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SAO PAULO, Dec. 25, 2008 (Viewpoint) – Across much of Latin America, the past few years have seen strong aggregate demand growth, relatively low interest rates, better controlled inflation and direct foreign investment flowing into the region. While many of these improvements were driven purely by local developments, the strong international economic climate over this period certainly played an important role as well, especially strong global prices for Latin America’s raw material exports. So, although the international economic downturn is not likely to affect the region’s economies as severely as has historically happened, the reduction of credit availability and falling commodities prices will expose significant Latin American economic weakness in 2009.

Latin American demand for paper and paperboard accelerated in 2008, due to the optimism in local markets during the first half of the year, consumer inventory purchasing and strong print advertising. But the global financial crisis has affected paper demand throughout the world and the situation is no different in Latin America.

The global economic crisis started affecting containerboard and boxboard demand in the last quarter of 2008. The segments of the paper packaging industry that experienced a decline in demand include those related to sales in supermarkets, such as food and hygienic and cleaning products. Demand for boxboard and packaging papers has been weaker as consumer product companies have been working off these inventories. This has lead to high cartonboard inventories for producers that supply these segments. Graphic paper inventories have also been building as a result of weakness in advertising in magazines and commercial printing.

However, it is also true that an economic downturn can change consumption habits in ways that support demand for paper and packaging. For example, some people will reduce consumption of durable goods and increase consumption of nondurable goods, which use more packaging relative to the value of the product. People will spend less money eating in restaurants, but will buy more packaged and foods, such as hamburger and pasta, to eat at home, thus increasing cartonboard consumption. Still, for the coming months, market participants seem to be very apprehensive about what is going to happen given the weakness of the global markets.

One of the major dramatic impacts of the global crisis on Latin America has been the correction in exchanges rates. The Brazilian Real has depreciated 30% against the US dollar, for example. It is fair to say that the recent weakening of the local currencies will help to minimize the share of imports in the trade balance, and, consequently, the high cost of imported paper will cause consumers to drain existing inventories and cut back on any potential inventory buying in the next year. Paper and paperboard net imports into Latin America are already on pace to decline by 5% in 2008, and total 6.2 million tonnes for the year.

It is difficult to anticipate how exactly the ongoing turbulence in financial markets will proceed and how this will impact Latin America. Our most recent projections show that total Latin American paper and paperboard demand growing by just 2% in 2009, down from 5% in 2007 and an estimated 4% in 2008. Demand growth is expected to pick up modestly during 2010. Apparent consumption is expected to surpass 30 million tonnes by 2013, after registering a 2.7% average annual pace from 2009 onward.

Even though the Latin America paper market is growing, has high operating rates and is highly dependent upon imports, investments in capacity expansion in Latin America has for the most part been limited to smaller rebuilds of existing paper machines. There have been some major investments in Brazil, however, such as the new 350,000-tonnes-per-year boxboard machine at Klabin’s Monte Alegre mill, which started in 2007, and International Paper’s new 200,000-tonnes-per-year uncoated woodfree paper machine scheduled to start up next quarter. The main reason for the lack of large investment is the low capital availability because any available capital is allocated to the market pulp business which maximizes the return on investment. The strength in local currencies has also played a key role. With the currencies having corrected, at least for now, paper and paperboard capacity is expected to accelerate, advancing at a 4.5% annual average pace in the next five years, up from the 3.0% average rate observed since the beginning of the decade.