Monday, January 31, 2011

Over reliance on commodity demand from Asia brings risks of rising protectionism

Brazil’s trade surplus has been fading fast in recent years and may soon turn to a deficit. The rebound in commodity prices after the global financial crisis has helped sustain Brazilian exports, especially to China and other Asian countries. But imports have been buoyed by strong domestic demand and the weak dollar, and have thus risen even faster. The appreciation of Brazil’s currency, the Real, has damaged exports of manufactured products in particular. Brazilian officials acknowledge that relying on commodities and China leaves the country exposed. There is some risk that the government of Dilma Rousseff, which took office at the beginning of January, could resort to selective protectionist measures to support Brazil’s manufacturers.

Trade trends

The new administration is growing concerned about the diminishing trade surplus, which peaked at US$46.5bn in 2006 but has been shrinking ever since. The surplus in 2010 amounted to an estimated US$20.3bn, down by around a fifth from its level in 2009. Although exports continued to rise, by 31.4% in nominal US dollar terms in 2010 to exceed US$200bn for the first time, imports accelerated at a much faster pace, by 41.6%. The recently appointed minister for development, industry and foreign trade, Fernando Pimentel, has expressed concern that the situation will continue to deteriorate. He expects the trade surplus to be down by half this year, to a level not seen since the early 2000s. The Economist Intelligence Unit forecasts a small trade deficit from 2013.

On the bright side, last year’s performance showed that Brazil’s important agribusiness sector is stronger than ever, and that the mining giant, Vale, remains a dominant player in the iron ore trade. Agriculture and livestock contributed US$63bn to the country’s trade surplus, according to official statistics. However, industry and services registered a deficit of US$42.7bn.

This confirms that Brazil’s trade surplus has become increasingly dependent on commodities. Brazil has enjoyed the full benefits of a prolonged commodity boom. Although prices slumped during the global financial and economic crisis, they were still up by 75% in real terms between the end of 2001 and the end of 2010, a period during which Brazil’s terms of trade improved by 34%, according to Spanish banking conglomerate Santander.

Iron age

Brazil is particularly reliant on demand from China, its leading trade partner, which mainly consumes Brazilian iron ore and soy beans. For the first time in more than 30 years, Brazil exported more primary products than manufactured goods last year. Foreign sales of commodities soared by 45% (helped partly by a 24% rise in price of non-oil commodities, according to Economist Intelligence Unit estimates), and commodities amounted to 44.6% of overall exports, up by four percentage points from their share in 2009. The share of manufactured exports fell from 44% in 2009 to 39.4% in 2010.

The question is what will happen after the commodity cycle peaks or even reverses. The Brazilian government wants its industry to be able to compete internationally, but its performance has so far been hampered by the weak dollar and what the government argues is a currency war–with countries such as the US and China devaluing or holding down the value of their currencies in order to boost their exports–to the detriment of countries such as Brazil whose currencies are appreciating.

The result of such currency imbalances is clear: the influential FIESP (Federação das Indústrias do Estado de São Paulo), the São Paulo industry federation, points out that the trade deficit with China in manufactured products rose to US$23.5bn last year, up by from just US$600m in 2003.

The consequences of the shrinking trade deficit are serious. It is helping to drive a worsening of the current-account balance, which was in surplus as recently as 2007 but is expected to show a deficit of 2.8% of GDP in 2011, according to Economist Intelligence Unit forecasts.

Trade war looms?

Mr Pimentel says that he is ready to act. The first measure will be to set up by July a new export credit bank to finance exports. The bank will depend on the government’s Banco Nacional de Desenvolvimento Econômico e Social (BNDES) and is expected to help boost foreign sales. Mr Pimentel has also hinted at selective tax breaks in the future, and has said that he intends to take active measures to defend Brazilian manufacturers against aggressive Asian exporters. Toy manufacturers are among those which have recently benefited from greater tariff protection–import duties on a range of such goods were raised from 20% to 35% in January. The government may do the same for other sectors, such as capital goods, where Brazilian manufacturers have been struggling to compete with Asian imports.

If Chinese demand and high commodity prices weaken Brazil may find it difficult to adjust. The government is trying to support the manufacturing sector amid continued appreciation of the Real. But there is a risk that its trade policies could become increasingly protectionist and transform the currency war into a fully fledged trade war.

A service of YellowBrix, Inc. (GARP)