Watching China’s Continuing Investment Push in Latin America (Bloomberg Law)

Jones Day partner Michael J. McGuinness examines China's pursuit of investment opportunities in Latin America, which will be impacted by the ongoing U.S.-China trade war.

Investors and markets should pay attention to China's trade and economic relationship with Mexico and Peru. In Brazil, the most attractive sectors will be oil and gas and mining, followed by electric power generation and transmission and renewable energy, including wind, solar, and biomass.

China has dramatically ramped up its investment in Latin America in recent years, raising speculation about its long-term interests and intentions. This conversation has taken on renewed importance in light of the trade war between China and the United States, which could irrevocably shift the complex commercial and political dynamics among the three regions.

Despite the mounting speculation and China's economic slowdown, China remains in for the long haul in Latin America. In addition to straightforward trade pursuits, it is also advancing what it calls its "Going Global" development policy, an initiative stretching back to 1999 that promotes overseas investment by streamlining procedures, simplifying currency rules, and increasing credit support for Chinese companies investing overseas.

As investors seek to more fully understand China's role in Latin America, they would be well advised to pay close attention to Brazil, which will play an outsized role in the relationship between China and Latin America more broadly.

Simultaneously, global markets will be curious to see how China approaches its emerging trade and economic relationships with Mexico and Peru.

Brazil: Setting the Tone

Politics is both transitory and transactional. While campaigning for election, Brazilian President Jair Bolsonaro adopted a hostile public posture toward China. Bolsonaro railed against China's efforts to mine Brazilian niobium, a valuable steel additive, expressing views that appeared to be influenced by right-wing Brazilian politicians and theorists fearing "cultural Marxism."

Concern with such sentiments is one factor contributing to a sharp decline in China's Brazil investments, which plummeted from $11.3 billion in 2017 to $2.8 billion in 2018. Other factors include Operation Car Wash—a sprawling corruption investigation that implicated dozens of Brazil's business and political leaders, setting off waves of turbulence.

More recently, though, the picture has changed. The slowdown might have resulted from an atypical period, marked by the scandal and rhetoric surrounding the election. Chinese investments in Brazil are expected to increase in 2020, and Bolsonaro has markedly softened his stance toward his country's largest trading partner, even announcing plans for a state visit to China in the near future.

But we are not witnessing a complete reset. Operation Car Wash, in fact, has created a vacuum in Brazil, enabling other players to gain relevance. State-owned companies have launched divestment and privatization initiatives, while the country's development banks have reduced subsidized financing lines.

That said, potential investment targets for China should benefit from this rearrangement, coupled with expectations that Bolsonaro will adopt a more pragmatic approach to the economy going forward.

China prioritizes extractive industries in its portfolio. In Brazil, the most attractive sectors will be oil and gas and mining, followed by electric power generation and transmission and renewable energy, including wind, solar, and biomass.

China's other big play will be infrastructure projects involving railroads, toll roads, airports, bridges, and ports. China also has signaled interest in the automotive industry, the information technology sector, and financial services. Despite some concerns about opposition, Reuters recently reported that Bolsonaro's vice president, Hamilton Mourão, claimed to support Chinese investment in infrastructure projects "as long as investors create local jobs and play by Brazilian rules."

Mexico: A Relationship in Flux

Mexico presents another uncertain financial landscape—though for greatly different ideological reasons than Brazil. China is one of Mexico's largest trading partners. And as the trade war between China and the United States escalates, Mexico could stand to benefit significantly. Chinese manufacturers looking to move production to countries not affected by tariffs might strongly consider Mexico.

That said, China's interest in Mexico remains nascent. Mexico received only $400 million in Chinese direct investments between 2000 and 2016, representing less than 0.1% of such investments during that period.

The Chinese are cautious in the wake of Mexico's cancellation of certain projects. In 2014, a consortium headed by the China Railway Construction Corporation Limited (CRCC) was awarded a contract to build a high-speed passenger rail link between Mexico City and Querétaro, only to have the project abruptly cancelled amid claims of favoritism and opacity.

Then, environmental concerns drove the cancellation of the $200 million Dragon Mart, a Cancún mega-mall that would have been "the largest venue for selling Chinese goods in the Western Hemisphere," according to The Los Angeles Times.

China's caution has been aggravated by troubling signals from the administration of Mexican President Andrés Manuel López Obrador (nicknamed AMLO). AMLO has signaled that he will not permit foreign investment into the "Proyecto Transístmico," which contemplates modernization of the Coatzacoalcos and Salina Cruz ports, reconstruction of the railroad connecting the two, and construction of new connecting highways. This is particularly troubling in light of Mexico's great need for infrastructure and logistics improvements.

Finally, while Mexico could benefit from the U.S.-China trade war, it is also in a tricky position. The U.S. government has recently asked Mexico not to welcome Chinese direct investments, particularly in strategic sectors.

One area of promise is tourism, which could open channels of trade between China and Mexico. Mexican tourism secretary Miguel Torruco Marqués has a close relationship with the Chinese government. His signature initiative, Operación Toca Puertas (or "Operation Door Knocking"), would promote Mexico's tourist hotspots to Chinese travelers.

Peru: Mining and Infrastructure

After a bilateral free trade agreement went into effect in 2010, China became Peru's top trading partner, supplanting the United States. In 2018, China accounted for 34% of all Peruvian exports.

Due to its enormous mining potential, Peru tops China's strategic investment priorities. The Peruvian mining industry is a crucial avenue for fueling China's fast-paced growth in the construction sector and steel production. Peru's top export to China is copper ore, followed by animal meal and pellets, and refined copper.

Peru's GDP growth has slowed since 2014, mainly owing to the decline in international commodity prices and the resulting drop in private investment and consumption. Nonetheless, Peru has been able to alleviate damages through prudent fiscal policies, while simultaneously benefiting from a surge in mining production.

Chinese players are pursuing multiple infrastructure projects in Peru. Aluminum Corporation of China Limited (Chinalco) is investing in a $1.3 billion expansion of the Toromocho copper mine. COSCO SHIPPING Ports Limited plans to build and operate a $3 billion port on Peru's Pacific coast. The China Railway Engineering Corporation plans to build a port in the southern city of Ilo, in a crucial copper mining region. And a subsidiary of the Zhongrong Xinda Group Co., Ltd. is building a $2.5 billion iron ore mine known as the Pampa de Pongo project.

In April, China announced Peru would sign a memorandum of understanding to join the Belt and Road Initiative, China's multibillion-dollar global infrastructure program—despite warnings from Washington.

Challenges and Opportunities

Chinese-owned firms across Latin America confront stricter social responsibility, environmental, and labor standards. The lack of compatibility between countries' tax and legal frameworks is another hurdle.

Nevertheless, China's interest in Latin America is deep, multi-faceted, and abiding. Despite pressure from Washington and local criticism based on environmental and social concerns, more Chinese players are appearing, and they are becoming more sophisticated.

As the trade and economic ties binding China and Latin America evolve, intersecting with and shifting the complex political terrain, global markets will be watching closely.

Isabel Junqueira, an associate in the São Paulo Office, contributed to this article.

Reprinted with permission from Bloomberg Law. Further duplication without permission is prohibited. All rights reserved.

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