China and Latin America: striking a new balance

Driven by demand for the commodities needed to fuel its fast-growing economy, China has successfully built strong commercial and investment relationships with Latin America over the last decade.

Despite the global economic downturn, China continues to invest billions of dollars in Latin America through investments, loans, acquisitions and currency swaps. These ever-growing ties between China and Latin America are likely to have significant consequences for the entire global economy.

China’s objective is to maintain its economic growth while conserving energy and national resources. China currently relies on imports for 50% of its 7.6 million barrels per day of oil consumption. As a result, China is looking to Latin America to supplement its supplies from the Middle East, Africa and Asia.

While Latin America holds 13.3% of the world’s oil reserves, the region only accounts for 6% of total output due to inadequate infrastructure. Venezuela’s oil reserves have attracted Beijing’s attention, evidenced by China having signed more than 20 agreements with Venezuela for long-term investments in exchange for oil in the past four years. According to a recent US congressional committee report, these oil accords potentially threaten the United States, which currently imports an estimated 12% of its oil supply from Venezuela – its biggest supplier.

China’s investment commitments

Overall, Latin American countries spend less than 2% of gross domestic product on infrastructure, increasing logistics costs by an estimated 15% to 34% of a product’s value. In contrast, industrialized countries spend roughly 10% of GDP on infrastructure. To counteract the global recession, many Latin American governments are focusing on labor-intensive urban transport, water and waste system projects, with many new initiatives beginning in the second quarter of 2009. Brazil plans to increase infrastructure spending by about 34%, and Mexico plans to spend US$3.4 billion on infrastructure to spur growth and employment. All of these economic stimulus programmes have created enormous opportunities for China investment dollars.

China has also made substantial investments to secure the region’s natural resources. For example, the Aluminum Corporation of China (Chinalco) invested US$3 billion in the Toromocho mines of Peru; China Minmetals Nonferrous Metals Company invested US$2 billion in a joint venture with Chile’s state copper giant, Codelco; and Baoshan Iron and Steel made a US$1.4 billion investment in a joint venture with Brazilian iron-ore giant CVRD.

New diplomatic initiatives

China is also improving its diplomatic relations with Latin America through international aid programmes, particularly in the Central American and Caribbean region. In fact, China’s policy of making investments without regard to domestic affairs in the host country has proven to be a huge advantage in Latin America. For example, since June 2007 Costa Rican President Oscar Arias has signed 11 agreements with China, focusing on economics, culture, trade, technology, tourism, immigration and finance. China’s motive behind its foreign policy moves and investment decisions is long-term stability, regardless of short-term profits.

Using the Renminbi in Latin America

Chinese Central Bank Governor Zhou Xiaochuan is beginning to implement a super-sovereign reserve currency strategy that aims to replace the US dollar with the Chinese renminbi as a global trade medium of exchange. While the renminbi has had little impact on international trade to date, the situation could change in the next few decades. China has learned from the current economic turbulence to take a proactive currency strategy so it can protect its assets against a rapid collapse in the US dollar.

Latin America has started to collaborate with China in this strategy. Recently, Argentina became the first Latin American country to sign a currency swap agreement with the People’s Bank of China, China’s central bank. The RMB70 billion (US$10 billion) agreement extends China’s efforts to reach economic accords that do not involve the dollar and at the same time provides dollar-scarce countries like Argentina with an alternative currency to pay for its imports from China. This trend is likely to continue and if China’s top five trading partners in Latin America (Chile, Mexico, Brazil, Argentina and Venezuela) surpass US$200 billion in exchange, the use of the RMB in Latin America could be enormous.

Important shift

China’s foreign policy towards Latin America is focused on the acquisition of natural resources that can support the nation’s economy for years to come. Today, most Latin American countries are willing to cooperate with China. Successes, such as the China-Venezuela relationship, have clearly demonstrated the benefits derived by both nations in fostering a relationship based on mutual respect and cooperation. It is an important shift for China, Latin America and the world.

Robert Lee is a partner and Gerardo Rodriguez-Albizu is an associate attorney with Diaz Reus & Targ