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20/10/2017by EOS Intelligence EOS Intelligence No Comments

EU-Mercosur FTA: Old Negotiations, New Zest

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The EU and Mercosur (a trade bloc comprising Brazil, Argentina, Uruguay, and Paraguay*) free trade agreement (FTA) negotiations date back almost two decades, to 1999. After failing to seal the deal in 1999 and again in 2004, the countries initiated new negotiations in 2010 and though started out slowly, they accelerated the process in 2016 (with hopes to finalize the deal by the end of 2017). A trade deal at this moment will be of significant importance to both sides owing to substantial amount of trade between the two blocs. The EU is Mercosur’s largest trading partner accounting for 21% of the bloc’s trade in 2015, while Brazil alone is the EU’s eleventh largest trading partner. However, despite a positive framework for the agreement to happen, there is still a great deal of resistance from few EU countries regarding the opening up of their agriculture sectors. Now it remains to see whether the two blocs can reach the much needed compromises and end up with an agreement by the end of the year or talks will remain hanging once more.
*Venezuela has been suspended from the trade bloc in 2016 and therefore is out of the negotiations

While this may not be the first time the EU and Mercosur sit to negotiate the terms of an FTA, it definitely seems to be the most promising one. The main reason the earlier efforts have gone in vain was the Argentinian leftist government’s adverse stance on trading outside their own backyard. This changed with the election of president Mauricio Macri in December 2015, who unlike his predecessor (Cristina Fernandez de Kirchner), looks at international trade as a growth opportunity for Argentina. Similarly, the impeachment of the Brazilian president Dilma Rousseff in May 2016 resulted in a new political wave in Brazil. While Brazil’s former president did take small steps towards trade liberalization, her successor, Michel Temer, has accelerated this process and has made the EU-Mercosur deal one of his top priorities.

Another reason this deal has gained immense importance for the Latin American bloc has been a declining bilateral trade among Mercosur’s two largest members, Argentina and Brazil, owing to recession. Trade between the countries declined from US$36 billion to US$22 billion during 2013-2016. This has forced the two nations to soften their stance on global trade.

Considering these developments, as well as the changing political and trade dynamics between several Latin American countries and the USA, following the arrival of Trumps administration at the White House, Mercosur’s openness and renewed interest in strengthening international trade ties is fully understandable. We wrote about it in February 2017 in our article Trump in Action: Triumph or Tremor for Latin America? and again later in June 2017 in Japan Hopes to Get a Slice of Mercosur Opportunity Cake as LATAM Exports to USA Decline.

On the other side of the negotiations table, as the EU has maintained a positive outlook towards foreign trade in general, the lost prospect of a Trans-Atlantic Trade and Investment Partnership with the USA under Donald Trump has also reinvigorated EU’s interest in the Mercosur FTA. Moreover, the EU views the deal with Mercosur as a suitable counter-measure to the growing Chinese influence in Latin America.

Apart from these aspects, the main reason for renewed commitment to the deal by both sides is the significant and increasing level of trade and investment between the two blocs. In 2014, EU’s investments in Mercosur countries reached US$494 billion. The EU’s exports to Mercosur expanded from about US$24.6 billion (€21 billion) in 2005 to about US$54 billion (€46 billion) in 2015. Similarly for Mercosur, its exports to the EU increased from US$37.5 billion (€32 billion) to US$49 billion (€42 billion) during the same period. Agriculture products constituted 48% of Mercosur’s exports to the EU, while machinery (29% of exports) and vehicle and parts (17% of exports) were EU’s largest export categories to the Latin American bloc.

The EU stands to gain a great deal from the FTA. As per current calculations, EU exporters would save about US$5.2 billion (€4.4 billion) annually on trade tariffs and stand to double their exports within five years of reaching a deal.

Despite hefty trade benefits and a lot of political and economic factors being in favor of the deal, agriculture remains a sore point. Several EU countries, led by France, do not want to open up their agriculture sector to Mercosur’s exports as they feel their domestic produce (especially grains and meat) cannot compete with that of Brazil and Argentina in terms of price. In addition, they are concerned that Mercosur’s agricultural produce are not subject to the same health standards as their domestic produce.

A quick glance at the average production costs indicates that the EU farmers have a reason to worry. As per estimates, if the deal comes through, the amount of maize available in Brazil and Argentina for export by 2020 will be between 23 and 26 million tonnes. While the average production cost of cereal in Mercosur is close to US$94/ tonne (€80/tonne), it is about US$141/tonne (€120/tonne) in the EU. This is likely to result in substitution of EU-grown maize with that from Mercosur, which will most likely result in a loss of about US$2.3 billion (€2 billion) by 2020 for EU’s agriculture sector. In addition, it can be expected to result in an indirect loss of about US$1.2-3.5 billion (€1-3 billion) as Mercosur-produced maize is likely to also replace wheat for animal feed during high production and harvest months.

In case of meat products, beef produced in Mercosur is more competitive than EU’s beef in terms of pricing. Moreover, a study of the usual trend of beef quotas suggest that they are first filled with noble cuts exports (including filet, entrecote, and rump steak) followed by other hindquarter cuts (such as topside and silverside). In case the deal takes place, it is expected that Mercosur’s beef will largely substitute local beef produce with Mercosur’s export volume (keeping in mind higher quantities of noble cuts, such as Hilton beef) expecting to reach 1 million tonnes. These would be worth US$18.8 billion (€16 billion) and would directly impact the local production and sales value. To bring this into perspective, the value of Brazil’s beef exports (the largest beef exporter among the Mercosur countries) to the EU was US$485 million in 2016. Moreover, low-priced imports from Mercosur will put pressure on the pricing in the domestic EU market resulting in close to a 30% downward price revision, which in turn is highly likely to result in further losses of about US$10.6 billion (€9 billion). In case the EU agreed to 300,000 tonnes at zero duty, this would expectedly result in US$3.5 billion (€3 billion) in direct costs and US$7.1 billion in indirect costs (€6 billion).

In addition to this, there are several non-tariff related issues with Mercosur’s produce, such as lack of tagging and traceability of livestock to identify and guarantee origin. Also, several drugs, such as hormones and growth promoters, as well as few antibiotics and insecticides that are banned in the EU are legally used in Mercosur. These factors have resulted in countries such as France, Ireland, and Poland opposing the EU-Mercosur FTA.

Another source of disagreement for the EU lies in the trade of sugar and ethanol, which the European producers claim should be excluded from the list of freely-traded items. This stems primarily from the fact that the Brazilian government provides subsidies worth US$1.8 billion annually to its ethanol and sugar producers, a fact providing them with an undue advantage compared to the European counterparts.

On the other hand, Mercosur is discontent with EU’s limited concessions on agricultural imports and its stance to continue quotas on the Mercosur’s food imports. Mercosur also has some concerns regarding providing the EU with access to public tenders, which in Brazil alone are worth about US$176 billion (€150 billion), however, they are positive that they will be able to reach a consensus during negotiations.

While few points of contention remain, negotiators at both ends are keen on resolving these issues and signing the deal by the end of 2017, remaining aware of the significance of this deal for both the sides as well as of the tendency for these talks to remain unresolved if not pushed soon. Moreover, both sides want to exploit the current favorable political scenario in Brazil and Argentina. With Brazil heading for presidential elections in 2018, the chances of a leftist-government coming to power do exist, and this can again put the deal in danger if it is not completed by then. Both sides of the negotiating table want to reach an agreement sought-after for the past 20 years as early as possible, even if it means compromising on some expectations.

EOS Perspective

A goal of completing the deal by the end of 2017 seems like quite a gun to the heads of both the blocs, as past experience, both in the case of this deal as well as other FTAs, proves that the process is never quick nor simple. Moreover, the EU seems somewhat divided on the deal, with Spain, Portugal, and Germany advocating for it and France, Poland, and Ireland opposing it. That being said, this deal – which has been on and off again and again since 1999 – has never been as close to getting finalized as it is now. This is primarily due to the fact that both Argentina and Brazil (that were the two main factors holding the deal back all these years) are extremely keen on reaching this agreement with EU, to the extent that they may be willing to compromise quite a bit as long as the deal includes provisions that leave room for future improvements and it brings increase in trade and thus growth for local economies. However, it remains to be seen whether they will be willing to stretch their compromises far enough to agree to the EU’s terms on the agriculture produce trade. At the same time, it is not clear how much the EU is going to push for these provisions, so there is a chance that both parties will manage to reach a well-rounded deal for both the sides. The least probable scenario is that the deal will come to a stand-still once more, however till the ink dries on the deal, nothing can be considered as certain.

19/08/2015by EOS Intelligence EOS Intelligence No Comments

Central America And Caribbean: Rising Stars In Investment Landscape

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Since 2010, less frequently discussed Central American and Caribbean countries such as Costa Rica, Panama, and Nicaragua have started to attract significant investment limelight. Effective government initiatives, complemented with availability of young and qualified labor as well as advantageous geographical location are helping these countries attract an increasing number of investments in various industries with each passing year. However, certain challenges continue to hamper these countries in realizing their full investment potential. Therefore, there exists a lingering need to take actions against such challenges and further bolster investment scenarios.

Costa Rica, Panama, Guatemala, Nicaragua, and Dominican Republic are emerging as attractive investment destinations in the Central American and Caribbean region. Their promising investment landscapes are reflected in estimated investment growth rates and net FDIs, amongst other investment parameters.

Government initiatives play a critical role in encouraging both domestic and foreign investors to establish and expand their operations in an assortment of industries, but certain challenges, for instance corruption, poor infrastructure, and weak legal system are plaguing the investment environments.

Government Initiatives

Investment Driven Industries

Challenges and Recommendations

Poor infrastructure, either at a general level or in terms of shortage of electricity is challenging Costa Rica, Guatemala, Nicaragua, and Dominican Republic. Since quality infrastructure is one of the critical pillars for various types of investments to operate profitably, effective steps need to be taken to prevent investments from being further hindered by this challenge. The affected countries should come together and synergistically utilize their resources through mutual agreements and infrastructure-oriented development projects.

Although, all of the five countries are presently experiencing relatively accelerated investment growth, they seem to not realize the opportunity cost being incurred from not taking sufficient actions to root out challenges faced by investors. Perhaps, only when total investment value growth starts becoming sluggish, these countries might recognize the importance of effectively implementing measures to overcome investor related risks.

08/03/2013by EOS Intelligence EOS Intelligence No Comments

South Korea – At the Crossroads!

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South Korea is the world’s fifth largest automobile manufacturer, behind China, Japan, the US and Germany. Automobile sales in South Korea breached the 8 million units mark for the first time in its history in 2012. The surge was mainly on account of strong overseas demand for locally-made models – exports accounted for 82% of these sales while domestic sales (accounting for the remaining 18%) actually contracted 4.2% to 1.4 million units in 2012.

Contracting domestic demand for local companies is mainly due to lack of real income growth, increased debt repayment burden and slump in the housing market in Seoul Special City (houses are often bought in South Korea for investment purposes). Meanwhile, overseas sales, cars exported from South Korea and vehicles assembled in overseas plants, expanded 7.9% to 6.8 million units in the same year.

The South Korean market is dominated by Hyundai Kia Automotive Group which accounted for 82% of domestic sales and 81% of exports in 2012. GM Korea, Renault Samsung and Ssangyong (acquired by Indian company Mahindra and Mahindra in 2011) account for 10% of the domestic sales while rest of the market is catered to by imports. BMW, Daimler (Mercedez-Benz), VW, Audi, Toyota, Chrsyler and Ford are the leading importers.

Free Trade Agreements

South Korea has aggressively pursued FTAs, with the provisional enforcement of an FTA with the EU from July 2011 and the full enforcement of an FTA with the US from March 2012. In the automotive industry, tariffs on parts and components were abolished as soon as the agreements came into force, whereas tariffs on vehicles will be abolished between South Korea and the EU over a three-to-five-year period and those with the US in the fifth year after enforcement of the agreement.

As a result of the FTA, exports to the EU sky-rocketed and the double-digit growth trend continued until March 2012. However, as the EU economy weakened, exports declined and returned to pre-FTA levels. In case of the US, exports surged around the time of the enforcement of the FTA in March, even though the tariffs on vehicles are yet to be scaled down. This phenomenon was labelled as ‘announcement effect’.

An interesting trend that has emerged is that whereas the domestic sales of South Korean cars declined by about 6.3% in 2012, domestic sales of imported cars increased by 24.6% in the same year. Moreover, for the first time, imports accounted for 10% of domestic sales, which is in sharp contrast to the 2% share about a decade back. European automotive OEMs have benefitted the most from this surge in demand for vehicles. This increased market share for European vehicles is mainly due to the fall in prices; as part of FTA between South Korea and the EU, the tariffs on large vehicles reduced from 8% to 5.6%.

Thus it can be said that while the enforcement of FTAs has been effective in boosting exports, it has brought about structural changes in South Korea’s domestic market.

Labour Strife

After an almost 4-year gap, strikes by the labor union returned to plague automotive manufacturing in South Korea in the summer of 2012. The industrial action, which also hit car parts manufacturers and some other industries, revived memories of the days when strikes were chronic in South Korea. Workers went on strike in 21 of the first 22 years since the unions’ formation in 1987; however, unions’ political influence has dimmed in recent years with declining memberships.

Hyundai, Kia and GM Korea were affected by the strikes and suffered record losses – Hyundai alone is estimated to have lost more than USD 1 billion. The main points of contention were the abolition of graveyard shift, wage increase and to confirming of permanent positions to the high proportion of contract workers. Although the companies agreed to most of the demands of regular workers, discussions with contract workers are still ongoing.

To offset the loss suffered from such strikes, OEMs are diversifying their production bases. Hyundai for one has moved to reduce the dependence on domestic manufacturing plants by expanding production in the US, China, India, Brazil and Turkey during the last decade. South Korean plants accounted for 46% of Hyundai’s capacity in 2011, down from 60% in 2008, when the last strike took place and 93% in 2000. Although another objective for establishing a global production network is to make inroads into the global markets.

Another consequence of strikes is that production costs are expected to shoot up, mainly on account of increased wages and also due to the additional investments that the OEMs will now have to undertake to make up for the reduced working hours per day; along with the abolition of the graveyard shift, another demand of the workers was to reduce the number of hours being worked in the two shifts from 20 to 17 hours.

Currency Uncertainties

The Won has been strengthening against the Yen and the US dollar since mid-2012, increasing production costs while adding to currency conversion losses, as sales in foreign markets translate into fewer Won. This has significantly eroded South Korean automotive OEMs competitiveness; companies such as Hyundai and Kia have consequently ceded market share to Japanese OEMs which are enjoying resurgence on the back of a brightening export outlook.

The Yen is also on a two-year low against the US dollar while the Won was at the highest level against the dollar since August 2011 in January 2013. Toyota can now in principle offer a discount of more than 10% to its US customers whereas South Korea’s Hyundai Motor has to raise the dollar price by over 5% to keep up with the Won.

A December report by the Korean Automotive Research Institute (KARI) states that South Korean export would shrink by 1.2% annually for every 1% drop in the Yen against the Won.

Over the years, the strategy of the South Korean Automotive OEMs has revolved around exports and the companies have established global production network to cater to geographies around the world. However, the recent upheaval in the foreign exchange markets have raised serious doubts about the company’s short-medium term prospects.

With increasing competition from global OEMs both in the domestic and global markets (resulting from FTAs) and currency uncertainties nullifying cost advantages that the Korean car makers have traditionally relied on, it is perhaps time for country’s OEMs to shift focus from quantity to quality – stressing superior design and engineering over sales growth.

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In our fourth discussion in this series, we understand the automotive market dynamics of Turkey. Its proximity to Europe and cultural affinity to Asia has seen a growing presence of both European and Asian OEMs. Is Turkey a long-term growth market for automotive OEMs, or is the market as developed as most western countries?

Part I of the series – Mexico – The Next Automotive Production Powerhouse?
Part II of the series – Indonesia – Is The Consecutive Years Of Record Sales For Real Or Is It The Storm Before The Lull?

08/02/2013by EOS Intelligence EOS Intelligence No Comments

Mexico – The Next Automotive Production Powerhouse?

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As the first of our five part automotive market assessment of the MIST countries – Mexico, Indonesia, South Korea and Turkey, we discuss the strengths and weaknesses of Mexico as an emerging automotive hub, and the underlying potential in this strategically located gateway to both North and South America.

Emergence of Mexico as a major automotive production hub is the result of a series of events and transformations over the past decade. The most important of which is the growing trend among automotive OEMs and auto part producers to have production bases in emerging economies. And the earthquake in Japan in 2011 tilted the tide in favour of Mexico just as ‘near-shoring’ was already becoming a key automotive strategy in 2011.

Automotive production in Mexico increased by 80% from 1.5 million in 1999 to 2.7 million units per year in 2011, largely thanks to a significant boost in investment in the sector.

Between 2005 and 2011, cumulative foreign direct investment (FDI) in the automotive sector amounted to USD10.3 billion. In the last year, several automotive OEMs have initiated large scale projects in Mexico; some of these projects include

Nissan – building a USD2 billion plant in Aguascalientes; this was the single largest investment in the country in 2012 and should help secure the country’s position as the eighth largest car manufacturer and sixth largest car exporter in the world
Ford – investing USD1.3 billion in a new stamping and assembly plant in Hermosillo, New Mexico
Honda – investing USD800 million in a new production plant in Celaya, Guanajuato
GM – investing USD420 million at plants in Guanajuato and San Luis Potosi
Daimler Trucks – investing USD300 million in a new plant to manufacture new heavy trucks’ transmissions
Audi – has decided to set-up its first production facility across the Atlantic in Mexico; with planned investment outlay of about USD2 billion, this move by Audi represents a significant show of trust by one of the world’s leading premium car brands
Mazda – building a USD500 million plant in Guanajuato; it has reached an agreement to build a Toyota-branded sub-compact car at this facility and will supply Toyota with 50,000 units of the vehicle annually once production begins in mid-2015

Bolstered by this new wave of investment, Mexico’s vehicle production capacity is expected to rise to 3.83 million units by 2017, at an impressive CAGR of 6% during 2011-2017.

Why is Mexico attracting such large levels of investment from global automotive OEMs? Which factors have positively influenced these decisions and what concerns other OEMs have in investing in this North American country?

So, What Makes Mexico A Favourable Destination?

Trade Agreements – Mexico has Free Trade Agreements (FTAs) with about 44 countries that provide preferential access to markets across three continents, covering North America and parts of South America and Europe. Mexico has more FTAs than the US. The FTA with the EU, for instance, saves Mexico a 10% tariff that’s applied to US-built vehicles, thereby providing OEMs with an incentive to shift production from the US to Mexico.
Geographic Access – Mexico provides easy geographical access to the US and Latin American markets, thereby providing savings through reduced inventory as well as lower transportation and logistics costs. This is evident from the fact that auto exports grew by 12% in the first ten months of 2012 to a record 1.98 million units; the US accounted for 63% of these exports, while Latin America and Europe accounted for 16% and 9%, respectively (Source – Mexican Automobile Industry Association).
Established Manufacturing Hub – 19 of the world’s major manufacturing companies, such as Siemens, GE, Samsung, LG and Whirlpool, have assembly plants in Mexico; additionally, over 300 major Tier-1 global suppliers have presence in the country, with a well-structured value chain organized in dynamic and competitive clusters.

The Challenges

Heavy Dependence on USA – While it is good that Mexico has established strong relations with American OEMs, it cannot ignore the fact that with more than 60% share of its exports, the country is heavily dependent on the US. The country needs to grow its export markets to other countries and geographies to hedge against a downturn in the American economy. For instance, during the downturn in the US economy in 2008 and 2009, due to decline in sales in the US, automotive production in Mexico declined by 20% from 2.17 million in 2008 to 1.56 million in 2009. Mexico has trade agreements with 44 countries (more than the USA and double that of China) and it needs to leverage these better to promote itself as an attractive export platform for automotives.
Regional Politics – Mexico is walking a tight rope when it comes to protecting the interests of OEMs producing vehicles in the country. In 2011, Mexican automotive exports caused widespread damage to the automotive industries in Brazil and Argentina and in a bid to save their domestic markets, both the countries briefly banned Mexican auto imports altogether in 2012. Although, later in the year, Mexico thrashed out a deal that restricts automotive imports (without tariffs) to its two South American neighbours rather than completely banning them, it does not augur well for the future prospects of automotive production in Mexico. One of the reasons automotive OEMs were expanding their capacity in the country was to be able to cater to the important markets in Latin America, particularly Brazil and Argentina. Now the Mexican government has the challenge of trying to keep everyone happy – its neighbours, the automotive OEMs and most importantly its own people for whom it might mean loss of jobs and income.
Stringent Regulatory Environment – The Mexican government, the Mexican Auto Industry Association and International Automotive OEMs are locked in a tussle over the government’s attempts to implement fuel efficiency rules to curb carbon emissions. Mexico has an ambitious target of cutting greenhouse gas emissions by 30% by 2020, and 50% by 2050. The regulations are similar to the ones being implemented in the USA and Canada, however, the association has complained that the proposal is stricter than the US version. Toyota went as far as filing a legal appeal against the government protesting the proposed fuel economy standard. Although the government eased the regulations to appease the automotive OEMs in January 2013, the controversy highlights resistance by the country’s manufacturing sector to the low-carbon regulations the government has been trying to introduce over the past few years. Such issues send out wrong signals to potential investors.

So, does Mexico provide an attractive platform for automotive OEMs? From the spate of investments in the country so far, it seems so – over the past few years, the country has finally begun to fulfil that potential and is now a key driver in the ‘spreading production across emerging economies’ strategy of companies looking to make it big in the global automotive market. However, there are still a few concerns that need to be addressed in order for Mexico to become ‘the’ automotive manufacturing hub in the Americas.

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In our next discussion, we will assess the opportunities and challenges faced by both established and emerging automotive OEMs in Indonesia. Does Indonesia continue to be one of the key emerging markets of interest for automotive OEMs or do the challenges outweigh the opportunities?

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