ASSIGNMENT 3

Latin America

73www.euromoney.com November 2015

Latin America’s economies are suffering a rapid and severe shift in their terms of trade. The development of free trade areas may provide a way forward and global initiatives, such as the Trans Pacific Partnership, could transform the region’s future

TPP to the rescue

I n late September Daniel Tenengau-

zer, RBC’s head of emerging market

and global FX strategy, was taking a

step back to explain to Euromoney

why he believed the widening spreads

of emerging market credit default swaps,

which had risen close to their post-crisis

highs, would keep going higher. “The key

question is, are we at the top of the range we

have had for the past three years or are we

going to break through? And my opinion is

that we are at the bottom of a new range,”

he explains.

Tenengauzer outlined three reasons for his

hypothesis, and they were all related to physi-

cal, real-economy factors. First, the decline of

economic growth in Europe – important for

trade because the European economy is more

integrated into global trade flows than the

US. The second was China’s slowdown and

the drag that is having on commodity prices.

“And last but not least – and one that won’t

be resolved in the near term – is a lack of new

trade agreements,” he argued. “We shouldn’t

forget that the [commodity] super cycle began

around 2001 after China officially joined the

WTO (World Trade Organization). Prior to

that we had Mexico joining Nafta and so

these major global agreements of the 1990s

and early 2000s were the backdrop to the

super cycle.”

The data support Tenengauzer’s argument.

Global trade has been sluggish in recent years

and unlike previous economic recoveries.

Global trade is falling in dollar terms and is

also weak in volume terms. Economists now

worry that recent EM weakness will affect

developed markets (DMs) through trade and

financial channels, through weak manufac-

turing activity and stronger DM currencies,

all of which points to further deflation.

Unlike in previous recoveries the world

lacks a dominant consumer and investor.

This time the US current account deficit is not

widening rapidly and China’s surplus has fall-

en from 10.1% of GDP following the global

financial crisis to just 2% last year. With no

large engines for trade growth, achieving

momentum becomes more difficult.

But two weeks after Tenengauzer’s down-

beat assessment, the Trans Pacific Partnership

(TPP) was announced. The deal has generated

genuine excitement among trade economists

who see the potential for very large welfare

gains – around $300 billion per year among

the Pacific Rim countries that have signed up

to what HSBC has called a “mega-regional

accord”. The 12 countries represent more

than 25% of current world trade and about

40% of global GDP. The countries involved

still need to ratify and many of the details are

yet to be published, so evaluating the precise

impact is impossible.

Douglas Lippoldt, a senior trade economist

at HSBC in London, who joined the bank last

year from the OECD, is upbeat: “It’s a bit of

positive news in a pretty gloomy period for

the global economy. We are talking about a

trade agreement encompassing something like

40% of global GDP, and the scope of this ac-

cord goes beyond traditional trade measures,

such as reducing import tariffs. It’s a ‘living

deal’, capable to address new trade issues

that arise. It ensures transparency in the

formation of future regulations for example,

and so it requires systemic reforms among

signatory countries. And if you look at the

types of things it will address, in terms of

processes and rule of law, it will have positive

effects beyond trade. When you have trade

liberalization combined with such systemic

reforms, this can lead to greater cross-border

ties – whether that’s through FDI (foreign

direct investment), licensing or trading – and

the TPP may lead to a significant uptick in all

these areas.”

IN LATIN AMERICA THE TPP THROWS

the region’s two trading blocs, the Pacific

Alliance and Mercosur, into even sharper

relief. The former is new and based on free

trade, monetary and fiscal orthodoxy and is

committed to harmonizing financial systems

and regulations to encourage greater capital

flows within and into its members. It consists

of Chile, Colombia, Mexico and Peru, all of

which, with the exception of Colombia, are

now also signed up to the TPP. In contrast

Mercosur, which is dominated by the large

economies of Brazil and Argentina – and

includes Paraguay, Uruguay and Venezuela

– seems to be going backwards in terms of

creating a single trading area.

In 2010 Mercosur announced that each

country could create 100 exceptions to the

common entry tariff. Argentina and Brazil

immediately imposed higher national tariffs

on various products. For example, Brazil

increased tariffs on communications products

and services, making these more expensive

for Brazilian companies and therefore the

national industry less competitive. There

are often complaints, especially among the

smaller nations, that the grouping is more a

political organization than an economic one

– and an ineffective one at that. Mercosur

has been negotiating a trade agreement with

the European Union since 2001 and the

most recent meeting, which was intended to

create a list of 10,000 items for further free

trade discussions with EU trade officials,

broke down with parties blaming Argentina’s

intransigence on opening its highly regulated

economy to European competition.

With Argentina predicted to enter reces-

sion next year and Brazil already in a severe

downturn, politicians in those countries

are beginning to talk again about develop-

ing Mercosur in a bid to increase economic

growth. However, East Capital’s chief econo-

mist Marcus Svedberg says the countries’

By: Rob Dwyer

November 2015 www.euromoney.com74

Latin America

all reliable – keep investing in the Pacifi c

Alliance.”

Although Colombia is absent from the

TPP, it has secured a free trade agreement

with the US – already its biggest trading

partner – and its pursuit of OECD status

means that it will be closely aligned with

the standards required to join at a later

date.

Unusually, the Pacifi c Alliance origi-

nated in the private sector. The Mercardo

Integrado Latinoamericano (Mila) stock

exchange initiative aimed to create a

single investment platform across Chile,

Peru and Colombia. This was later

extended to Mexico. However, while

the volumes of trades on Mila remain

low, the idea of pan-Andean develop-

ment struck a chord among banks and

businesses resulting in a fl ow of private

capital into these countries.

“The Pacifi c Alliance is an example

of government following business,”

admits Cárdenas. “Business was saying

that it was very comfortable investing

among the four countries and there was a

convergence of views, helped by the fact

that the macroeconomic framework is

very similar. Business has taken the lead,

but now the governments have come

and launched different initiatives. First

was free trade and now we are pursuing

problems are all domestic and developing

Mercosur is a peripheral issue: “I am not

convinced that free trade agreements have

a major impact. I’m a little bit doubtful

about how much it adds [to economic

growth].”

He explains: “However, while I am

sceptical, the beauty of trade deals is that

they don’t exclude the others – countries

can be part of multiple agreements. At the

end of the day, even though they don’t

add all that much, it’s still a net positive.”

However, Svedberg says the danger of

these groups is the negative association

that can touch all member countries. He

uses the example of Mercosur, which he

says is perceived to be struggling: “It’s

very tempting to dismiss an entire sub-

regional group and say that is less inter-

esting. That might be true for some of the

countries, but it’s not necessarily for all of

the individual members of group.”

W hile there may

be negative

connotations

with Mercosur,

policymakers in

the Pacifi c Alliance say that the indi-

vidual countries benefi t from the positive

impression that investors and businesses

have of the whole. The Pacifi c Alliance

countries are all still registering strong

positive growth and are benefi ting in the

main from structural reforms carried out

in recent years and from a commitment

to infrastructure development that is

limiting the impact of these economies’

exposure to commodities.

Rodrigo Valdes, Chile’s minister of

fi nance, told attendees of the Institute

of International Finance’s conference in

Lima in October that the good reputation

of the Pacifi c Alliance is a benefi t as inves-

tors increasingly differentiate between

emerging market countries.

“It’s easy to say that EMs are the same

but they are not,” says Valdes. “Some are

better managed, and the macro policies

that matter most are those that were

implemented in the good times. I think

[the Pacifi c Alliance countries] have been

very careful. We saved and we prepared

and therefore we are in much better

shape to withstand the headwinds that

are coming from abroad. We have all

developed a middle class, have evolved

[market-friendly] policies and are very

strong democracies with very competitive

markets. We are still very good countries

for foreign investors.”

Colombia’s minister of fi nance Mau-

ricio Cárdenas agrees: “Investors look at

countries for their macro indicators and,

in this case, the Pacifi c Alliance has the

upside that it is a region of four countries

that will become more integrated. This is

good because it will lead to the con-

vergence of best practice and common

standards as well as creating a large

[single] market.”

Cárdenas also points out that two

members – Chile and Mexico – are

already OECD countries and he says

Colombia is close and Peru wants to

join. “If you are looking where to keep

investing in EM – where the countries are

“We saved and we prepared

and therefore we are in much

better shape to withstand the

headwinds that are coming

from abroad”

Rodrigo Valdes,

Chile

November 2015 www.euromoney.com76

Latin America

fi nancial markets. The next stage is to make

sure that [the four countries] are even more

comparable, with tax convergence, so that

investors can invest in any of these countries

and it having the same treatment as if it were

a domestic investment.”

Cárdenas says the increasing alignment of

the four countries has had tangible effects on

policy making: “We four fi nance ministers

are communicating all the time and in a way

that helps decision making. We are in the

budget cycle and we discuss that and it’s very

helpful – we are very busy in WhatsApp!”

Chile’s Valdes says the TPP will be comple-

mentary to the Pacifi c Alliance. “The TPP is

a different story because it is a global treaty

with many different countries converging

on a set of free trade rules. These are very

different countries, while the Pacifi c Alliance

has something different in terms of bringing

together a view about how policy making

should be done. I think the Pacifi c Alliance

is more of a process. We work together on

many different aspects – trade, foreign affairs

and fi nance.”

However, while Valdes hints that the

Pacifi c Alliance is forging the stronger

opportunities, HSBC’s Lippoldt believes

the TPP will create greater possibilities for

growth: “The benefi ts from trade liberaliza-

tion come from having economies of scale,

from having market scale. So I am thinking

that the members of the Pacifi c Alliance that

are engaged in the TPP will have signifi cant

benefi ts accruing from the latter. If the Pacifi c

Alliance members wish to go beyond the TPP

and have a deeper regional integration among

themselves then there could be additional

gains to be had. For example, diminishing

the importance of borders will create new

economic opportunities that business will be

able to seize upon. It will be useful to have

this forum for discussion and we have to see

how it evolves – especially once the TPP is up

and running.”

Lippoldt is also excited about the parallel

free trade initiative in Asia – the Regional

Comprehensive Economic Partnership

(RCEP) between the ten Asean countries plus

India, China, Japan, Australia, New Zealand

and South Korea. The conclusion of the TPP

is likely to speed-up the RCEP negotiations

and Lippoldt believes the development of

these two regional agreements offers big

benefi ts and potentially a massive boost from

their subsequent integration. He argues that

the TPP is not an anti-China initiative, as it

has been portrayed in some quarters, and

instead offers a path to regional agreements

turning global. This is easier than trying to

create purely global agreements in one step;

with Kazakhstan’s entry, the WTO now has

162 members, an unwieldy number of coun-

tries with which to secure agreements.

“This has real potential. The Chinese

authorities have kept in touch with US offi -

cials about the TPP and they have gone out

of their way to stress they are not ruling out

potential engagement with the TPP in the

future,” says Lippoldt. “The welfare gains

from the TPP could be about $300 billion

per year for the group and I think it would

be a similar number for RCEP, the other

regional group. But if you merge the two

you get huge economies of scale and welfare

gains could mushroom to $1.9 trillion per

year. So that’s why the TPP should be seen

as a fi rst step in what could be a much

larger process.”

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Global trade is collapsing in value terms…

…and also looks weak in volume terms (2005 =100)

Source: IMF, Bloomberg, HSBC

Source: CPB Netherlands Bureau for Economic Policy

Analysis, HSBC

Trade groups – from Latin America to the world

Mercosur

Who: Argentina, Bolivia, Brazil, Paraguay,

Uruguay and Venezuela.

Size: Population 260 million. GDP $2.9

trillion. Total trade: $635 billion.

When: 1991 (although origin traced to

1985 bilateral free trade agreement be-

tween Argentina and Brazil)

Latest: The establishment of common

external tariff was watered down in 2010

when countries were allowed to create ex-

ceptions. Currently in negotiations for free

trade agreement with the EU but progress

slow.

Who: Chile, Colombia, Mexico and Peru

Size: Population of 216 million. Equivalent

to ninth largest global economy and 50%

of Latin America’s global trade. GDP $2.1

trillion. Global trade: $1.2 trillion.

When: June 2012

Latest: Finance Ministers are targeting

Who: in Latin America Chile, Mexico and

Peru. Plus Australia, Brunei, Canada,

Japan, Malaysia, New Zealand, Singapore,

the US and Vietnam.

Size: Population of 870 million. GDP $28

trillion. 25% of global trade.

When: Agreement announced in October

12 months.

Who: in Latin America none. Asean 10

(Brunei, Cambodia, Indonesia, Laos,

Malaysia, Myanmar, Philippines, Thailand,

Singapore, Vietnam) plus Australia, China,

India, Japan, New Zealand, South Korea.

Size: Population 3.4 billion. Trade volume:

30% of global.

When: Origins in 2013 no public target

date for conclusion.

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