Latin America widens trade relations in the time of Trump
June 5, 2018
As the United States imposes tariffs on steel imports, Latin America downplays the threat of a trade war but looks to reinforce commercial ties with other countries. By Lucien Chauvin, Amy Guthrie, Thierry Ogier and Mat Youkee
In April, during the Summit of the Americas in Peru, US Vice President Mike Pence made a show of the United States' commitment to open trade with Latin America. In meetings with four leaders in the region — Mauricio Macri from Argentina, Sebastián Piñera from Chile, Juan Manuel Santos from Colombia and Martín Vizcarra from Peru — Pence possibly tried to walk back some of the bellicose trade rhetoric from President Donald Trump.
Commerce Secretary Wilbur Ross, the only other Cabinet member to attend the summit in Lima, stressed the crucial role played by the United States' neighbors in the hemisphere. Latin America exported $406 billion in goods to the United States last year, with roughly 80% of that as manufactured products, and ran a $117 billion surplus with the northern power. In contrast, Latin America had a trade deficit of $67 billion with China, with around 90% of exports in raw materials, Ross said.
"It is an interesting comparison, the difference between our commercial relationship with the region and the relationship with China," Ross said. "The message is that Latin America is very important to the United States."
With Chinese products in mind, Trump had previously threatened to slap higher duties on steel and aluminum imports but made temporary exceptions for imports from Mexico and Canada, the United States' partners in the North American Free Trade Agreement (NAFTA). He also negotiated quota agreements on steel and aluminum shipments from Brazil and Argentina.
But on June 1, following months discussions, Trump put a 25% tariff on steel imports and a 10% tariff on aluminum imports from Mexico, Canada and the European Union (EU) in the name of national security.
Mexico wasted little time to respond. Hours after Trump increased the import tariffs, the Mexican government put higher duties on US imports of flat steel, pork products and other food items. It also started proceedings against the United States at the World Trade Organization (WTO).
"Mexico considers the measures imposed by the US, arguing threats to national security, violate the WTO's agreement on safeguards… [and] also violate the 1994 General Agreement on Tariffs and Trade (GATT)," Mexico's economy ministry said in a statement.
Other reactions to the United States' protectionist stance have run the gamut in Latin America. Some exporters fear disaster, while others see the opportunity to pick up the slack caused by a trade war.
But not everyone is intimidated by Trump's tough talk. "It was yet another messy policy move by Trump — shoot first and see who falls down," says Alberto Pfeifer, coordinator of international affairs at the University of São Paulo.
"So far, we've seen a war of missives and declarations between the United States and China, rather than a trade war," says César Rojas, a professor at the University of Santiago, Chile (Usach). "Trump doesn't always achieve what he sets out to, but he's a major source of uncertainty for global trade."
If China retaliates by putting tariffs on US soybean imports, Latin American farmers could come out winners, says Scott Farnham, a senior research analyst at the Institute of International Finance (IIF) in Washington DC. Brazil is already the world's leading exporter of soybeans, he says, and Brazilian producers stand to reap the benefits if China starts buying more.
"The reality is that these kinds of conflicts often create opportunities for other countries," says Ecuador's Foreign Trade Minister Pablo Campana.
But Daniel Godinho, the former secretary of foreign trade in Brazil, thinks trade tariffs will likely do more harm than good in the long run and says exporters cannot bank on a possible trade war between the United States and China to increase sales. "Some limited opportunities do not compensate for the expected long-term negative effect of price volatility," he said during an April conference call with the Atlantic Council.
The overwhelming response to Trump's tariffs in Latin America has been to seek the expansion of trade with partners other than the United States. Brazil and Chile, for example, have crafted a new free trade agreement, and everyone from Mexico in the north to Argentina in the south are looking to form commercial alliances.
"Facilitating trade is important for us to have real integration in our continent. The relationship between Brazil and Chile is stronger than ever," Chile's Piñera said at the signing ceremony in Brasília on April 27.
Other pacts are aimed at crashing trade walls globally. As Trump bragged about how easy it is to win a trade war, representatives of the Pacific Alliance met in Santiago to hammer out an altogether different vision for their economies. Formed in 2011 by Chile, Colombia, Mexico and Peru, the four-member nations have a combined GDP of nearly $2 trillion and account for 54% of Latin America's exports.
The trade bloc recently admitted four associate members — Australia, Canada, New Zealand and Singapore — and grants observer status to more than 50 nations, including China, France, Germany, Japan, the United Kingdom and the United States, along with its neighbors in Mercosur. "It could become a global player once Asia Pacific is included," says Rodrigo Yáñez, director general of international economic affairs in Chile.
"We were originally against the idea of integrating with Mercosur, but now, with the political shifts in Argentina and Brazil, we want to facilitate integration so we can, as a region, move forward and consolidate a free market," he says.
The butterfly effect
In the unintended consequences and knock-on effects of a global economy, the impacts of a stand-off between the United States and China are difficult to predict, and some risks are tricky to mitigate.
China is already the primary trading partner for both Chile and Peru, largely due to the Asian importer's unabated demand for copper. Chile earned $34 billion from copper exports in 2017, while Peru received $13.8 billion, but any dip in prices has a magnified effect. Copper prices dropped below $3 per pound after Trump's first riffed about higher tariff but they have since risen to around $3.07 per pound.
In the domestic markets, trade associations in Chile and Colombia have asked their governments for better safeguards against the dumping of rerouted Chinese steel products. And Latin America could also face a glut of agricultural products from the United States, particularly grains, if China imposes a 25% retaliatory tariff on US soy and pork imports.
"We have limited exposure to the aluminum and steel tariffs," Yáñez says. "But protectionism, no matter where it comes from, impacts an open economy such as ours."
Brazil: An impasse on imports
When the US government demanded Brazil's steel and aluminum producers either pay higher tariffs or accept quotas on exports, Brazil answered by saying it would not play along. But the US simply replied with a take-it-or-leave-it stance and offered a quota on imports. Brazilian steelmakers said they had to accept the imposition or lose buyers in a crucial export market and risk lowering production levels even more.
In 2017, Brazil shipped $2.63 billion in steel products to the United States, or about one-third of its overall output of 34.4 million tons. Increasing tariffs to 25% from 0.9%, as Trump had proposed, could have cost the country's steelmakers around $350 million per year, according to Fernando Ribeiro, coordinator at the Instituto de Pesquisa Econômica Aplicada (IPEA), a government economic research organization.
"Brazil has always preferred multilateral negotiations. The United States took this measure on steel to lead its various partners to negotiate bilaterally, which puts the United States in a position of strength to gain more concessions," he says.
South Korea, for example, recently agreed to cut steel exports by 30%. But Brazil found itself in a weaker position by entering one-on-one talks with the United States, says Monica de Bolle, a senior fellow at the Peterson Institute for International Economics (PIIE) and a professor at Johns Hopkins University.
"Brazil will be competing with the big boys like Russia and South Korea," she says. "It's a blow to the Brazilian steel sector and may affect an already flimsy [economic] recovery."
But Trump's measures to protect the US steel industry could still backfire, at least according to Brazil's Trade Ministry. Brazil is the largest importer of metallurgical coal from the United States, with sales of nearly $1 billion per year. Much of that coal goes to make the steel that returns to the United States as semi-finished products.
In the short term, as Brazil keeps climbing out of a deep economic recession, rising domestic demand will lessen the blow to exports. Domestic steel sales rose 12.5% year-on-year in the first two months of 2018. Looking ahead, automakers in Brazil expect to increase production by around 13% in 2018, which will prop up sales of flat steel products.
"The outlook helps soften any impact coming from this US tax move," says Frederico Tralli, the head of equities in Brazil for BNP Paribas.
During a visit to New York to meet investors in March, Brazil’s then-Finance Minister Henrique Meirelles harkened back to the restricted policies of the Estado Novo era of the 1930s and said the country had learned a lesson from previous trade wars. "Protectionism is good for no one," he said.
Meirelles left the cabinet in March with an eye to running for office, but the Brazilian government pressed ahead with its free-market approach. In addition to signing the trade agreement with Chile in April, Brazil has sped up negotiations with other markets and is working to improve agreements already in place, including the Mercosur trade bloc with Argentina, Paraguay and Uruguay.
Mexico: All eyes on NAFTA
When Trump signed the tariff order, he seemingly ignored the importance of Mexico and Canada as members of NAFTA. But after months and months of talks to redraft the free trade agreement ahead of deadline, negotiators appeared to hit a snag over duties for car imports.
If negotiators can work out a deal, they will be able to clear the cloud of uncertainty that has hung over Mexico since Trump won the US election in November 2016. But if the talks fall through, Mexico will face constrained economic growth prospects, not to mention the havoc that could affect the peso and other assets.
"The whole trade issue for Latin America seems framed by the potential for NAFTA to get renegotiated," says Jim Barrineau, co-head of emerging markets debt at Schroders.
The asset management firm decided to deepen its underweight position on Mexican credit in February. At the time, Barrineau's team felt the market was overly optimistic about Mexico's chances of renegotiating NAFTA before the presidential elections in July and they were concerned about the possible outcome of the vote.
The decision seemed to pay off after Trump's proposed steel and aluminum tariffs prompted worries of a global trade war. "It just goes to show the direction of travel for trade issues is going to be negative," Barrineau says. "We think additional issues will be forthcoming that will increase volatility in Latin American markets."
"We believe markets can only focus on one topic at a time, which currently still seems to be NAFTA and, to a far lesser extent, the upcoming presidential election on July 1," Benjamin Theurer, an equities analyst with Barclays in Mexico, said in an April 23 note to investors.
In Barclays' view, Mexican equities only partially reflect the risks associated with the leftist candidate Andrés Manuel López Obrador winning the election. By early May, López Obrador held a commanding double-digit lead in opinion polls over his nearest competitor, Ricardo Anaya, the conservative head of a left-right coalition.
López Obrador, widely known as AMLO, has said he could revise Mexico's efforts to open the oil industry to foreign investment. Meanwhile, the oil industry is lobbying hard to keep dispute resolution language in the updated NAFTA agreement to protect investments in Mexico.
AMLO has also threatened to cancel construction of a $13.3 billion airport in Mexico City. The billionaire Carlos Slim, whose son-in-law helped design the new hub and whose construction firms are working on the project, has said calling off the project could "suspend the country's growth."
Yet, despite all the uncertainty around NAFTA and the elections, foreign direct investment in Mexico rose 11% year-on-year to $29.7 billion in 2017. US investors accounted for 47% of total FDI last year, while Canadian investors contributed 9%. Lesser trading partners in Asia and Europe also provided notable increases in investment, according to figures from the Mexican government.
"In fact, investment is higher, even in sectors that have been a little up for debate, such as the automotive sector," says Paulo Carreño, general director of ProMéxico, a division of Mexico's Economy Ministry that promotes international trade and investment.
Roughly a third of Mexico's $2.4 trillion economy depends on exports, with more than 80% going to the United States. Mexico has long sought to reduce its dependency on trade with its northern neighbor, but the threat of NAFTA unraveling has given the country a fresh sense of urgency.
On April 24, the Senate ratified Mexico's membership in the new version of the Trans-Pacific Partnership (TPP), the trade agreement that Trump abandoned on this third day in office. Mexico also struck a preliminary deal with the European Union on April 21 to update a 21-year-old agreement with a market that represents 500 million consumers. The prior EU deal covered mostly industrial goods, but both sides wanted to ease trade for agricultural products and update language on services and investment.
China also offers opportunities for Mexican exporters. For example, when China slapped a 25% retaliatory tariff on 128 US imports in April, Mexican pork producers asked the Mexican agricultural authority to negotiate authorization to export to the country.
As Carreño puts it, Mexico's most important trade strategy "is called diversification and this doesn't derive from a change of administration in the United States."
The Andes: High export expectations
Peru logged the highest export growth rate in Latin America and the third highest in the world in 2017, as revenues from foreign sales surged nearly 22% year-on-year to $44.2 billion.
Other Andean nations were not far behind. Colombia recorded a 19% jump in exports last year, including a 5.3% rise in non-mineral exports to $14.9 billion. In Ecuador, after a decade of former President Rafael Correa railing against free trade, exports rose nearly 14% year-on-year in 2017, and non-oil exports grew 18% in the first two months of 2018. Chile also saw a 12.7% bump.
And, despite talk of trade wars, this year looks downright rosy, with optimists referencing the global economic recovery and the recent rebound in commodity prices. "We have reasons to be optimistic," says Felipe Jaramillo, president of the state export promotion agency ProColombia. "We have started 2018 on the right foot," he says, citing a 13.9% hike in Colombian exports in the first two months of the year.
The Andean economies also have little exposure to the proposed US levies. According to Javier Díaz, president of Colombia's national trade association Analdex, Colombia sold just $226 million in steel and aluminum products to the United States in 2017, with only $55 million subject to increased tariffs. Still, shares in the Chilean steelmaker Compañía de Acero del Pacífico dropped 3% after Trump suggested raising tariffs on steel imports.
President Santos told reporters at the Summit of the Americas that Colombia's trade agreement with the United States was working well, but he did express some concern about the proposed tariffs.
"Despite the fact that Colombia is very small," he said about the country's steel exports to the United States, "we want to be included in the countries exempted from the tariff."
Although the United States remains Colombia's top market, receiving 27.9% of total exports, the relationship barely registers when viewed from the other end of the telescope. "We represent less than 1% of [US] imports," Jaramillo says. "Colombian exports are not a risk to US industry or security."
Where to go
Nonetheless, the new tone of US trade policy is causing countries in the region to seek out new trading and investment partners. In one fell swoop, the TPP will provide Chile and Peru with access to four new trading nations — Brunei, Malaysia, New Zealand and Vietnam.
China is already Peru's largest export market. Last year, Peru increased sales to China by 36.4% to $11.6 billion and built a $2.7 billion trade surplus with the Asian nation. The United States trailed with $6.9 billion in exports, followed by the European Union trailed with $6.5 billion.
India has also shown its worth as an export market for Peru, after sales jumped 111% year-on-year to $1.8 billion in 2017 and climbed 243% to $362 million in the first two months of 2018.
Ecuador is also reaching out to more trading partners, reversing a trend from recent years. "We have corrected issues not dealt with in the past, and Ecuador is now attracting FDI in our export sectors. We are a stable, dollarized economy that is increasingly attractive," Foreign Trade Minister Pablo Campana says.
Colombia has a trade deal in place with South Korea and is negotiating an agreement with Japan. "Even as the Santos administration has focused on free-trade agreements with the United States and the other NAFTA nations, it is making strong inroads in Asia," Díaz says.
Colombia also wants to take full advantage of its position as a founding member of the Pacific Alliance. At this point, trade within the bloc remains modest. Colombia sends less than 10% of its exports to Chile, Mexico and Peru, while Mexico sends just 1.2% to the group.
The Alliance's new associate members also provide promise. "Australia represents a special opportunity to attract foreign investment and increase exports," says Jaramillo, who visited Australia in March to lobby for better business relations.
Traditional exports — oil, copper, gold and zinc — are largely responsible for the uptick in total exports. "We are seeing a turnaround. Revenue from oil, which is 30% of Ecuador's export total, is up, and there is an important change in agriculture and industrial production," Campana says.
The increased demand is attracting non-US investors to the region. For example, the mining company Anglo American announced in late March that it would partner with Canada's Lumina on two concessions in Ecuador, while Lundin Gold closed a $400 million financing deal with Australia's Newcrest mining for the Fruta del Norte project.
Calling Peru's mining industry "buoyant," Deputy Mining Minister Ricardo Labó says several large projects with more than $10 billion in investments will likely get going this year. Jinzhao Mining Perú, a subsidiary of China's Zhongrong Xinda Group, is scheduled to start work on the $2.5 billion Pampa de Pongo iron ore mine in the second half of 2018.
"We are hearing very positive things from investors," Labó says. "Mineral prices are high, which is helping companies make decisions that they have been postponing for most of this decade."
Exporters in the Andes is also sending far more agricultural products abroad. In Peru, after barely making a blip on the screen at the start of the decade, avocado exports reached revenues of $581 million in 2017, up 46% from 2016, and blueberries brought in $363 million, a 50% increase.
Ecuador's private sector began adding technology to improve shrimp farming, achieving revenues of $3.04 billion in 2017. For the first time, shrimp replaced bananas as Ecuador's second most important export after oil, according to the Central Bank.
Bananas earned $3.03 billion from exports in 2017, and Ecuador remains the largest banana producer in the world, racking up nearly a quarter of global banana trade last year.
The United Nations' Food and Agriculture Organization says Colombia ranks as the country with the fourth largest potential to expand its arable land. "If Colombia can provide investors with legal security for land use, the country can benefit from China's growing food demand," Díaz says.
Colombia is also gaining in exports farther up the value chain, as well, producing goods from garments to videogames. "A few years ago, we were only known for bananas, coffee and flowers," Jaramillo says. LF