China Research

A discussion forum on emerging markets, mainly China – from a macro, micro, institutional and corporate angle.

The EU-Mercosur free trade agreement – welcome but not without problems

December 9, 2024

The EU and the five active Mercosur countries – Brazil, Argentina, Uruguay, Paraguay and since recently Bolivia – finally made it, quite surprisingly when the trade deal with the EU really happened; highly desired by many corporations – but it took 25 years of trade talks to get there (https://ec.europa.eu/commission/presscorner/detail/en/qanda_24_6245). Initial reactions were mostly positive but not unisono. A number of obstacles for a good development of the agreement still have to be eliminated or improved, both in the short and the longer run.

Some (still) opposing EU countries

It is generally expected that the new free-trade agreement will be particularly beneficial to EU countries when it comes to the export of investment goods, cars, pharmaceuticals, many services and other products with currently high tariffs. For Mercosur countries, particularly exports of agricultural products and critical minerals to the EU promise to become more attractive – however, some EU countries with still large agricultural production certainly dislike the new trade agreement. Altogether, there are particularly three striking problems to be tackled.

Problem no 1: To get the EU to join the deal

It certainly won’t be an easy call to convince reluctant EU countries with a relatively high share of agricultural production such as France, Italy, Poland and the Netherlands to join the agreement with Mercosur. This trade agreement must be approved by 15 of the 27 EU states which totally must represent 65 percent of the whole EU population. A simple majority by the European Parliament is also needed.

Problem no 2: Exaggerated expectations directly after such a deal.

I remember quite well the strongly positive expectations for mutual trade gains from previous (free) trade agreements that covered other geographic areas. However, in most of these cases very positive predictions never came true or it took a long time until major achievements could be noticed. For example, the big Southeast Asian & Pacific trade deal by the name of Regional Comprehensive Economic Partnership (RCEP, https://crsreports.congress.gov/product/pdf/IF/IF11891) from 2020 still remains quite unobserved; despite the fact that the member countries – with China on the top – stand for almost 30 percent of global GDP.  Limited enthusiasm for the RCEP can be particularly referred to poor customs administration, delivery delays and lack of transparency. Thus, a main objective for the EU-Mercosur agreement should therefore focus on acceptable or good institutional conditions. This may be difficult.

Problem no 3: Economic imbalances and weak growth in Mercosur countries

When looking at the two largest Mercosur countries – Brazil and Argentina – they have been characterized by really disappointing growth performances in the past decades, Argentina even more than Brazil. Varying changes of economic policy regimes have not helped so far. Both countries have been underperforming during many years. Thus, potential growth is quite low in Mercosur countries. Reforms of the institutional framework are badly needed. The EU – Mercosur deal may hopefully speed up necessary improvements, also when it comes to productivity.

Summary: The EU-Mercosur agreement can be interpreted as an important signal to the opponents of free trade – but has its limits due to Brazil’s and Argentina’s insufficient growth performance. Hopefully, future policy changes will improve the growth outlook.

Hubert Fromlet
Affiliate Professor at the School of Business and Economics, Linnaeus University

China’s downsizing of growth continues – and worries continue to grow  

November 26, 2024

Economic growth in China has been declining visibly in the past few years. Looking more deeply into the structural problems of China, a further downsizing of GDP growth seems unavoidable on trend – despite the latest stimulation and rescue measures.

Structural issues more important than short-term statistics

Financial markets are short-term minded by nature. For this reason, Chinese short-term numbers cause a lot of global attention, too – more than they deserve per se. Nobody can sufficiently judge the correctness of official Chinese statistics for GDP, inflation, urban unemployment, the PMIs, bad or non-performing loans, etc.  

Thus, it also seems impossible to come to a conclusion on the efficiency of the recently announced two financial support packages of enormous 10 trillion RMB totally (6 plus 4 trillion which means in USD 838 billion for  2024-2026 and USD 539 billion for five years to come; in Swedish about USD 838 miljarder plus 539 miljarder). According to IMF sources, “hidden local debt” may amount to as much as totally 60 trillion RMB – an amount that would be far away from tranquillizing – and very contrary to what China’s minister of finance the other day described as “controllable” (more on the topic and definition of  “hidden debt” and China’s scaring total domestic debt situation in one of my forthcoming blogs).

The size of this latest government action indicates that Chinese political leaders now have become really worried about the local debt issue – but the real magnitude of these problems remains uncertain due to the unknown true dimension of the total provincial and local indebtedness.

Again, the institutional factor of poor transparency remains as one of China’s major shortcomings – and China’s recent policy reaction against overwhelming local debt came very late also in this special context.

As a matter of fact, the local debt problem is not new. Already in 2013, I published an article on this topic though local debt in China was not really addressed as important by the international analyst community at the time (https://publications.bof.fi/bitstream/handle/10024/44981/172270.pdf?sequence=1&isAllowed=y). It became indeed more obvious for a broader scale of (Western) analysts first more recently when the signals of the bursting real estate bubble became more scaring. 

Other relevant structural issues

Apart from the debt situation, other trend or long-term issues should be far more relevant for deepening corporate analysis than purchasing manager indices and quarterly GDP figures like, for example, economic policy in general terms, the role of the market economy in official policy strategy, the vast government subsidies to SOEs, the frequent institutional shortcomings, the bursting apartment bubble, the structure and credibility of the financial system as a whole – plus last but not least the strongly shrinking population in the forthcoming decades (see about Chinese demography my articles in this blog from April 10 this year, https://blogg.lnu.se/china-research/?p=3530). 

We keep in mind: This summing up of endogenous structural risks could be extended and needs completely different analytical tools compared to the ordinary business-cycle approach.

However, the above-mentioned structural factor “stability of the financial system” should already have gained (some) strategic priority by now also by Chinese political leaders – expressed in the here described attempt to achieve a better balanced local debt structure. At the same time, we should not forget government-subsidized unprofitable production (for exports) which certainly hides further risks for non-performing bank loans. 

The uncertain issue of financial stability

All this should lead to the conclusion that the volume of bad or non-performing loans should be discussed more broadly than it still is the case when official Chinese publications and comments have been published. 

Altogether, China must work very hard to avoid a future financial explosion. Consequently, China may also be the biggest single financial threat to global financial markets at some point in the future. It is late for China to decrease risks – but (hopefully) not too late. 

The number of Chinese medium- and long-term challenges could, of course, be extended further. Many obstacles still have to be tackled – either decreased or eroded.

We know that the quality of Chinese statistics has been underperforming for a long time, particularly as regards GDP. And there is no evidence that things have improved during the ongoing crisis – or whatever China’s growth problems may be called. Here we have one of the reasons why financial markets should not overestimate the role of business cycle analysis on China.

Even BOFIT – the specialized research institute of the Finnish central bank Suomen Pankki – wrote in its latest forecast on the Chinese economy that “BOFIT’s alternative calculation of Chinese GDP suggests real growth might have been considerably lower” (add: in the third quarter 2024).

According to BOFIT, China’s GDP will grow by around 4 percent in 2024, and when considering the latest stimuli by 3.5 percent in 2025. Since BOFIT rather estimates growth numbers than predicts precisely – which makes a lot of sense – the outlook for 2026 shows an estimated GDP growth of roughly 3 percent (https://www.bofit.fi/en/forecasting/latest-forecast-for-china/). 

3 percent is also the size of BOFIT’s currently estimated potential growth rate for China. Nobody knows about this exactly – but I wouldn’t go higher myself.

Certainly not before I get a more secure feeling that transparency finally is improving.

Hubert Fromlet
Affiliate Professor at the School of Business and Economics, Linnaeus University

Trump’s victory – bad news for emerging markets

November 7, 2024

Donald Trump’s victory in the American presidential election gives a number of reasons for second thoughts. One should deal with the consequences for emerging markets. 

Worsening trade and interest rate conditions

President-elect Donald Trump is not really a skilled economist. He does not care about economic basics – or he simply does not understand elementary economic principles. This is bad news for many emerging countries.

First, Trump is a dedicated supporter of protectionism; despite the fact that science stands completely united with the conclusion that protectionism can do a lot of harm (also to emerging economies). This would certainly be true if Trump introduced tariffs on all countries with 10-20 per cent which he had announced in the presidential campaign (against China even more). This would have a negative effect on exports from individual (emerging) countries to the U.S. – but also on total world trade (which already has been growing more slowly in the past few years).

Second, Trump wants to cut taxes or maintain already previously lowered taxes which probably raises government debt and at some point also U.S. interest rates (which many emerging countries’ foreign borrowing is linked to).

Third, high U.S. rates may also – at least for some time – strengthen the U.S.dollar. This would also do harm to emerging-market borrowers in USD. 

Fourth, another plan by Trump – i.e. to cut independence of the  Federal Reserve (Fed) – may in the worst case lead to higher inflation and interest rates as well.

Fifth, after some time, Trump’s “America-first-policy” may develop into an own goal because of finally growth-impeding consequences at home (mainly via higher interest rates).

Sixth, weakened world trade and global growth as the result of more protectionism may at some point also lead to shrinking demand for commodities (often the main revenue source for emerging countries) – particularly if mainly China with its enormous imports of commodities will be hit by higher tariffs all over the globe (as intended).

Anyway: Decisive will be how president Trump will act – not what he has been saying so far.

Hubert Fromlet
Affiliate Professor at the School of Business and Economics, Linnaeus University