Testing the China-Peru relationship
August 14, 2011 - Miami Herald

BY MARGARET MYERS, mmyers@thedialogue.org

China-Peru engagement has flourished over the past few years. A free-trade agreement and booming trade are significantly expanding bilateral contact. A full 38 percent of China's total regional investment will be directed toward Peru this year, up from just 0.6 percent in 2010.

But Peru's growing relationship with China may soon face a critical test. Chinese and other investors are bracing themselves as Peru's new president, Ollanta Humala, prepares to impose a windfall tax on mining companies. With Chinese investment in Peru focused almost entirely on the extractive sector, Humala's tax has the potential to significantly impact current and future Chinese investment.

Humala is wrestling with an uncomfortable dilemma. He committed himself in recent months to orthodox economic policy, effectively renewing confidence among Peru's many foreign investors. But in an appeal to his political base, the former leftist has also promised a policy of social inclusion that, among other things, would address the needs of the poverty-stricken, primarily indigenous populations in Peru's mining regions.

To fund proposed social programs, the president and his newly-appointed mining and energy minister, Carlos Herrera, will implement a windfall tax on mining profits. Mining companies, they say, have benefitted tremendously from access to Peru's natural resources while populations in resource-rich regions suffer the effects of mining-related pollution and environmental degradation.

Humala's promotion of both economic growth and social inclusion is certainly attractive -- Peru is in need of both. But the president's ability to strike a practical balance between investor-friendly economic policy and social reform remains to be seen. A properly implemented and sufficiently large windfall tax could finance much-needed social and environmental projects. But high tax rates might also disrupt foreign investment, negatively impacting growth prospects.

Large Chinese firms like Chinalco, Shougang, Zijin, and Minmetals are no doubt awaiting the outcome of windfall tax deliberations. Chinese mining ventures account for 30 percent of total sector investment, and there are plans to invest an additional $7 billion by 2014. A heavy tax could have a measurable effect not only on profits but also on future investment.

Despite concerns, mining companies are waiting surprisingly patiently for Peru's new leader to chart his course. Some have been reassured by meetings with Humala. Southern Copper Corporation, the largest copper producer in Peru, was pleased last week by the president's perceived dedication to mining sector cost-competitiveness despite a tightening of state control.

Humala's recent appointment of growth-friendly technocrats to high-level government positions has also eased investor concerns. But the president's political inclinations are still somewhat ambiguous. His social ministers are primarily left-leaning and likely supportive of a substantial tax. Many wonder how the president will navigate inevitable divergences within his cabinet -- tax-related or otherwise.

But despite uncertain politics, and even in the face of profit loss, China is unlikely to abandon Peru, or even to significantly decrease ongoing economic engagement.

The Andean country and its resources are a significant part of China's long-term, global investment strategy. Peru is among the top three producers of copper in the world and its exports are used to electrify much of China. Peru also exports significant quantities of zinc, lead, and iron across the Pacific. Access to Peru's resources, even at higher costs, remains a priority for China. China's broader urbanization and modernization efforts increasingly rely upon Peru's resource deposits.

Whether Humala can deliver his mixture of economic development and social inclusion will depend upon his skill as a leader. Considering his lack of political experience thus far, such skill remains to be seen. But whether the new leader adopts policies similar to those of his predecessor, Alán García, the so-called "Lula model," or even something closer to those of Hugo Chávez, China seems bound to stick around for the foreseeable future. A tax on mining profits is a burden the Chinese are willing to bear.

Large investments and a thirst for commodities have tied China to the region's resource-rich countries for the long-run -- or at least until the copper, oil, and iron ore run out.

Margaret Myers is the director of the China and Latin America program at the Inter-American Dialogue.