Update Country Report Curaçao 28 Nov 2018

China's president, Xi Jinping, is set to embark on another trip to Latin America, this time taking in Argentina (for the G20 summit) and Panama. His latest visit puts the spotlight once again on China's growing-and changing-role in Latin America and the Caribbean (LAC). The relationship between China and LAC has grown rapidly in the past decade, but is now also increasingly shifting from trade-particularly in the form of commodities exports from LAC in exchange for higher-value final goods imports from China-to deeper economic interdependence. As China's labour costs and purchasing power converge with those of more developed economies, it will soon start to narrow its current-account surplus and boost imports.

The Belt and Road Initiative (BRI), a global Chinese infrastructure investment and trade project that ten LAC countries, have joined (the latest being Chile, in November), will serve as the main economic conduit to greater Chinese influence in the region. Despite fears that Chinese interest in LAC is driven by geopolitical goals, The Economist Intelligence Unit views China's interest in the region as long-term and strategic but primarily economically motivated.

With increasing infrastructure investments and free-trade agreements China is looking to build commercial ties beyond the commodity cycle to secure both export markets and the eventual ownership of the consumer goods supply chain for its growing middle class. Although this is a massive undertaking with long-term geopolitical consequences, Chinese focus on soft power in these countries, in the form of diplomacy and cultural exchange, continues to lag behind the development of strategic economic relations. However, China's less interventionist approach to deal making (when compared with Western institutions) may also afford it a soft power advantage in the long term.

History of trade and investment relations

LAC's traditional commercial relationship with China has been characterised by trade in commodities and raw materials, which an industrialising China used to create higher-value-added products that it would then sell to the region. Indeed, as at 2016, agriculture, mining and oil accounted for 70% of LAC's exports to China, 70% of Chinese state financing to the region and 52% of Chinese foreign direct investment (FDI) flows into the region. In total, China accounts for around 10% of LAC's exports and represents just under 20% of the region's imports.

Since 2005 the two main Chinese policy banks, the China Development Bank (CDB) and the Export-Import Bank of China (ExIm Bank), have provided around US$150bn in financing-more than the World Bank, the Inter-American Development Bank and the Development Bank of Latin America (CAF) combined. Of these two actors, the CDB, whose mandate is to promote the government's macroeconomic and development policies, has provided the bulk of loans (US$120bn). The ExIm Bank, which is focused on trade, has provided US$30bn.

Chinese loans to LAC fell from US$22bn in 2016 to US$9bn in 2017 owing to a change in policy regarding Venezuela. The Economist Intelligence Unit estimates that this trend will have reversed in 2018, with lending activity picking up again. In 2019 continuous strong momentum in lending growth is likely.

Whether the terms of Chinese financing and investment are more or less onerous than those of Western institutions tends to vary on a deal-by-deal basis. Although data such as loan terms and interest rates are opaque, Chinese deals typically include a requirement for the recipient of a loan or equity investment to purchase Chinese equipment, but they do not contain the same environmental and governance conditions that multilateral banks such as the World Bank would impose. Moreover, Chinese companies do not abide by the same market governance rules: for example, in 2018 a Chinese company, Tianqi, acquired major lithium assets in Argentina and Chile. With these acquisitions Tianqi now owns more than 50% of the world's lithium production. Such a position might be blocked by Western anti-trust authorities, but these acquisitions received Chinese antitrust approval.

A strategy for deeper economic interdependence

Notwithstanding growing trade links, until recently no LAC nations were part of the BRI. China's increasingly ambitious inclusion of LAC into the BRI has been launched in large part through an alliance between China and the Community of Latin American and Caribbean States (CELAC). The China-CELAC Forum, launched in 2015, allows China to build ties and shape regional policy in the region without US or Canadian participation.

The China-CELAC forum has enabled massive investments in 91 infrastructure projects (including 28 power generation plants, 15 ports, seven highways and seven railways), not all of which have clear economic rationale. However, for some of the key recipients, such as Venezuela, Ecuador and Cuba, these investments were the only available forms of financing and a large proportion of FDI at the time, giving China a great deal of economic and political leverage over these governments. In Ecuador, for example, long-term loans-for-oil deals amounting to more than US$10bn were signed in a period of low oil prices, allowing China to secure a stream of oil deliveries at a pre-agreed low cost.

China-led infrastructure projects, largely related to commodity production and export, are still prevalent in the region. However, there are other developments taking place that suggest the potential for a much broader and deeper relationship. These developments were signalled in 2014, when Mr Xi, then recently inaugurated, announced China's concentrated strategy towards LAC via the "1+3+6 Co-operation Framework". This consisted of:

• one plan: a broad goal to grow China-CELAC trade to US$500bn and investments to US$250bn by 2020 (both have fallen short);
• three drivers: trade, investment and financial co-operation; and
• six industries: energy and resources, infrastructure construction, agriculture, manufacturing, scientific and technological innovation, and information technology.

This plan is a reflection of China's own economic rebalancing, which presents opportunities for both China and LAC to move up the production value chain. China is no longer the source of extremely cheap labour it once was, and its economic growth will eventually be geared more towards consumption. In fact, China's GDP per head overtook that of the entire LAC region in 2016.

As Chinese GDP per head continues to grow quickly, and growth in LAC's GDP per head languishes, the rising purchasing power of the Chinese consumer will require a reliable source of imports that go beyond natural resources. In this effort, Chinese policymakers want to shift emphasis from the traditional focus on raw materials and infrastructure projects to logistics, manufacturing and advanced technology investments.

Recent data suggest this adjustment is beginning to take place. Since 2012 Chinese FDI has shifted dramatically from an energy and mining focus to services and technology. From 2000-11 to 2012-17, Chinese oil, gas and mining FDI as a proportion of total LAC FDI dropped from more than 80% to just below 30%, although total FDI to the region grew from US$44bn to nearly US$65bn.

Chequebook diplomacy and the BRI

Traditionally China has supported communist and socialist countries in the region, such as Cuba and Venezuela, with official development assistance. Between 2004 and 2014 China provided around US$12bn to LAC, with Cuba being the recipient of more than US$6bn. Small countries, such as Jamaica, Guyana and Bolivia have received more than US$1bn each in official aid from China. In the past two years a series of Central American and Caribbean countries have abandoned their recognition of Taiwan in favour of diplomatic ties to China, including Panama in June 2017, the Dominican Republic in April 2018 (in exchange for US$3.1bn in loans and investments) and El Salvador in August 2018.

This wave of diplomatic outreach has given way to deeper economic ties through China's promotion of the BRI in the region. Ten LAC countries have so far officially signed up to the initiative: Panama, Venezuela, Bolivia, Trinidad and Tobago, Antigua and Barbuda, Dominica, Uruguay, Costa Rica, Guyana, and Chile. The latter, which joined in November, becoming the largest economy to join the BRI, is seeking to become a larger entry point for FDI in the region, particularly in infrastructure development. Six LAC countries are also prospective members of the Asian Infrastructure Investment Bank, a Chinese development bank intended to rival the World Bank.

China-LAC relations from the US point of view

For the US, LAC's traditional leading partner in trade, diplomacy and security, China's ascension brings with it new geopolitical challenges. The disapproval felt by the administration of Donald Trump of China's role in the region became evident when the US withdrew its ambassadors from Central American countries in September 2018 in protest of their recognition of China and their signing onto the BRI. China currently maintains just three FTAs in LAC (with Chile, Costa Rica and Peru), but Panama, an economic hub for the region, entered a fourth round of negotiations in November, and Colombia also launched a bilateral FTA feasibility study this year.

The US's concerns over China's influence seem also to have been at play in the decision to include a "poison clause" in the new US-Mexico-Canada Agreement (USMCA), to the effect that if Mexico or Canada were to enter into a trade deal with a non-market economy (in other words, China), the US reserves the right to pull out of the USMCA. Although the Trump administration proclaims to be concerned about China's rising influence, The Economist Intelligence Unit does not expect meaningful changes to the prevailing US policy of benign neglect towards LAC. As a result, we expect the region-especially the smaller economies-to continue to build closer political and economic ties with China in the medium term.

Weak challenge from Mexico and Brazil

There are some important exceptions to Latin America's trend towards deepening relations with China. It is likely that Mexico will continue to see China more as a competitor than a trade opportunity, and Mexico's ties with the US will remain close. In Brazil, the president-elect, Jair Bolsonaro, holds a deep anti-Communist bias, which is bound to colour the LAC's largest economy's foreign policy regarding China. Under a nationalistic economic agenda, Mr Bolsonaro, who complained during the electoral campaign that the Chinese "are not buying in Brazil, they are buying Brazil itself," wants to maintain exports to China but defend strategic sectors from Chinese investment in energy and some natural resources.

A more adversarial tone towards new Chinese investments under Mr Bolsonaro is likely to have limited effect on the overall relationship with China owing to the depth of trade and investment ties between the two countries. However, Mr Bolsonaro will increasingly align Brazil towards pro-Western international politics, and his affinity for Mr Trump may prompt discussions of a Brazil-US trade deal as a US response to Chinese influence in the region.

Despite some unease in Mexico and Brazil, which may frustrate China's entry into LAC's largest markets in the short term, China's influence in the region is set to grow. The G20 summit in Argentina on November 30th-December 1st will be the first to be held in South America and the second in Latin America since the 2012 summit in Mexico. As the world awaits a possible truce in the trade war between Mr Trump and Mr Xi during their official meeting at the summit, many countries in the region will be focusing on the economic benefits that they can derive from closer co-operation with China.