latin America program for the US think tank Inter-American Dialogue. “In terms of China’s trends [in Latin America], agribusiness, green technology and renewable energy are going to be big areas of investment in the future.”
The service sector is one worth avoiding because it would be difficult to compete with the locals, said Alicia Garcia-Herrero, chief economist for emerging markets at Spanish investment bank BBVA.
Investment opportunities vary significantly country-to-country, with some small nations particularly welcoming Chinese investment.
“China has it easier with countries such as Ecuador, Bolivia, even Venezuela,” Garcia-Herrero said. “They are isolated and they have a very populist regimes. They need an ally.”
But that hasn’t discouraged interest in the larger Latin American nations with Brazil, for example, drawing those seeking to tap its large domestic consumer market and Mexico attracting those looking to gain access to the US market.
Larger countries have seen a rapid acceleration in investment. Chinese investment in Brazil, Argentina and Chile nearly tripled to US$15.6 billion in the 12 months to May 2011, compared to the same period a year earlier, according to a report by accounting firm Deloitte.
Brazil, Mexico and Argentina – the three largest Latin American countries by GDP – as well as Chile – large in area but smaller in GDP – provide a cross-section of the varied opportunities and investment environments that the region has to offer.
Brazil is an appealing investment target for China as the 10th largest economy in the world, accounting for 40% of the region’s economy.
Trade between Brazil and China increased 16-fold from 2001 to 2010. Brazil sends the largest share of its exports to China, while China is Brazil’s second largest import partner after the US.
Much of the exports that interest China are the result of Brazil’s abundance of natural resources. The largest country in Latin America by land area, Brazil, is rich in natural resources, produces more oil than it consumes and ranks second for iron ore production.
But Brazil is urging Chinese companies to invest in non-raw materials to help balance the economy.
Many opportunities for investment feed off of Brazil’s domestic consumption. Brazil and Mexico are creating as many middle class households as any country except China, according to Garcia-Herrero. Brazil’s middle class is expected to grow 66% between 2010 and 2020, according to recent research by BBVA.
To that end, half of China’s US$9 billion investment in Brazil last year went into the technology sector, according to preliminary projections. Perhaps the most indicative of the potential for Brazil’s tech sector is Foxconn, the world’s largest maker of electronic components. The Taiwan company is considering opening operations in Brazil as a result of rising labor costs in China, where most of its operations are located. The move could eventually see items such as Apple’s iPad manufactured in Brazil.
Agribusiness is another viable option but companies may want to seek the assistance of a Brazilian public relations firm or a major advisory group, as many Chinese companies are now doing to ease the process, said Myers, of Inter-American Dialogue. That might help avoid difficulties Chinese companies have had making agricultural acquisitions elsewhere in the world, most recently in New Zealand where courts may block the Chinese purchase of one of the country’s largest dairy farms.
Real estate in Brazil could also offer big payoffs for investors and individuals.
“There’s tremendous real estate potential elsewhere [besides Sao Paulo and Rio de Janeiro],” Myers said. “Elsewhere” includes the state of Bahia, which presents an undeveloped housing market with plenty of options. Bahia is a major tourist destination with a growing economy that will see local demand drive the real estate market. Furthermore, Bahia is known for its cheap labor costs, an advantage global companies such as Ford Motor have benefited from.
As a place to do business, Brazil is not without pitfalls. The country’s strict labor code, high tariffs and complex legal system is part of the reason why some foreign SMEs have failed, Myers said.
Chinese car maker Chery Auto provides an interesting case study on navigating Brazil’s tariffs and regulations. Chery made inroads in Brazil’s automobile industry with plans to open a US$400 million factory in the city of Jacarei by 2013.
“Chery Auto is held as being one of the major success cases because unlike most SMEs – and there’s been a tremendously high failure rate for SMEs in Latin America – it really learned to adapt to Brazilian culture,” Myers said.
But the Brazilian government is putting the brakes on foreign investments in the auto sector. It raised taxes 30% in January for vehicles that have less than 65% local content, as well as those that are assembled outside of Brazil, Argentina, Paraguay, Uruguay or Mexico, based on existing trade agreements.
Following the announcement of the tariff, Chery said it would continue construction of the factory but put on hold further plans for expansion. In February, Brazil announced it would lower the tax in March, calling the measure a temporary “emergency brake.”
The new factory will help Chery shield its cars from trade barriers to some extent, but the use of the tariff even in an “emergency” does point out the potential for backlash to foreign investment in Brazil.
Chile’s legal attraction
Chile is regarded as the easiest Latin American country to do business in, according to the World Bank’s Doing Business 2012 ranking, making it an attractive proposition for investors. Worldwide, the west-coast nation ranked 39th out of 183 countries. Chile also rates well for “Protecting Investors” at 29th while it was 27th for ‘Starting up a Business’.
“Chile is on top of its game in comparison to other South American countries,” according to Myers, with copper, amongst other natural resources, being of particular interest to China.
Interest from Asia has grown with three countries in Chile’s top 10 sources of authorized investment: Japan (11.6%), Korea (1.6%) and China (1.5%).
Much of this is the result of strong progress toward securing credit transactions, speeding up approvals related to cross-border trading and encouraging further two-way investment between China and Chile.
Business summits are providing platforms for Chinese companies to find new business opportunities in Chile. A November event in Lima, Peru, brought together 100 of China’s leading companies in the technology and manufacturing sectors.
State Grid, China’s leading electricity infrastructure company, is also looking for investment opportunities in Chile, according to Garcia-Herrero. They reportedly intend to invest nearly US$10 billion in Latin America, specifically Brazil and Chile, over the next 10 years.
Other sectors, besides natural resources, don’t receive as much interest from investors, but Chile can still remain an attractive proposition because it holds investment-grade rating on its sovereign debt and is known for reliability and clear rules.
Mexico is gathering interest from China as a plausible avenue for gaining further access into the US market. Manufacturing in China and exporting to the US was a sure-fire business strategy as recently as a few years ago, but trends in labor cost and exchange rates have helped close the gap between the two.
China’s labor costs have increased while Mexico’s remain relatively constant. At the same time, the peso has depreciated against the US dollar while the renminbi has rapidly appreciated.
Mexico has already surpassed China as the cheapest country in the world for companies looking to manufacture products for export to the US market, according to a study conducted by consultancy firm AlixPartners. But Myers said Mexico has yet to develop the efficiency that companies have become accustomed to in China.
Nevertheless, this trend has more companies looking at Mexico as a destination for foreign direct investment to manufacture in and then re-export to the US.
Manufacturing heavier goods such as furniture, transportation equipment and machinery in Mexico rather than China saves on shipping costs, owing to Mexico’s proximity to the US.
Mexico has a strong trade relationship with the US and sends 85% of its exports to the US. Much of this is the result of the tradition of maquiladoras, factories that assemble final products for shipment to the US using imported components. China could similarly use Mexico as a base for such final assembly.
If enough production is based in Mexico to meet thresholds set forth in the North American Free Trade Agreement (NAFTA), Chinese companies can also greatly reduce their tariff burden for US-bound exports.
The auto sector appears to be a thriving opportunity for some of this activity with China’s Geely Automobile Holdings, among others, announcing plans to build auto factories in Mexico. The US$250 million investment over three years could achieve an annual output of up to 300,000 units. This would satisfy the Mexican government, which mandates that foreign investors inject US$100 million of capital and annually produce 50,000 cars. However, Chinese car companies have yet to follow through on most of their planned investments.
“Mexico is an attractive option given that the demand for Chinese goods in the US is still fairly high,” said Myers of Inter-American Dialogue.
Companies could also try to tap into demand in the Mexican market. Mexico, like Brazil, has a rapidly growing middle class which may provide further opportunities for foreign investors to target domestic consumers. Mexico is predicted to see its middle class increase by nine million people between 2010 and 2020, according to BBVA research.
Hard going in Argentina
Argentina is the second largest nation geographically in Latin America, boasting the third largest population. China’s interest in Argentina is rooted in agriculture and mining – over the last three years, China has invested US$15 billion primarily in Argentinian oil and farming. But that interest is drifting towards other sectors such as infrastructure and banking.
Much of the infrastructure investment revolves around China’s plans to provide the financing and technical advice for major rail and sanitation projects. From an agricultural perspective, Heilongjiang Beidahuang Nongken Group, China’s largest farming company, is spending US$1.5 billion over the next five to 10 years to lease and develop farms across 300,000 hectares in Argentina’s southern-central state of Rio Negro. The investment should see soybeans and corn grown and produced on the farms before being exported to China.
Natural resources such as copper, gold and silver have drawn interest from Chinese companies with three mining companies doing business in the northern Salta and Jujuy states.
Trading between China and Argentina hasn’t all been smooth sailing. Argentina has used protectionist measures to shield local manufacturers from competition with cheap Chinese imports.
“I would not go to Argentina because I think there is not much opportunity for SMEs,” said Myers, citing the country’s political and economic mismanagement as one of the reasons. Argentina has done very little to promote itself as an exporter or as a destination for foreign direct investment beyond the commodity sector.
But there are some efforts to change that with a “Forum to Promote Chinese Investment in Argentina” that was held in Buenos Aires in December. Representatives from 18 of China’s largest companies, covering sectors from metals and banking to real estate and pharmaceuticals attended the event along with many Argentine businessmen looking to initiate strategic relations.