PERU-CHINA TRADE DIVERSIFIES, BUT INVESTMENT STRUGGLES

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SUBJECT: PERU-CHINA TRADE DIVERSIFIES, BUT INVESTMENT STRUGGLES


1. Summary: With a bilateral trade relationship growing stronger,
the GOP is trying to attract increased Chinese investment to Peru.
Since 2004, China has overtaken the United Kingdom and Chile to
become Peru's second largest export market and second largest import
market (behind the U.S.). Peruvian trade with China is mostly
focused on minerals exports, but recent figures for 2006 show
agricultural exports to China increasing by more than 100 percent
(year on year growth). Trade Minister Mercedes Araoz has even
floated the idea of a free trade agreement with China, but faces
internal pressure from sectors such as textiles that complain from
unfair competition.


2. Chinese foreign direct investment in Peru is still small
compared to U.S. and European FDI in Peru, and it is concentrated in
mining. The single largest Chinese investment in Peru has been in
an iron ore mine, but the project has been burdened by labor
problems and operating losses. Nevertheless, it is clear that
despite those difficulties, China views Peru as an important
investment destination, judging from a recent official tour of Peru
by Chinese investors, publicity over recently-arrived Hong Kong bank
HSBC and the announcement at the November 2006 Hanoi APEC summit of
the PRC's official invitation to President Alan Garcia to visit
China. End Summary.

MINIMAL CHINESE INVESTMENT
--------------


3. With $122.2 million in 2005, China's share of the $14 billion of
Foreign direct investment in Peru was only 0.86 percent, far below
U.S. and Spanish investments of over $4 billion each. Despite this
comparative difference, the Chinese have started to invest more
significant amounts, mostly in the mining sector.

PROFITS AND PROBLEMS AT IRON ORE MINE
--------------


4. China's main investment in Peru is the Shougang Steel
Corporation's 1992 purchase of an iron ore mine in central Peru.
Shougang (formerly known as the Capital Iron And Steel Company) is
one of China's oldest state-owned companies, and China's fourth
largest steelmaker. In 1992, Shougang paid $118 million for the
state-run Steel Peru mine to create Shougang Steel Peru S.A.A,
Peru's main iron ore producer. Shougang Steel Peru's mining and
processing plants are located in a desert area called Marcona (about
250 miles south of Lima). The company registered exports of $256
million in 2006, an increase of more than 18 percent over 2005.


5. Despite these profits, Shougang Steel Peru has been plagued by
strikes and worker unrest, and the conflict is frequently in the
headlines. The Chinese management's differences with labor unions
and local politicians led recently to a five-month strike that began
in June 2006. The strike forced management to shut down production
for several months. It was settled in October 2006, and resulted in
some improvement in equipment, working conditions and wages. Actual
losses were not published, but the media estimates that the company
lost over $3 million in sales. Observers familiar with the plant
say the Chinese have made minimal actual investment in the plant's
production or equipment since it took over.


6. The GOP has recently hosted two visiting Chinese business
investment delegations, including one in November 18-25, focusing
mostly on gold, coal, steel, and phosphate production, as well as in
the construction, road, energy generation, plastics, real estate,
chemical, computer, agricultural machinery, textile, and service
industries. The GOP has also established a Peru-China Business
Committee to foster commercial and investment relations between the
two countries. This committee is made up of Peruvian companies such
as Sociedad Agricola Drokasa (agriculture),Inca Tops (textiles),
Corporacion Pesquera Inka (fishing),Sunshine Export, Banco
Interbank (banking),among others.

EXPORTS TO CHINA: FOCUSED ON MINERALS
--------------


7. While the U.S. remains the main destination for Peruvian exports
($5.2 billion in 2006),China is now the second largest export
market for Peruvian products with exports to China totaling $2.2

billion in 2006, an increase of more than 200 percent over $597
million exported in 2002. Minerals increased their share of total
exports to China, growing to $1.5 billion in 2006 from $256 million
in 2002. Total Peruvian exports for 2006 were $23.4 billion.

--------------
Top Six Peruvian Products Exported to China
(in USD millions)
--------------
Product 2005 2006 Percent Change
-------------- ---
Copper Concentrates 502.7 926.9 84.4
Fish Meal 585.5 427.8 -36.9
Lead Concentrates 139.8 271.7 94.3
Molybdenum 220.8 103.7 -112.9
Petroleum Bitum Oil 17.0 99.7 486.5
Iron Concentrates 142.1 86.2 -64.8
(Source: Adex, SUNAT)


8. Exports to China are dominated by a few mining companies, among
them Antamina Mining Company (33.96 percent of total exports) with
$769 million, followed by Shougang Steel Peru (6.93 percent),
Southern Peru Copper (6.08 percent),and BHP Billington Tintaya
(4.59 percent).


9. While starting from a small base, Peru's agricultural exports to
China have been showing impressive growth: from $1.7 million in
2005 to $4.6 million in 2006 (an increase of more than 170 percent).
The top five agro industrial export categories were processed
seaweed (32.6 percent),grapes (24.4 percent),tara (tally stick
18.7 percent),strawberries (6.8 percent),and canned tomatoes (4.9
percent).

IMPORTS FROM CHINA: TWENTY-FOLD GROWTH
--------------


10. Imports from China to Peru have shown astronomical growth,
jumping from $41.6 million in 2002 to $910 million in August 2006.
Products imported from China have moved from basic (artificial fiber
textiles, toys, and dolls) to more sophisticated value-added ones,
like electronics (televisions, telephones, and radios).

--------------
Peruvian Imports from China 2005-2006
(in USD millions)
--------------
Product 2005 2006 (to August)
-------------- --------------
Machine Parts and Accessories 18.5 29.2
Memory Units 22.0 22.7
Telephones 21.3 22.5
Radio Receptors 24.2 20.3
Motorcycles 21.5 20.0
Other Input Output Units 15.7 18.6
(Source: Adex, SUNAT)


11. The GOP has tried to promote increased trade with China, and in
September 2006 Trade Minister Mercedes Araoz floated the idea of
negotiating a free trade agreement with China. This announcement
was met with criticism by Peru's local textile sector. Local
textile companies are in fact lobbying to impose safeguards on
textile imports from China. In a recent safeguards action, INDECOPI
(National Institute for Defense of Competition and Intellectual
Property) ruled that no harm was caused to the local industry by
Chinese textile imports. In fact, INDECOPI noted that there
actually was an increase in tax revenue for the government as well
as an increase in employment because of Chinese imports.


12. In April 2006, the Hong Kong-Shanghai Banking Corporation (HSBC
Bank Peru S.A., the wholly owned subsidiary of HSBC Latin American
Holdings (UK) Limited) received authorization by Peru's supervising
body to start banking operations in Lima in October 2006. HSBC Peru
officials said they would focus their activities on the corporate
banking sector and local and international companies with a level of
sales superior to US$ 20 million, as well as some commercial
banking. At a recent event, the bankQs management said HSBC was
bullish on the economic outlook of the Peruvian economy and its
prospects for long-term growth.

THE ROAD AHEAD
--------------


13. Despite Shougang's difficulties and the bad press these have
given China here, the trade and investment relationship continues to
strengthen. The increase in non-mineral exports is encouraging
Peru's counter-cyclical agricultural exporters of fruits and
vegetables. While minerals still fetch top dollar in China, the
GOP, according to Juan Carlos Rios, Peru's Commercial Counselor
based in Beijing, is encouraging Peru's exporters to focus on
satisfying Chinese domestic demand with more value-added products in
the areas of agriculture, fishing, textiles, and mining, and
focusing on quality rather than volume. With the GOP preparing to
host APEC in 2008, we expect even greater interest from Beijing in
the rapidly expanding Peruvian economy.
STRUBLE