The “China syndrome” was once a synonym for disaster: the meltdown of a US nuclear reactor that would burn a hole through the Earth to China. These days the China syndrome refers to something less cataclysmic but only marginally less dramatic than the 1979 disaster movie of the same name. China’s economy, seemingly incapable of growing at less than 10% a year, is powering global growth and sucking in raw materials and manufacturing capacity from around the world.
For some in Latin America, this has been close to disastrous. Many of Mexico’s maquiladoras – factories that use cheap labour to assemble goods for the US market at a fraction of the cost of US manufacturers – have transferred operations to China almost overnight. For others, China’s growth is a godsend. South American exports of mineral and agricultural commodities are providing the raw materials China needs for construction and food, as tens of millions of its people move from the countryside to the cities.
Big winner
Brazil is among the biggest winners. Growth in global demand driven by China led last year to a one third year-on-year increase in both Brazil’s exports and its trade balance, to all-time highs of $96.5bn and $33.7bn, respectively. Export growth has helped to allay fears about Brazil’s ability to pay its debts, calming investors and helping to produce an almost unprecedented period of economic stability.
Trade is not the whole story. China’s long-term need for reliable supplies of raw materials means it is willing to invest in the infrastructure needed to bring those goods home. Chinese delegations to Brazil have talked of investments there in railways, ports and other infrastructure in the order of $8bn. Joint ventures between Brazilian and Chinese companies in Brazil are being discussed and some are already operating in China: Brazilian aircraft manufacturer Embraer, for example, has been making regional passenger jets with joint venture partners in China since 2001.
Banks cash in
It all means business for Brazil’s banks. Government-owned Banco do Brasil, which has long had a representative office in Hong Kong, last year opened a representative office in Shanghai, the first Brazilian bank to do so. Itaú, Brazil’s second biggest private-sector bank, is awaiting approval from authorities in China to open its own office there (Brazilian authorities have already given it the go-ahead). Others will follow.
“By definition, China is an important market for us and for Brazil,” says José Maria Rabelo, director of foreign trade at Banco do Brasil. “[The office in] Hong Kong is not enough to meet the demand for business. Trade has grown strongly in recent years and much of it passes through Shanghai.”
Banco do Brasil’s operations primarily provide finance for Brazilian companies sending goods to China and, to a lesser extent, those importing Chinese goods to Brazil. Trade finance is the bank’s bread and butter; last year it financed $9bn-worth of Brazilian exports. But trade finance alone may not attract too many banks to China.
Carlos Gomes Lopes, banking analyst at Citibank Asset Management in New York, says: “At the end of the day, trade finance is a business with relatively small spreads. So although the volumes are large, banks won’t get rich this way.”
Eduardo Vassimon, international director at Itaú BBA, Banco Itaú’s investment banking arm, says the bank aims to go beyond standard trade finance. “CVRD [the world’s biggest iron ore miner] is a big customer of ours but it already knows the region and has a strong presence there,” he says. “We will work with this kind of company but we will be able to add more value for companies that are less familiar with China.”
As well as helping smaller exporters to get established, later this will mean getting involved in joint ventures and bilateral direct investment in both Brazil and China.
Modernisation process
Mr Vassimon is upbeat about doing business with Chinese banks. “Chinese banks are going through a process of modernisation and Westernisation, so their international areas behave very much like international banks. They are a bit different in terms of culture and the level of formality, but globalisation has led to changes in the way they do business. They are very professional.”
Others, however, advise caution. Foreign manufacturers operating in China have found it notoriously hard to protect their designs from being copied by unlicensed locals. Similarly, Chinese banks are giving some cause for concern. “They need a lot of improvement [for example] in terms of allocation of resources,” says one observer. “The true state of their finances is unknown. Trade finance is pretty safe because it’s based on letters of credit and you only deliver in exchange for goods. Structured operations [involving local banks] are much riskier. But, so far, Latin American banks haven’t done anything crazy.”
Banks will test the waters further when it comes to financing direct investment, although this has got off to a slow start.
Embraer is one of Brazil’s pioneers. It entered China in December 2001, spending $25m on 51% of a joint venture with China’s Aviation Industry Corporation II on the basis of estimated demand in China for 635 regional passenger jets over 20 years. Despite Embraer’s controlling stake, the joint venture is a Chinese company registered under Chinese law.
Maurício Botelho, chief executive officer of Embraer, says the venture has run up against fiscal and other problems. “It was the right moment to do it but it may take longer than we initially thought [to produce a return],” he says.
Elsewhere, the move into China has been stop-and-start. Marcopolo, a Brazilian bus and coach maker, recently postponed plans to make spare parts in China as a first step towards full-scale manufacturing.
The most ambitious plans are being laid by Brazilian company CVRD. It plans to produce metallurgical coke in China with local partners Yankuang Group and Itochu Corporation. At home, it plans to build a steel mill in northern Brazil with Baosteel of Shanghai for an estimated $1.5bn; and with Chalco, a Chinese aluminium producer, it plans to build an aluminium refinery, also in northern Brazil, for an estimated $1bn.
These projects will take time to get off the ground though. Roger Agnelli, CVRD president, said in March that high Brazilian taxes – equal to 20% of the projects’ installation costs – have raised questions about the viability of the Baosteel and Chalco plants, although he said that negotiations with the government to delay tax payment until the plants enter production may offer a solution.
Though projects may be delayed and the amounts involved remain uncertain, there is little doubt that Brazilian banks will be called on to help finance significant investments by Chinese companies and Brazilian exporters in coming years.
“At the Chinese end, banks are only slowly starting to follow Brazilian companies,” says Rodolfo Spielmann, a partner at management consultancy Bain & Company in São Paulo. “What’s going on in Brazil in terms of trade and investment is much more important. This is where Brazilian banks will play a leading role.”
Mr Spielmann says big Brazilian banks such as Itaú and Bradesco, the biggest private-sector bank, will be well placed but will also face stiff competition from the likes of BankBoston (the local operation of Fleet, part of Bank of America) and Citigroup.
Finance for such projects will take various forms. Last year, for example, CVRD became the first Brazilian company to issue a 30-year bond, raising $500m at interest of 8.25% a year. Merrill Lynch was the sole bookrunner, with Deutsche Bank, JPMorgan and Morgan Stanley as co-managers.
“Demand from China puts companies like us in a privileged position,” says Fábio Barbosa, chief financial officer at CVRD. “We have 20% of the Chinese market because of the quality of our product. China needs high-grade iron ore.”
He says the 30-year plain vanilla bond was one of several options. “We can issue bonds, we can use structured programmes, we can use trade finance,” he says. “We work with all the big international first-tier banks.”
Sources of finance
A large part of finance for projects in Brazil is likely to be provided by the BNDES, the Brazilian government’s development bank. Other sources include the Inter-American Development Bank; it recently set up a $575m Brazil Infrastructure Investment Fund to which it contributed a $75m senior loan.
Otherwise, in addition to borrowing overseas, investors may raise money on Brazil’s local markets. “This is more expensive but, in compensation, there is no currency risk,” says Mr Gomes Lopes at Citibank. “The market is sophisticated and that would be an interesting source of business for banks.”
For the time being, trade finance remains the biggest and fastest-growing business area. But Brazil’s banks are sufficiently sure of the potential for higher-value added business from China to give it higher priority than current business levels necessarily warrant.
For Itaú BBA, for example, its Chinese representative office will be only its third such overseas operation (the others are in Argentina and the US). “It’s a bet on the future,” says Mr Vassimon. “But China is without doubt one of the three most important areas of the world for us and it will become more and more important in the future.”
