China/Brazil: New trade imbalances

“I am going on to defend a new economic order and a new commercial policy in the world.” These were the words of Brazilian President Luiz Inácio Lula da Silav before his May visit to China to see his counterpart Hu Jintao. Not surprisingly, Lula’s May meeting did not achieve a new world order but came away with one deal and a series of smaller concessions. The eye-catching deal was that between the China Development Bank, which agreed to provide up to $10bn in loans mostly for investment in Brazil’s pre-salt oil find, and Brazilian state-owned oil company Petrobras which guaranteed future oil supplies to Chinese national oil major Sinopec as repayment for the loan.

While the investments promised were large, the deal looked little different to others signed by China with other big oil producers and was dwarfed by one to Russia which totalled $25bn to two companies. Even that loan-for-oil deal may prove to have less substance than initially appears. Petrobras does not usually commit future output, fearing losing control of its book and being in hock to clients, notes David Zylbersztajn, president of Rio-based consultancy DZ Negócios com Energia.

Zylbersztajn says the rate to be paid and mechanism to determine the price per barrel were vague and notes that $10bn is a drop in the ocean of the investment needed to develop pre-salt fields. Adriano Pires, former member of the national petroleum agency board who is now head of Centro Brasileiro de Infra Estrutura, a Rio de Janeiro-based research institute, said the lack of detail suggests the deal may never be honoured. Lula did secure Chinese agreement to lift import restrictions on Brazilian chicken and take some more imports of beef. Officials also signed smaller commitments on Brazilian port construction, the joint launch of two satellites, and biofuel exports to China. Yet, other requests were met with a deaf ear and the re-forging of the trading relationship and attempts to develop a new economic order fell flat.

The established trading pattern where Brazil exports commodities to China which returns a growing, if limited, range of mostly basic manufactured goods is unlikely to change any time soon. The reason trade has spiked is a huge increase in China’s ability to absorb more of the same, especially soya and iron ore. Indeed, bilateral trade rose a staggering 63.2% year-on-year to a whisker under $49bn in 2008, with trade in farm produce increasing by 83.4% to just over $9bn, according to data released by the Brazilian General Administration of Customs. Brazilian exports to China in the first four months increased by a further 64.7% year-on-year.

Despite the huge increases in trade, Brazil represented less than 3% of Chinese foreign trade last year even though China is now Brazil’s biggest trading partner. The skewed and unequal partnership means Brazil has more to lose and often over-estimates Chinese interest in Brazilian industrial goods. The Chinese remain interested in a narrow range of products, almost all of which are commodities.

Still, that China does have enormous appetite for raw material and is willing to pay for copper, iron, petroleum and soy should help Brazil. It encourages production and investment by Brazilian companies, says Albert Fishlow Professor Emeritus at Columbia University’s School of International and Public Affairs. In soy, consumption in China has grown more than 100% this decade with further increases likely as the country grows wealthier and needs soy for animal feed and edible oils. Brazil has been expanding fast in supplying China, with production growing three times since the beginning of the 1990s, making Brazil the world’s second largest producer after the US.

However, analysts estimate that a current global soy shortage could turn into a significant surplus next year with the US expected to produce its largest ever harvest and Argentina and Brazil increasing areas under cultivation. That is likely to provoke further volatility in prices and risks continuing the boom-bust conditions of Brazil’s agricultural sector.

Appetite is growing in leaps and bounds for iron ore too and the Chinese are proving tough negotiators in this space. Steel companies there were prepared to give little quarter in the recession despite their long-term relationship with giant iron ore miner Vale. Chinese steel companies were digging in their heels to gouge out a huge reduction in contract prices with Vale, which sells 70% of its ferrous produce to China, even as Vale signed off deals with Japan and South Korea. That brinkmanship on the part of the Chinese looks to have backfired as commodity prices including those for iron ore have recovered swiftly, rising by more than 33% this year to the beginning of August.

Moreover, China remains mostly confined to a role as buyer and has not engaged in the offtake contracts (where a guaranteed supply of future produce is given for financing projects) signed by Japan and increasingly Korea with Brazil. Rather, Chinese companies have been scouting in Latin America for opportunities to buy mines but while the country has been highly visible in bidding there is little transparency on results, mining bankers agree.

The Chinese don’t know the mining and project finance space very well and are not comfortable with risk sharing, says Hugo Dryland, managing director and global head of mining at Rothschild in Washington DC. With clients pressuring advisers for a fast turnaround, the long timeframe needed to secure Chinese participation means that they are not as significant as they should be, he believes.

Steve Smith, managing director and global head of metals and mining at WestLB in London, agrees the Chinese are not concluding as many deals as expected. Still, he expects China to become more prominent in supplying FDI, providing financing and as equipment providers in the longer-term.

For now, though, disappointment reigns in the investments Chinese companies have attempted to make in Brazilian iron ore. Chinese firms have dropped out of projects, such as two attempts by steelmaker Baosteel to create steel joint ventures with Vale, which foundered on environmental and political difficulties. For Brazilians, these failures seems just part of a wider story of unlived-up-to promises. When President Jintao visited Brasilia four years ago, he left Brazilians expecting $7bn of Chinese investment. So far, investments have been confined to $141.6m or about 2% of the promised amount.

And Brazil’s cherished plan to increase sales of manufactured and technological goods is likely to meet strong resistance from China particularly in the case of Brazil’s cosseted aerospace company Embraer. An attempt to ink a deal for China to take 45 Embraer planes at the summit in May lead nowhere and it is likely that the Chinese, who are seeking to develop their own aerospace industry, have scant interest in incentivising imports from Brazil in higher value and technologically advanced areas.

Chinese exports

Meanwhile, Chinese products are still relatively small fry within Brazil, giving the latter little clout in the relationship. Chinese-made products account for 13% of total imports into the country and constitute just 2.2% of what Brazilian companies and individuals consume, according to the Foreign Trade Study Centre Foundation. Even in areas seen as particularly vulnerable, the Chinese are yet to make big inroads. Chinese products account for 5.4% of cloth, 3.3% of clothes and 3.7% of the leather goods and shoes bought by Brazilians. The skewed nature of the relationship means the bargaining power is usually with the Chinese.

The import figures may be low for now, but Brazilians greatly fear the expansion of Chinese goods. Since Lula came to power, China has expanded its exports to Brazil by 214%. Fears are particularly prevalent today as consumers in the developed world are tapped out, making Brazil an attractive market for Chinese exporters. Furthermore, the real has been the best performing currency against the greenback this year and was up 27% by early August, making Chinese goods cheaper.

A disproportionate amount of the anti-dumping cases launched by Brazil are against the Chinese. In March, 35% of the 123 such cases launched by the Brazilian government were directed at China, according to the National Confederation of Industry. One Brazilian aim at the May meeting was to persuade the Chinese to adopt voluntary reductions in textile exports, but the move failed.

The big fear is that China will start to expand exports to Brazil and then move into a whole range of more value-added and technologically advanced new items, says Fishlow. China is looking to move into cars, a huge market for Brazil in South America. If China is able to produce cars cheaply and develop battery-operated cars, it will have a major impact on Brazil’s export and domestic market, he says.

Government-to-government

The Chinese concentration on a limited range of Brazilian primary goods and failed promises to direct more FDI together with Brazilian fears about a possible surge of imports make the relationship between the countries prickly under the surface of bonhomie. Political aims also often do not coincide. Lula sought to push more trading between Brazil and China in their own currencies, with the hope of giving one in the eye to the US dollar, perhaps a tall order when the use of local currency trading is absolutely nascent even within the Latin American economic union, Mercosur.

The Chinese reaction was cool to the currency suggestion, partly because the Chinese are concerned that promoting the yuan in trading relationships would have a harmfully appreciative effect on the currency and because China is seeking a solution through an alternative global currency that could be run by the International Monetary Fund (IMF).

Finally, there’s significant lack of understanding of Chinese culture and practices in Brazil representing one of the largest blocks to further developing the relationship. A perceived backwardness in labour and environmental standards compared to developed countries and a lack of transparency make Brazilians wary of becoming too dependent on the emerging superpower. Even so, Brazil is unlikely to be able to change the nature of its trading relationship with China. Over-reliance on exports of a small range of volatile commodities are likely to encourage economic volatility and will continue to squeeze out exports of manufactured goods.

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