Coming together: the Latin American way

Even with all the spectacular economic gains made in Latin America over the past decade, the region is still in its infancy when it comes to integration and trade agreements. “Intra-regional trade in Latin America is half of [the volume] in Asia. Asia achieved that in 10 years. Latin America has been making attempts at regional integration for the past 50 years,” says Mexico’s former central bank governor and current chairman of Banorte, Guillermo Ortiz.

But with the development of the Pacific Alliance between Chile, Peru, Colombia and Mexico, there are hopes that finally a breakthrough is in sight.

Mercosur's failure

Past attempts at promoting cross-border trade have struggled, as illustrated by the disappointing record of Mercosur. Created in 1991 with the aim of bringing together the heavyweight markets of Brazil and Argentina, as well as Venezuela, Uruguay, Paraguay and later Bolivia, the project has never lived up to its initial promise. Argentina's protectionist policies are proving off-putting for investors, Brazil has not been as open to cross-border trade as many had hoped, and many business executives in Paraguay and Uruguay struggle to see the benefits of their countries’ Mercosur memberships. Venezuela has since gone its own way.

Uruguay’s finance minister, Fernando Lorenzo, says his country “wishes that Mercosur had a policy more predisposed to [serious and expedient] negotiations with important trade partners” such as Europe, with which negotiations started more than a decade ago but have yet to conclude.

The EU and Mercosur have agreed to exchange proposals for free-trade talks by the end of 2013, but some Mercosur members, including Argentina and Venezuela, have indicated that fast approval of such an agreement does not interest them. “Mercosur has had halts and turns; this is indicative of the different perspective on trade within the group,” says Mr Lorenzo.

In October, even Brazil’s president, Dilma Rousseff, expressed her disappointment and criticised the lack of integration within Mercosur in comments she made to the local press. Brazilian exporters recently took matters into their own hands and set up protests to complain about Brazilian goods being held up at the Argentine border due to trade restrictions.

Can the Pacific Alliance do better?

With the Pacific Alliance looking to avoid the mistakes made by Mercosur, counting very strongly in its favour is the fact that much of its initiative has come from the private sector, rather than from governments, and this means the approach being taken is pragmatic and market friendly. 

The will to succeed is perhaps best illustrated by the development of the Mercado Integrado Latinoamericano, or Mila, in which Chile, Peru and Colombia have already integrated their stock exchanges. As of August, Mila had a combined market capitalisation of almost $631bn and if, pending certain reforms, Mexico joins the exchange, Mila’s market cap will be similar to that of Brazil’s stock exchange, at more than $1100bn.

Furthermore, compared to the much-maligned Mercosur, where one-fifth of total trade is done between members, the Pacific Alliance is looking to primarily trade overseas, with a particular focus on the fast-growing economies of China and south-east Asia. All member countries have free-trade agreement in place with each other, but trade between them is in low single digits as a percentage of total cross-country deals.

“There is a sense of opportunity, we need to consolidate our ties with fast-growing economies in Asia, and we need to be pragmatic rather than political,” says Peru’s finance minister, Luis Castilla, about the Pacific Alliance project. Speaking at the annual conference of the Institute of International Finance, running alongside the International Monetary Fund (IMF) and World Bank’s meetings in October in Washington, DC, Mr Castilla said: “It was businessmen from the countries that pushed for [the integration project] and governments followed.”

At the same event, Mr Ortiz reiterated the importance of the union. “We need to be pragmatic. I have for the first time real hope that the Pacific Alliance is going to work. There are very concrete steps and an agenda that are being pursued,” he said.

A forced hand?

In some ways, the Pacific Alliance and other new initiatives such as the Trans-Pacific Partnership (TPP) – which was formed in 2005 by Chile, Singapore and New Zealand and later joined by Brunei, though other countries, most notably the US, have involved themselves in an expanded TPP in recent years – are a response to the failure of past trade agreements and, in particular, the inability to reach a conclusion in the 12-year old Doha round of the World Trade Organisation regarding a multilateral trading system. Even with the efforts of WTO’s new head, Brazil’s Roberto Azevedo, to bring new life into the organisation, there is little faith that the multilateral approach, with all its complexities and divisions, can deliver.

“The best-case scenario is a multilateral deal, but if you mention the Doha round, most people tend to fall asleep because they’ve heard it all so often,” says Gerard Lyons, former chief economist at emerging market specialist lender Standard Chartered and currently advisor to the Mayor of London, Boris Johnson. “The reality in life is that if you can’t overcome a problem you work around it, and that is what we are seeing with lots of bilateral or regional trade deals.”

Clearly in terms of size and scope, the Pacific Alliance and the TPP are oceans apart. The TPP involves 12 countries representing almost 40% of world gross domestic product (GDP), that are involved in more than one-third of the $18,000bn global trade market. The Pacific Alliance countries have a combined population of 215 million and account for one third of Latin America’s GDP, at $1500bn, which makes it significant in regional terms but less so from a global perspective. But the Pacific Alliance still offers a few lessons on global trade deals.

Ambitious thinking

The Pacific Alliance's ambitions, in fact, are impressive. Earlier this year, it agreed on liberalising trade between the four countries for 92% of all goods, with a view to extend this to 99% within the next three to seven years.

More importantly, there appears to be a commitment to focus on the commercial aspects of the alliance rather than on geopolitical elements, which can often be destructive. This is not so clear-cut, for example, with the TPP where there are suspicions that the US is pursuing the arrangement as a counterweight to the growing influence of China. Since the US became involved with the original four members in 2008, it has become the de facto leader of the TPP negotiations.

China, which is not in the TPP, has misgivings about the venture. In a June 2012 paper for the Centre for Strategic and International Studies, Wen Jin Yuan wrote: “The rapid movement of the TPP agenda has caused China some disquiet… China is actively promoting the regional economic integration of east Asia, which depends heavily on external neighbouring economies, and the TPP agenda is considered by many Chinese policy-makers and scholars as a centrifugal force arising to rip [apart] the regional economic integration of east Asia. 

"Moreover, there is also a strong [feeling] in Chinese academic and policy circles that the main reason behind the Obama administration’s support for the TPP agenda is the US’s desire to use the TPP as a tool to economically contain China’s rise.”

Trade agreements founded on geopolitical rather than purely economic considerations can lead to undesirable outcomes. Barbara Kotschwar, research fellow at the Washington, DC-based Peterson Institute for International Economics, says that while competition between trade blocs is healthy and should help to open up markets, there can be difficulties if the rationale is not entirely economic. “Unfortunately, economics don’t always determine how decisions are made. The TPP has some geostrategic elements to it,” she says.

Another way of looking at it is that the TPP and the Pacific Alliance are complementary, which is why Chile, Mexico and Peru belong to both. Ultimately, the success or otherwise of any trade or integration agreement is going to depend on the underlying philosophy behind it and the willingness on the part of the members to work together for practical outcomes.

Poor performances

Too often in Latin America, differences in political and economic approaches have resulted in agreements stalling or heading in directions that are driven by ideology rather than economic pragmatism.

Mercosur has notably underperformed, as have the 12-country strong Union of South American Nations, or Unasur, and the Central American Integration System, or Sica. The region also recently saw the formation of the Bolivarian Alliance for the People of Our America, or Alba by its Spanish acronym, the brainchild of Hugo Chavez, Venezuela's late president. The aim of Alba is to create a powerful economic zone, but its limitations were shown when at the organisation’s last meeting in Ecuador, president Rafael Correa denounced free trade as a cause for "hunger and poverty". That meeting in August was attended by representatives from Bolivia, Cuba and Nicaragua, as well as Antigua and Barbuda, Dominica, St Vincent and the Grenadines and the bloc's latest recruit, St Lucia.

In stark contrast, the Pacific Alliance is steadfastly following a pro-market strategy. Colombia’s finance minister, Mauricio Cardenas, says there are three different approaches being taken in Latin America. “There are the countries of the Pacific Alliance, which [share] a common view on the role of private sector, the importance of macroeconomic stability, and have more market-friendly policies. Then you have the Alba countries, more interventionist, less reliant on the market, [where the role of the state is greater], and then Brazil, which is separate.”

Practical thinking

Surprisingly, the Pacific Alliance was initiated in 2011 by Peru’s previous leftist president, Alan Garcia, whose government began implementing open-market policies once in power and sought regional integration to support the local economy. Commitment to the project was renewed by the current centre-left administration of Ollanta Humala, who has also enforced market-friendly views. The idea resonated with Chile, Colombia and Mexico, all of which have traditionally favoured open-market policies. The first formal steps for Costa Rica’s entry were made in May, while Panama may also join in the near future. Many other countries from within and outside Latin America have expressed an interest in the project, including Canada, Japan, Australia and Guatemala.

This willingness to be practical rather than political bodes well for the alliance and may represent a new Latin American way. It is already producing concrete results, such as the easing of visa requirements for travellers to the region. Once admitted to one Pacific Alliance country, a visitor can now move easily within the area. In the future, this travel liberalisation could be made longer term so that workers from one country can readily move to jobs in another member country.

Furthermore, alliance members have already been able to share resources to support their exports abroad by using each other’s embassies and trade promotion agencies, and creating common postings in Vietnam and Ghana. They are also embarking on necessary reforms to harmonise tax policies and have initiated financial markets integration, under the Mila project.

However, despite the optimism around the project, there is still a lot of work to be done and daunting challenges to overcome to make it into a success.

Hurdles to clear

Much emphasis has been put on the size that the common trading platform, Mila, will have once Mexico joins, which undoubtedly will increase the Pacific Alliance's global influence and relevance. But size on its own will not necessarily attract investors, and Mila faces many operational challenges. “It is not just a matter of size; being bigger doesn’t mean being better,” says Carlos Maggioli, director of Itaú BBA securities operations. “Can you create a platform in which corporates are willing to take risks? Can you expand flows? Just by showing that Mila is the same size of Brazil would not necessarily bring investors to the platform.”

Brazilian bank Itaú has a direct interest in the success of Mila, as it has just set up brokerage operations in Chile, is about to open in Mexico and is looking to expand in Peru and Colombia. The speed of Mila's development is, however, not as fast as Mr Maggioli would like. So far, transactions on the Mila platform represent only a very small percentage of volumes traded on individual markets, and there are cost issues. Reforms needed to facilitate trading, such as the harmonisation of tax rules between countries, are not yet in place, and liquidity between the three currency markets is very limited, which makes transactions expensive.

“If you invest Peruvian soles, you’re based in Peru, and want to buy Colombian pesos, you need to do two foreign exchange transactions: you need to go to the US dollar and from the US dollar to the peso,” says Alejandro Berney, head of Latin America securities and fund services at Citi. “That means that it is much cheaper for a Peruvian investor to buy an exchange traded fund in New York for Colombia or Chile, instead of trading between the three countries.”

The lack of a common clearing house also means that players keep counterparty risk until the transaction settles. Although some initial discussions have started, no one expects regional clearing to materialise in the short term.

On the positive side, the similarities between institutional investors and pension funds in the Mila countries will provide demand once the other issues are resolved, according to Juan Andrés Camus, chairman of BTG Pactual in Chile and a board member of Santiago Stock Exchange.

On the banking front, the Pacific Alliance has also generated greater collaboration. Privately, some bankers say that they aim to replicate the same level of service and price that large international banks offer to, say, a Mexican corporate client exporting to Peru. “[International banks] dominate this space, they see the transaction from beginning to end; we want to do the same by partnering with other local institutions in the Pacific Alliance countries,” says one head of transaction services.

Infrastructure hopes

More importantly, the other missing ingredient to make the Pacific Alliance a success is infrastructure. More than $200bn-worth of investments are planned in the region’s transport schemes by the end of the decade, with projects mainly aimed at reducing logistical bottlenecks in the transport of raw materials to east Asian markets, according to research publication LatAm Confidential.

Despite the efforts of the Initiative for the Integration of the Regional Infrastructure in South America (IIRSA), launched in 2000 with a 10-year horizon in its first phase, not much progress has been made, says Roberto Steiner, an economist at the Universidad de los Andes in Colombia.

Now in its second phase, IIRSA’s future will be driven by Unasur, born in Brazil in 2008 to include all South American economies. The transportation challenge is particularly relevant to Colombia. “In terms of transportation infrastructure, Colombia lags way behind almost any other country in the region, and this is a region that is way behind other regions in the world, so we are starting from a very low point,” says Mr Steiner. “That’s a particular problem when you are involved in international trade.”

Colombia is now running a $25bn road programme based on private-sector concessions, in which the country's government will invest $8bn. Additional funds will be used to modernise and expand ports and airports. Crucial is the development of Buenaventura port, on the Pacific coast, to take full advantage of the Panama Canal expansion – due for completion next year – and the resulting increase in traffic to and from Asia.

Given the total size of projects across the region, private sector involvement will be necessary to provide all the required financing. Also attending the IMF and World Bank’s annual meeting, Enrique Garcia, president of Corporación Andina de Fomento, a Latin American development bank that was originally set up to serve the Andean region, said that while his organisation, the International Finance Corporation and the Inter-American Development Bank are all providing funds, individual governments must also attract private sector investment. “Many of the meetings I've had [in Washington] are precisely oriented at [creating new financing products]. What is evident, nonetheless, is that you have to double [current] investments and the countries that don't plan to include the private sector are not going to make it.”

It is the member countries’ understanding of this philosophy that makes observers hopeful that the Pacific Alliance can achieve its aims – in contrast to past regional initiatives – and that this really is the start of a new Latin American way.