Industry Trend Analysis - Brazil-Colombia Trade Agreement A Boon For Both - SEPT 2017


BMI View: A new bilateral agreement on automotive trade between Brazil and Colombia will significantly improve vehicle trade between the two countries. The production impact will be strongest for Colombia and has prompted us to revise up our production forecasts. The export gains in volume terms for Brazil will have less impact on total production but will be important for producers diversify ing exports away from Mercosur countries.

We have revised up our Colombia passenger car and light commercial vehicle (LCV) production forecasts on the announcement of a new bilateral trade agreement with Brazil allowing for partial free-trade in light vehicles between the two countries. As a result, we believe Colombian passenger car production will expand by an annual average of 10.4% over our full forecast period to 2021, up from our previous average growth forecast of 4.6%. Similarly, we forecast LCV production to grow by an annual average of 10.9% over the same period, up from our previous forecast of just 0.4% annual average growth. We have, however, maintained our current production forecast for Brazil.

Free Trade A Blessing For Production
Colombia - Light Vehicle Production, Units & % chg y-o-y
f = BMI forecast. Source: OICA, BMI

In April 2017, both Brazil and Colombia's governments signed an eight-year automotive trade agreement that grants both countries' producers tariff-free access for a specified quota of light vehicle exports. During the first year of the deal, automakers in Colombia will be able to export up to 17,000 light vehicles to Brazil without incurring a tariff, nor incurring Brazil's IPI tax - a tax on all industrially manufactured products. In return, Brazilian exporters will be granted tariff free access to the Colombian market for the same size quota of 17,000 vehicles. The quotas will then be raised to 25,000 units in the second year and later raised to 50,000 units for the third to eighth year.

Brazil A Ripe Market When Free Trade Option Available
Vehicle Sales By Production Origin, Units & % Share Of Imported
Source: ANFAVEA, ANDEMOS, BMI

The agreement will allow Colombia's local producers to finally integrate themselves into the large and highly protected Brazilian market that has, until now, remained closed to them. Despite the Brazilian vehicle market having reached more than 2mn units in 2016, imports still play a very small role, accounting for just 13.0% of total vehicle sales in the country, compared to 64.2% in Colombia ( see chart above).

Colombia Not An Established Trade Partner
Brazil - Light Vehicle Imports By Origin, Units
Source: ANFAVEA, BMI

This is due to Brazil's significantly high tax burdens on imported vehicles, as shown by the country's poor ranking in the 'tax rates' pillar of our Autos Sales Risk Reward Index, coming in at 117th out of 124 countries ( see ' Americas Autos Sales: LatAm Sales Recovery Glossing Over Weaknesses ' , March 3). These prohibitively high taxes have meant that only producers based in countries holding bilateral automotive trade agreements with Brazil such as Mexico, Argentina and Uruguay have been able to gain a meaningful foothold in the market, accounting for 76% of all imports ( see chart above). It also explains why Colombia failed to deliver any new light vehicle exports to the country in 2016.

However, with the new trade agreement, Colombian producers have been granted tariff and IPI tax-free access to the Brazilian market, bringing it in line with the advantages extended only to Brazil's closest automotive trade partners Mexico, Argentina, and Uruguay. This in turn will allow Colombian producers to greatly expand exports to Brazil, where local producers still remain comparatively less competitive and vulnerable to foreign producers with tariff-free access. Having been reliant on sagging domestic sales and exports to weakened local Central American and non-Mercosur South American countries such as Ecuador, Peru and Chile over the last few years, the opening up of Brazil's market will be an attractive opportunity for raising production.

From a company perspective, we highlight General Motors Company and Renault Motors as the two biggest beneficiaries of the deal. These two companies are the only two major producers of light vehicles in Colombia and also already benefit from a strong presence in the Brazilian market as well. This will make it easy for them to distribute and market their Colombian-made models in the country without having to launch into a costly brand marketing campaign. Sales of these companies also account for more than 40% of Colombia's local vehicle market according to our sales by brand data and they will be able to extend this domestic dominance by sourcing a wider range of new models produced in their Brazilian plants under the new agreement.

Diversification Gains For Brazilian Production

While we have raised the production forecast for Colombia, we are maintaining our current production forecasts for Brazil. The share of exports from Brazil has been growing as producers seek to reduce their reliance on the stagnant local market but exports still account for less than a quarter of Brazil's total production ( see chart below). At the same time, even with tarifffree access we believe markets like Argentina, Mexico and more developed Asian and European markets will be more important for Brazil's exporters in volume terms.

Agreement Good For Exports But Minimum Effect On Total Production
Brazil - Light Vehicle Production By Target Market, Units
Source: ANFAVEA, BMI

Nevertheless, we highlight that Brazilian manufacturers will still benefit from free access to Colombia's vehicle market in terms of the diversification of their export operations. Brazilian producers already account for 9% of new vehicles imported into Colombia despite not yet having preferential access to the market ( see chart below). This highlights that consumers have a strong preference for some models made in Brazil and are willing to pay higher tax rates on them. This suggests there is potential for Brazilian producers to expand their retail presence much further. This will help their broader regional strategy of diversifying exports to hedge against the cyclical swings of demand in the Mercosur trade bloc; a strategy which many began in 2014 as the region's market collapsed ( see 'Export Markets To Provide Some Relief For Domestic Producers', August 25 2016).

Brazil To Increase Footprint In Colombia
Colombia - Sales Of Vehicles By Origin, % Of Total Imported
Source: ANDEMOS, BMI