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

Emerging markets and a strong dollar

May 27, 2024

Emerging markets are usually more sensitive to weak current account balances than advanced countries. A deficit in the balance on current account urges for a currency inflow since it implies a debt for imports vis-a-vis other countries that has to be paid. This inflow can be done in the three following ways:

¤ by receiving currency reserves via foreign direct investment (which often does not work as an available or sufficient financial source),

¤ by borrowing money in foreign currency (mostly in U.S. dollar, USD), or

¤ by selling stocks, bonds, etc to foreign investors (if such financial products exist in the emerging country and foreign demand for these papers is there).

Statistics show that emerging markets borrow the lion share of their foreign credits in USD which may be challenging in times when the American dollar is strong on global currency markets. This is actually the case. Serving existing debt in USD uses to be even much more challenging.

By the way: During a meeting the other day with American financial analysts, I heard the view that the USD historically tended to be strong when investments in research and development (R&D) in the U.S. were high. This is explained by an increasing demand for American technology stocks and also foreign action for FDI in the U.S., thus leading to a high demand for the dollar and therefore to the strengthening of the American currency. I am not quite sure about the general validity of this suggested correlation. But it can be observed that such conditions can be found these days.

Back to emerging markets. What we can see today is an increasing willingness of certain emerging markets to avoid or decrease new borrowing in USD. However, this is not easy to achieve since USD markets function by far as the biggest global supplier of new loans, also to emerging markets. 

The ongoing situation with the strong dollar is, of course, particularly difficult for emerging countries with high indebtedness in USD. Such countries may be found in all continents – countries that are or have been reporting growing pressure on their currencies in 2024 such as the Nigerian Naira, the Egyptian Pound, the Turkish Lira, the Indonesian rupee, the Argentine peso or the Brazilian real (watch for this the following IMF table: https://stats.bis.org/statx/srs/table/e2?m=USD). Of course, some of these and other weak currencies of emerging markets have also been impacted by other negative factors than the strong dollar, for example domestic political ones.

At the same time, there are also countries trying to reduce their exposure to the dollar (which also can be seen in the IMF table quoted above). Indonesia is such an example. However, such a trend will not be easy to achieve – but Thailand actually managed it in the past few decades. Perhaps another option may gain momentum as it is currently the case in South East Asia, i.e. trying to expand borrowing within the region at the expense of the USD.  

Conclusion: Analysts of emerging markets should watch the further development of the USD and its impact on indepted emerging markets.

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

New reasons to cry for Argentina?

November 16, 2023

In my earlier professional life, I had the pleasure of having quite frequent visits to Argentina. Argentina is a wonderful country with gentle people and fascinating nature. And all these wonderful football (soccer) players. Unfortunately, it is hard to see how the economy could improve after the ongoing presidential election. Sorry to say that economic policy has been a disaster for many decades. It seems difficult to see promising policy changes in the near future.

The current economic situation

Before looking into the future, it may be worthwhile summarizing briefly the current state of Argentina’s economy. Here are some important indicators:

¤  GDP growth : -4.9 % Q2 (yoy)

¤  Unemployment: 6.2 % (June)

¤  Inflation (CPI): 143 % (Oct)

¤  Current account to GDP: -0.7 % (2022)

¤  Government debt to GDP: 85 % (2022)

Most worrisome among the five key indicators are high inflation and the weak development of GDP. The three other indicators look currently still acceptable.

Will developments turn better?

There are still two presidential candidates in the second election round on November 19. One is the current minister of economy, peronist Sergio Massa, mostly launched as candidate of the middle or even left. As a minister, Massa has already implied different regulations and controls of prices and imports.

The other candidate is the extreme libertarian, anarcho-capitalist Javier Milei – with lots of strange and extreme plans. Only his idea of closing down the central bank, the introduction of the U.S.dollar as Argentina’s currency and the neglect of global warming can make me scared.

After having studied the economic programs of the two remaining  candidates – the most business-oriented candidate has already failed – my political and economic worries about Argentina have not declined. It could be a good idea for the current and next President of the United States to co-operate more with this strongly urbanized and pressured country.

One hundred years ago, Argentina still belonged to the 10 wealthiest countries in the word. After this glorious time, the descente went on almost without interruption. Hard to see that the next president will achieve all the badly needed changes !

 

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

 

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