Tag Archives: commodities

Peru: Riding China’s Coattails

Posted on by emmuser
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Peru has emerged as a star performer in Latin America. The economy is on a tear, expanding by an average of over 7% per year since 2006. In comparison, the region as a whole grew by an annual average of only 4% per year. Peru even managed to eke out positive growth in 2009 during the global financial crisis.

However, a continuation of this performance is unlikely. Peru has achieved impressive growth, at least in part, by riding on China’s coattails. This contrasts with Colombia, whose direct ties to China remain very limited. (See: How Exposed is Colombia to a China Slowdown?)

Going forward, Peru’s economic fortunes largely rest on the outlook for China and on how global commodity demand shapes up.  As China’s growth looks set to moderate, so will Peru’s. (See: IMF’s Latest Growth Forecasts for China Look Overly Rosy) Moreover, Peru could really hit the skids if the Middle Kingdom’s hearty appetite for copper and other metals substantially diminishes.

Trade with China

Exports to China have risen steadily and helped propel the economy’s fast growth. The two countries signed a bilateral free trade agreement that entered into effect in March 2010, further strengthening their trade ties. In 2011, the Asian giant became Peru’s biggest market. China now accounts for 16% of the country’s total exports, as seen in Figure 1 below. This is not an incredibly high percentage, but it’s still significant.

Peru’s export markets are pretty diversified relative to others in the region. For example, over 40% of Colombia’s exports go to a single market, the US. (See: How Exposed is Colombia to a China Slowdown?) Nevertheless, Peru’s growing trade dependence on China means its economic fortunes are increasingly tied to Chinese demand.

Figure 1: China has surpassed the US as Peru’s top trade partner

Source: Promperu

Investment from China

China’s direct investment in Peru is among the highest in Latin America, as shown in Figure 2. Almost all of this investment has gone into the country’s mining sector. According to data from Peru’s investment promotion agency, Proinversion, Spain and the US remain the biggest direct investors in the country, but that could change.

Peru’s Prime Minister Salomon Lerner expects Chinese direct investment in Peru to increase by 30-40% in 2012-13 (See related article from Andina). Of course, that assumes strong Chinese demand for the country’s resources continues.

Figure 2: Peru received more Chinese investment in 1990-2009 than any other Latam country

Source: ECLAC*

*ECLAC’s analysis of Chinese FDI is based on data collected from companies and on data provided in announcements of investments and M&A activity, more than on official BOP data.

Global Commodity Demand

Mining is an important economic driver in Peru, and China’s seemingly insatiable demand for commodities has propelled metal prices upward. But will it last?

Liam Peven of the WSJ outlines three potential scenarios for commodities based on: 1) continued robust growth in China, 2) a soft landing (mild slowdown), 3) a hard landing. (Note: I don’t see scenario 1 happening, but clearly the WSJ is more optimistic than I am).

Peven does warn, “Demand for steel, copper and other industrial metals could drop significantly if China does stall, because those materials are heavily used in construction—which would be at risk from weakness in the Chinese real-estate market—and because China often accounts for some 40% of global demand for those materials.” (See WSJ article: As China Goes, So Go Commodities)

Metals – led by copper and gold – generated 60% of Peru’s export revenue in 2010, as shown in Figure 3. Not only does mining drive the country’s exports, it also feeds into domestic demand in the form of job creation and investment. As a result, a downturn in China would have far-reaching effects on Peru’s economy. Notably, gold prices tend to move differently than those of other metals given gold’s perception as a safe haven, which could provide Peru some comfort.

Figure 3: Copper and Gold dominate Peru’s exports

Source: PromPeru

On the Bright Side

Clearly Peru is vulnerable to a slowdown in China, but there is some good news. Policymakers have taken advantage of the boom times to lower the country’s public debt-to-GDP ratio and to bolster the country’s competitiveness through growth-enhancing reforms.

As seen in Figure 4, public debt has fallen from 47% of GDP in 2003 to 25% in 2010. Notably, the debt ratio fell even amid the global downturn in 2008-09. Meanwhile, Peru ranked 36th out of 183 countries in the World Bank’s 2011 Doing Business Survey, which is ten places higher than last year’s ranking. Among the many reforms, the government made it easier to start a business and simplified the process to register property. This is very positive and will boost Peru’s longer-term growth potential.

Figure 4: Peru’s public debt ratio has steadily declined from a peak in 2003

Source: IMF

Bottom Line

Despite the positives mentioned above, Peru is among the most vulnerable of Latin America’s economies to a downturn in China. It would directly affect the Andean country through its strong trade and investment ties to the Asian giant and more broadly affect Peru through a fall in global commodity prices.

The Weekly Mishmash: October 9

Posted on by emmuser
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1.  Why China won’t conquer the world

By Xué Xinran, Telegraph

Ms. Xinran provides a personal account of the growth challenges facing China. She’s a Chinese expat who describes the frenetic pace of life in her homeland and goes on to criticize the education system, saying it ‘stifles rather than encourages creativity,’ an important ingredient for entrepreneurship. She agrees with Larry Hsien Ping Lang, a finance professor at the University of Hong Kong, who fears that China’s ‘bubble economy’ is on the verge of bursting. They believe China’s economy must slow down to give time for its education system and society to catch up.

EM Muser: This article adds to recent commentary (see Patrick Chovanec and Jim Walker) that chips away at the image of China as an unassailable economic giant. While it’s unclear to me how much China will slow and the exact timing, growth forecasts showing Chinese growth continuing at over 9% on an annual basis in coming years look way too optimistic. (See my recent post: IMF’s Latest Growth Forecasts for China Look Overly Rosy)

2. Megatrends for Investors

By Dr. Shane Oliver, AMP Capital

Dr. Oliver  points to strong commodity prices as a key long-term investment trend. “After a 25-year bear market into the end of the last century, commodities are now just over a decade into a secular bull market driven by strong structural demand on the back of industrialisation in China and other emerging countries, all at a time of still- constrained supply. notwithstanding cyclical fluctuations, the longer-term trend in commodity prices is likely to remain strong, possibly accentuated by a continuing long-term downswing in the US dollar and other major advanced country currencies.”

EM Muser: I share a similar view to Dr. Oliver. A growing world population, combined with greater challenges in producing commodities (due to scarcity or climate change in the case of agriculture), make me a believer in the medium- to long-term commodities story. But I think commodity prices will fall in the near-term, particularly given slowing demand from advanced economies.

3. Hungary’s new path is the hidden danger to Europe

By Ian Bremmer, FT

The president of the Eurasia Group writes a scathing critique of Hungary’s political direction in his latest FT op-ed and asserts that the government’s efforts to wear away the country’s democratic institutions have the potential to taint the EU’s image. “The Fidesz government has leveraged its ability to warp the constitution, cementing institutional and democratic rollbacks into the rule of law. Mr Orban’s consolidation of power at the expense of democratic institutions exposes a fundamental challenge for the EU as a whole – it cannot enforce the very credo that spawned it. Hungary’s disregard for democracy and civil liberties could threaten the European brand in the eyes of potential new members and the world at large.”

EM Muser: I agree with Bremmer and have a written a number of posts on Hungary’s underlying political and economic problems. (See Hungary and Turkey: Political Parallels, Hungary’s Latest Debt Relief Plan: From Bad to Worse, Hungary’s Vicious Circle: Anemic Lending and Weak Growth, Fitch Raises Hungary’s Ratings Outlook: Odd Timing). I find Hungary’s ongoing swing away from democracy particularly unnerving considering how unnoticed it has been by the international community.

4. Colombia: Ready for the Worst

By Daniel Volberg, Morgan Stanley

Mr. Volberg  lays out two key reasons why Colombia’s economy is in relatively good shape to face global headwinds: 1) solid balance sheet (strong international reserve cushion, a modest current account deficit, and access to the IMF’s flexible credit line), and 2) significant room for monetary and fiscal stimulus.

EM Muser: This piece is short and to the point. I looked at Colombia’s economy in a recent blog post and came to similar conclusions as Mr Volberg. In addition to the excellent arguments that Volberg makes, I believe Colombia’s strong domestic demand orientation and its resilience during the height of the global financial crisis in 2008-09 also provide room for comfort. (See: How Exposed is Colombia to a China Slowdown.)