Argentina Likely To Suffer As Trade Pact Ends

Argentina and Brazil have failed to renegotiate their existing autos trade pact before the June 30 deadline. The pact allowed Brazil to export US$195 worth of vehicles and auto parts free of tariffs to Argentina for every US$100 that Argentina exports to Brazil. Argentina is seek ing to renegotiate the pact that sets limits on trade in the autos sector. Brazil has said it is willing to temporarily extend the pact to avoid a jump in Argentina's trade deficit, but only under the current terms.

While they attempt to agree on an alternative deal, it is unclear how trade will be affected. One potential outcome is that they will return to a more liberal trade regime. If this were to happen, BMI believes that export volumes from both countries could potentially increase, although the degree of change is largely dependent on a potential devaluation in Argentina's currency. It is our core view that exports from Brazil to Argentina would increase more than trade flows the other way, as cheap Brazilian imports flood the market, thereby exacerbating Argentina's autos trade deficit.

Further, w e believe that Argentina will seek to negotiate a new trade pact over the coming months, or may seek to implement a quota system in order to limit the flood of cheap Brazilian cars.

Effect On Brazilian Exports To Argentina

BMI maintains a bullish view on vehicle production in Brazil, and we expect to see ongoing investment in the sector ( see 'Production Soars As Government Policy Bears Fruit', June 18 ). In the first five months of the year, some 89.5% of cars produced in Brazil were for the domestic market as the government incentivizes domestic manufacturing through tax breaks .

As it currently stands, companies are eligible for this tax break whether they invest in Brazil or in any of the other Mercosur countries - Argentina, Paraguay, Uruguay, and Venezuela. The majority of investment on the back of the legislation has been in Brazil (which then exports to elsewhere in the bloc), and we do not expect to see much investment in the other members of the trading bloc under the current rules.

In March, Argentina stated that it is to negotiate with Brazil over the country's local content requirement rules, and seeks to include a rule to require manufacturing of some autos and auto parts to be carried out in Argentina ( see 'Trade Negotiations Unlikely To Boost Investment', March 13 ). It is currently unclear whether this will come into effect. Nevertheless, BMI maintains a bearish outlook for vehicle production in Argentina, and we do not expect to see significant investment in the sector over the medium term.

Export volumes to Argentina are a comparatively small share of total Brazilian output, but this may increase somewhat as th e limit is no longer in place. We maintain our 2013 production forecasts for Brazil, as we believe that increased exports to Argentina would not significantly increase total vehicle output.

In 5m13, vehicle sales in Argentina increased 15.0% year-on-year ( y-o-y ) , to 374,130 units, and BMI forecasts a 10% increase in 2013. The majority of vehicles sold in the country are imported owing to the relatively small size of domestic production, despite the recent weakness in the currency which serves to make imports more expensive in real terms. Imported cars are priced in dollars, but can be bought in pesos at the official rate; if a buyer pays with pesos bought with dollars on the black market (the implied rate), it will be considerably cheaper. We believe that this, at least in part, helps explain the recent surge in sales growth in the country. BMI believes that, without the limit in place, cheap Brazilian exports could flood the market.

We caution, however, that there are considerable downside risks to our 2013 sales forecast for Argentina, as much of the growth over the year to date has been fuelled by a weak black market exchange rate and poor government control. We expect to see a devaluation in the official exchange rate, although we are not sure when this will happen (although it is our core view that this is likely to be in 2013). It is therefore unclear how long such an effect will continue to impact the market.

If sales in Argentina collapse, it may serve to limit the impact of the trade pact ending, as imports from Brazil would most likely decrease.

Effect On Argentina 's Exports To Brazil

In 5m13, vehicle production in Argentina increased 18.7% y-o-y, to 331,089 units. This recent surge has been on the back of substantial increases in domestic sales and exports, due chiefly to weakness in the currency ( see 'Forecasts Maintained As Growth Unsustainable', June 6 ). Indeed, vehicle exports in Argentina increased 26.0% y-o-y in 5m13, to 180,890 units. Over this period, some 88% of Argentina's autos exports went to Brazil as part of the Mercosur trading bloc.

Vehicle sales in Brazil have been relatively strong, and we expect to see 5.8% growth in the passenger car segment in 2013 ( see 'Sales Set To Pick Up As Policy Filters Through', April 5 ). BMI believes that unfettered trade between the two countries could result in a boost in Argentina's exports to Brazil, but we don't expect this to have a substantial increase in volumes as the count r y already constitutes a significant proportion of total output. Furthermore, liberal trade between the two countries is unlikely to adversely impact Argentina 's autos production volumes, as the majority of this is for export and not the domestic market.

We maintain that few autos companies will invest in Argentina due to its relatively poor business environment, and a number of other factors. The weak currency will serve to impact profit margins for international auto manufacturers, making the market unattractive ( see 'Ford Predicts Regional Loss, But BMI Bullish Long Term' ). Also, Mercosur membership allows companies to invest in Brazil and export to Argentina, resulting in little investment in Argentina - a trend we expect to continue.

Mexican Example

In June 2012, Mexico said that Argentina ha d pulled out of an auto trade pact over a disagreement on the conditions of an autos trade deal ( see 'Negotiation Over Trade Pact Sought', June 26 2012 ). In March 2012, Argentina announced that it would seek more favourable terms to the agreement, attempting to replicate Brazil's efforts. Brazil has concessions limiting the number of Mexican auto exports to the country following concerns about cheap vehicle imports undermining the formers' domestic production industry.

This article is tagged to:
Sector: Autos
Geography: Brazil, Argentina, Mexico