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World – Macro-economic scenario 2024-2025
It may seem odd to stick an ‘extension without disruption’ label on an economic and financial scenario beset by political uncertainties of varying intensity, which will be removed either sooner (legislative elections in France) or later (US presidential election). Whereas the second event is likely to significantly structure/alter a scenario’s major plot points, the first is less likely to wipe out the backbone of a quarterly global scenario.
In the Eurozone, growth is still expected to accelerate, underpinned by private consumption. The cracks showing in the US seem unlikely to drag down growth, which could once again prove its staying power – just as inflation has done as we reach the end of this deflation road.
In the US, the resilience that characterised the 2023 economy actually hung on into early 2024. Coupled with the booming job market, reduced short-term sensitivity to interest rates (balance sheet repair, persistently low cost of debt) meant growth could better absorb monetary tightening, which turned out to be the most aggressive in decades. And while the negative impact of monetary policy has been much less brutal than was feared, it has not vanished. Its effects play out over time. Corporate debt is up, to be refinanced at higher rates in 2024 and 2025; actual mortgage rates are climbing back up; defaults on other types of debt (credit cards, auto loans) are on the rise; surplus savings (specifically in lower-income households) have dried up; and savings rates have declined quite a bit. These are the first cracks still forecasting a mild recession as 2024 flips to 2025. After 2.5% in 2023, our scenario is based on growth of 2.0% in 2024 and just 0.4% in 2025: declining growth paired with an alternative scenario in which the economy is likely to once again display surprising resilience. In line with a soft slowdown paired with an upside risk to growth, the slide in inflation should continue on a gradual and uneven trajectory, leaving inflation higher than its target until the end of 2025.
In the Eurozone, though European elections have confirmed the overall balance in the European Parliament’s representation, uncertainty about the vote in France is ushering in a downside risk. Estimated as ‘politics as usual’ before the French National Assembly was dissolved, our central scenario does not include this risk and does retain its key assumption. The principle of accelerated growth driven by private consumption remains, despite the cautious approach consumers are still taking and a deflationary process that promises to be rocky in 2024.
The decline in inflation – the benefits of which are already visible – is now a little less easy and a little less clear. Inflation is hanging on, owing mostly to its inertia in services, which reflects delayed pressures on payroll costs, connected to the late recovery of past losses of purchasing power in wage negotiations. And lastly, though consumption is the prime mover of this recovery, it may bring a bit brisker external demand with it, buoying Eurozone GDP by 0.8% in 2024 and by 1.5% in 2025.
Rather than the ‘pivot’ the markets were waiting for, it has focused on the ‘plateau’. And now this is a matter of extending that plateau before easing later.
Obviously, there are few hopes that the ‘American obstacle’ will be quickly removed, a constraint especially for some emerging countries; inflation numbers indicate that it is merely moving toward its target slowly, that growth is holding steady, and that the labour market is solid despite recent signs of weakening – all of which calls for prudence.
The Fed will need a little more time to be convinced that inflation is on a clear path toward 2%, and a little more time before it goes ahead with a first cut to its key rate. That could happen in September and would likely be followed by another reduction in December, bringing rates down by a total of 50bp in 2024. In 2025, easing could be more aggressive, totalling 150bp over the first three quarters. However, this kind of projection hinges on a relatively pessimistic economic scenario. If the economy and the labour market hold up better than expected, the Fed may adopt a more gradual pace.
The US status quo has not prevented the ECB from starting to cut rates. It will continue unless there is strong downward pressure on the EUR or a much clearer recovery, especially if it is more inflationary than expected.
Core and headline inflation are expected to reach 2% during H225 and allow the ECB to extend the rate relief that began in June, when it cut rates by 25bp. Our scenario points to gradual and ongoing easing, with the ECB lowering its deposit rate by 25bp every quarter until September 2025 to bring it back to 2.50%, our estimate of the neutral rate.
Indeed, the monetary easing theme has been floating around for a long time now. Whether it has already begun or is on the horizon (or being delayed, as in the US), easing is no guarantee that interest rates will fall. Several factors, including the widespread risk of inflation and the possible increase in the neutral rate, argue for stable or even slightly higher rates.
In the US, our bond yield projections have been nudged upward all along the curve. We currently expect 10-year Treasury yields to be 4.30% at the end of 2024, then 4.05% at the end of 2025. The upward revision of the long-term yield signalled in the dot plots deserves a look: stuck at 2.50% between 2019 and 2023, it was raised for the second consecutive FOMC, from 2.5625% in March to 2.75%. Such a nudge speaks of the possible increase in the neutral rate, which may be linked to factors like deglobalisation and slowing demand for Treasury bonds from world central banks, sovereign funds and national financial institutions.
In the Eurozone, the ECB began cutting its key rates and is expected to continue. The markets are fully pricing in this monetary easing cycle and expect the deposit rate to fall back near 2.50%. Amid a relatively optimistic outlook on European growth and persistently high public deficits (an excessive deficit procedure is affecting Belgium, France and Italy, all of which must present a debt-reduction plan by September), European sovereign yields have little chance of declining, especially if the Fed delays the start of its own easing cycle. Our scenario is for a German 10Y yield of about 2.65% at end-2024.
With spreads tight, adding a political risk premium (with no risk of redenomination) has resulted in a widening French spread compared to the Bund of up to 80bp. This OAT-Bund premium will continue to fluctuate according to the political uncertainties that will not necessarily be removed at the end of the election in the absence of a clear majority.
Next come some unique stories such as the political risk for the Eurozone, the worsening fiscal situation in Latin America or, on the contrary, the favourable carry for some Asian and European currencies. Our scenario calls for a modest depreciation of the EUR, to USD1.05 at the end of 2024.
Where is the median European voter from and what do they want?
As announced during our webinar European elections: continuity or change? on 17 May 2024, the elections of 6 to 9 June confirmed the overall balance of power within the European Parliament.
With 26.4% of the vote and 190 elected Members of the European Parliament (MEPs), the European People’s Party (EPP) gained 14 seats compared with the outgoing Parliament and asserted itself as the main European political force. The median European voter is now an EPP voter, whereas in 2019 they were a Renew Europe voter.
The EPP has stabilised its position in Germany, where it has its largest contingent with 30 MEPs, and Spain, where it gained 9 seats (returning 22 MEPs). It made progress in Poland (up from 16 to 23 seats) and Hungary (up from 1 to 8 seats), establishing itself as a credible alternative to Viktor Orbán’s party. Conversely, the French and Italian contingents were reduced (down 8 seats to 6 and down 12 seats to 9 respectively).
The social democrats of S&D polled 18.9% and limited their losses to three seats, managing to hold on to 136 MEPs. Their biggest gains were in France and Italy, where they increased their number of seats from 7 to 13 and from 15 to 21 respectively. Meanwhile, Germany’s socialist contingent lost two seats, returning just 14 MEPs.
The liberal-centrist Renew Europe group suffered the worst defeat, returning only 80 MEPs, compared with 102 in the outgoing Parliament, and just 11% of the vote. The biggest losses were in the French contingent, which lost 10 seats, holding on to just 13, and Spain’s Ciudadanos, which was nearly wiped out, holding on to just one seat out of a previous 9. The German liberals of the FDP gained one seat to become the group’s second-largest contingent after France.
The outgoing “grand coalition” (PPE, Renew Europe and S&D) thus lost 11 seats but, with 406 MEPs, held on to a 44-seat majority.
The Greens’ group, which often votes with the majority, suffered heavy losses, losing 19 seats, mainly due to the collapse of Germany’s Greens (returning 16 MEPs, down from 25) and France’s Verts (down from 12 to 5 MEPs). Conversely, the Greens made progress in Denmark and Sweden.
The far left gained 2 MEPs; with 39 MEPs, it might be able to change the configuration if it joins forces with other parties.
The real winners in these elections were the parties to the right of the EPP: the conservatives of the ECR (European Conservatives and Reformists) and the identitarians of ID (Identity and Democracy), which together won a further 16 seats. Compared with pre-election polls, these gains may appear limited. Above all, the expected collapse of the EPP and corresponding shift to the ECR and ID did not materialise.
With 76 seats, the ECR is now the fourth-largest European political force. Its progress is mainly down to the Italian contingent from Fratelli d'Italia, which won 14 more seats and now has 24 MEPs, making it the group’s main party ahead of the Polish PiS, which lost 7 seats (down from 27 to 20).
ID now has 58 MEPs, compared with 49 in the outgoing Parliament, mainly thanks to the progress of France’s National Rally, which gained 12 seats, and the Dutch and Austrian contingents, which gained 6 and 3 seats respectively, making up for the loss of 14 seats by the Italian contingent from Lega.
Parties not registered with a parliamentary group lost seats, in particular Hungary’s Fidesz party and Italy’s Five Star Movement (M5S), which lost three and two seats respectively. Meanwhile, Alternative für Deutschland (AfD), recently kicked out of the ID group, significantly boosted its presence (from 12 seats to 17) and is now Germany’s second-largest political force, with 15.9% of the vote, behind the CDU but ahead of the SPD.
Forty-four new MEPs from new small parties not yet affiliated could redraw the boundaries of existing parliamentary groups. The large national contingents of Fidesz and M5S could appeal to certain groups, while AfD’s radicalisation should see it relegated to a more solitary role. The groups that look the most fluid are those to the right of the EPP. However, the fault lines between the pro-NATO and pro-European Union PiS and Fratelli d'Italia in the ECR group on the one hand and the more Russophile and Eurosceptic parties of the ID group (National Rally and League) on the other make any union between these right-wing groups a complicated prospect. Such a union would, however, constitute the third-largest political force, ahead of Renew Europe. Voting agreements are very likely in some areas (such as immigration).
It will be the EPP, then, that dictates Europe’s political line, with the option – admittedly a complicated one – of forming an alternative political alliance to its right. However, a so-called “constructive” right-wing coalition with Renew Europe, the EPP and the ECR would not command a majority, requiring support from ID. The EPP has therefore quite naturally turned to its historic coalition allies, affirming that voters have mandated it to work with the parties with which it has the most common ground in terms of values: commitment to the European Union, respect for the rule of law and a pro-Ukraine stance.
What is emerging is an EPP leadership built around a centrist consensus: a coalition agreement aimed at setting a clear direction not dictated by how the Parliament happens to vote, especially with votes more scattered than in the past. But the EPP has also sent its partners a clear message: the vote of confidence by EPP voters is not a backward-looking vote but rather a vote for the future. The EPP is thus calling for a break with past policy, in particular to take into account questions of security and citizens’ income. It is also calling for policy to be clarified in three areas: energy transition, agricultural policy and innovation policy.
The EPP’s coalition allies have answered the call, but on one condition: there is to be no alliance with the far right. Renew Europe has said it is ready to work on what the groups have in common, notably security issues, support for Ukraine and strengthening the single market. The S&D group wants to make the Green Deal more “social” and work on a “Made in EU” strategy. It accepts the idea of the coalition platform being expanded, but only to include the Greens.
The first test for this coalition will be the vote on the presidency of the European Commission. While the coalition has in the past demonstrated a high level of voting discipline (around 90%), discipline has always been lower when voting for the president of the European Commission (around 80%). This time, though, the Spitzenkandidat principle means we can expect greater cohesion. Ursula von der Leyen is the candidate of the party that won the most votes, unlike in 2019, when her candidacy was put forward by the centrists after they refused to support the EPP candidate. A deal seems to have been struck at the last European Council meeting at the proposal of Ursula von der Leyen, with a balance of parties across the various institutions being ensured by the candidacies of Portugal’s António Costa (S&D) for the European Council (whether for half a term, followed by a member of the EPP, or for a full term remains to be defined) and Roberta Metsola (PPE), to be followed by Katarina Barley (S&D) for a full term, as president of the European Parliament. Renew Europe could secure the post of High Representative for Foreign Affairs with Kaja Kallas and the NATO presidency with Mark Rutte.
Ursula von der Leyen should, in theory, ensure a degree of continuity in the work of the Commission and could provide S&D and the Greens with reassurance as to the continuation of the Green Deal. However, judging by her last State of the Union speech, she seems to have taken on board growing resistance to the green agenda. She will therefore be forced to deviate from a regulatory agenda which, during her last mandate, had moved forward at a very sustained pace, ultimately promising to deliver a very attractive European green market.
Now that the regulatory framework is in place, the task of the next Commission will be to work towards creating the conditions needed to ensure that green production in the EU can be profitable in the short to medium term and maintaining a low-carbon manufacturing base in Europe. The right and the liberals should therefore be able to find common ground on leveraging the single market’s potential, innovation, and boosting competitiveness, and the social democrats will be able to join them on strengthening green industrial policies, protecting the single market and ensuring an inclusive transition.
But who will seize the political initiative? France’s loss of influence in all political groups in the European Parliament, with the exception of ID, will have implications for the Franco-German axis, which has come out of the elections weaker in both the European Parliament and the European Council. Will it be able to be as much of a driving force as in the past? Shifting alliances between countries are probably going to be more frequent than before.
India: a lacklustre win for Narendra Modi
At the end of a six-week electoral marathon marked by intense heat waves in the north of the country, India’s 650 million voters delivered their verdict: yes to a third term for Narendra Modi, prime minister for the last ten years, but no to the supermajority he was seeking, which would have given him carte blanche to govern as he saw fit. The voter turnout rate was 66%, compared with 67% in 2019.
Neither fraud detected in several states, nor the freezing of the Congress Party’s accounts, nor arrests of opposition figures, nor the campaign’s extreme violence, notably against Muslim communities, nor fake exit polls predicting a huge majority for the BJP (Bharatiya Janata Party), nor the personal involvement of Modi, who took part in over 200 meetings, could change the course of the election.
Even though the opposition, united around the Congress Party under the INDIA banner (Indian National Developmental Inclusive Alliance), did not achieve its goal of preventing Modi from winning a third term, it is set to have won 234 seats, compared with 240 for the BJP, 63 fewer than it previously held. The “saffron wave” expected by Modi, who had been hoping to win between 370 and 400 seats, failed to materialise.
Worse still, the BJP did not even secure an absolute majority (272 seats) and is thus going to have to rely on its allies (53 seats) to govern. The bitterest defeat came in the party’s stronghold of Uttar Pradesh, India’s most populous state lying in the country’s northwest, where the BJP and its allies won just 36 seats, compared with 64 in 2019.
Initial negotiations with two key regional leaders, Nitish Kumar from Bihar and Chandrababu Naidu from Andhra Pradesh, are already underway, but their support is likely to come at a heavy price and does not preclude a degree of instability over the next five years. Ultimately, the Modi camp has emerged much weakened from these elections, which show just how resilient Indian democracy can be, despite the attacks on it these last few years.
A big win for the BJP would have allowed Modi to push through sweeping constitutional change, notably concerning the role of the Hindu religion in Indian society, and further exclude the Muslim community (around 200 million people).
Whereas the BJP focused its campaign on community polarisation and the person of Modi, the INDIA alliance decided to hone in on economic issues – a strategy that paid off.
Despite India’s impressive growth figures, its population is still waiting to feel any tangible benefits. In the 2024 tax year (March 2023 to March 2024), GDP increased by 8.2%, a record level that should, according to Modi, be seen as “a foretaste of what’s to come for India”. But specialists in the Indian economy regularly call these numbers into question, saying the authorities have a tendency to overestimate performance.
It should be noted that the Indian economy has still not been able to create enough jobs to meet demand from new entrants into the labour market. Some 813 million Indians still rely on food aid (5 kg of cereal a month per person) to be able to feed themselves and 60% of the population lives on less than $5 a day.
While the official unemployment rate hovers around 7%, the proportion of working-age women in work remains extremely low at 26%, compared with 74% of working-age men. Half the population still derives its sole income from farming, while 42% of young graduates are unemployed. Informality rules, with only one out of every ten Indians having an employment contract and the social safety net that comes with it.
These last few years, the agricultural sector has not been spared by climate change, with harvests hit by heat waves, drought, flooding and invasive pests. While the monsoon accounts for around 80% of annual rainfall, the unpredictability of its extent and timing is undermining the structure of India’s agricultural sector, which mainly relies on small farms averaging only just over 2.5 acres.
Faced with falling yields as well as higher operating costs, particularly as a result of the surge in energy prices since the start of the war in Ukraine (oil accounts for approximately one third of India’s total imports), Indian farmers are locked in a tug of war with the authorities to try to get them to expand the floor price mechanism, which already applies to some cereals, to other agricultural products. Yet this issue, of key importance in a country where only just over 40% of the population lives in urban areas, was not at the centre of the BJP’s campaign. The loss of many seats in the mostly rural state of Uttar Pradesh indicates that voters are mainly worried about the economy rather than Modi’s anti-Muslim crusade.
With inflation tending to exceed the central bank’s target (between 2% and 6%) and food products making up half of the consumer price index, the issue of keeping a lid on prices remains just as central as that of jobs and labour market integration for young people and women.
Labour market weakness is partly a result of decisions by the authorities to focus public investment on relatively non-labour-intensive sectors (mining, energy and services, particularly in new technologies), with the result that added value has risen much faster than employment in some sectors. The industrial sector accounts for only 26% of added value and jobs, compared with 40% and 32% respectively in China. Industry is often key to a country’s development trajectory: as well as being labour-intensive and helping formalise and structure the labour market, it offers a way into international trade.
India still has a long way to go on that score: even though it still accounts for less than 2% of total global exports, the import tariffs it imposes remain well above those in force in other Asian economies that are its direct competitors in areas like assembly, electronic devices and goods related to climate transition. The upshot is that, while India may appear to be a central element in a strategy of diversifying production sites away from dependence on China, investors are put off by the large number of tariff and non-tariff barriers to entry and see it as a market that’s hard to break into.
Lastly, as a result of the previous points and the uneven distribution of recent growth gains, inequality has exploded in India under Modi, who has strongly favoured a few major families, chief among them the Adani family, implicated in a huge corruption and fraud scandal. Public investment linked to concessions (airports, roads and ports) has been focused on a handful of operators. The result is that 1% of India’s population owns 40% of the nation’s wealth: more than in the United States or even Brazil, one of the world’s most unequal countries. And therein lies the source, no doubt, of some of the frustration that’s been expressed at the ballot box over the last few weeks.
UK – 2024 General Elections
The British will be heading out on 4 July to vote in early general elections. Polls predict a victor for Labour that could see the party take a large majority in the House of Commons. Labour has adopted a new philosophy centred on security (aka "securenomics"). On the domestic front, it is planning far-reaching supply-side reforms with a particular focus on private investment.
Xi Jinping visits Hungary, an economy in remission
After visiting France and Serbia, the Chinese president was in Hungary from 8 to 10 May. His visit was an opportunity for the two countries to strengthen political and economic ties: way back in 2004, before Viktor Orbán et Xi Jinping were leaders of their respective countries, Hungary and China entered into a “friendly cooperative partnership”. However, it was only when Orbán came to power in 2010 that Hungary began to see China as a key partner in its economic development.
In 2017, the two countries came together in a “comprehensive strategic partnership”. Hungary was also one of the first countries to participate in Chinese initiatives in Central and Eastern Europe such as the Belt and Road Initiative (BRI) and the “16 + 1” cooperation forum1. The country very quickly derived tangible benefits from this strategic choice, notably in the form of infrastructure construction loans. China and Hungary have also entered into agreements to strengthen their trade ties. However, while Hungarian exports to China were growing, most of the commercial benefits were going to China. Over its first few years, the effect of this partnership on Hungary’s economy was thus far from what one might call decisive.
And yet, despite global geopolitical tensions, Hungary’s prime minister has maintained course: during this first visit by Xi Jinping, the relationship between the two countries was elevated to an “all-weather comprehensive strategic partnership for the new era”. And for good reason: in the post-Covid era, the bilateral relationship has kicked up a gear in a way that is very valuable to Budapest, with private Chinese foreign direct investment (FDI) into Hungary taking off. The success of China’s electric vehicle sector, combined with fears of tariff tensions between the European Union and China, presents Hungary with an opportunity that’s hard to turn down after so many years of investing in such a partnership. According to the government, €16 billion-worth of Chinese FDI has already flowed into Hungary, mainly in the electric vehicle and battery sector.
This investment is all the more important given the economic shock suffered by Budapest by way of its external balances: Hungary has been one of the European countries hit hardest by the inflation crisis, notably because of its reliance on Russian gas, though rising food prices and the weak forint have also played a part. Now, in the first half of 2024, disinflation is underway but the process remains slow: after averaging 17.6% in 2023, inflation finally fell back below 4% in the first quarter of 2024. This allowed the central bank to cut interest rates as early as October 2023. However, persistent political and geopolitical tensions have weighed on the forint. Services are now the main driver of inflation overtaking energy and food. This all means the process of monetary easing will have to be a slow one.
The upturn in growth thus remains fragile (with growth expected to come in at 2.3% in 2024 and 3.4% in 2025, compared with -0.9% in 2023),making Chinese investment all the more significant. Rising real wages are supporting domestic demand, while the recovery in European demand and the opening in 2025 of production facilities financed by Chinese FDI should support exports. When it comes to investment, divergent factors are at play: slow fiscal consolidation has led to the postponement of some public investment in 2024 (worth 0.8% of GDP ) and interest rate hikes in 2023 have filtered through to construction, hampering real estate investment; on the other hand, European funds (worth 7% of GDP) will enable public investment to bounce back, while FDI, notably from China, will support private investment.
Since 2020, public finances have suffered due to slowly falling expenses: while the public deficit has fallen, it is still high and, to add to the uncertainty, the government is struggling to map its future trajectory. Above all, the government is doing little to boost revenue, which has been falling as a proportion of GDP since 2015 (down 5.8 points), and has done nothing to offset rising expenditure. At the same time, Hungary’s reliance on Russian energy and tensions with the EU have made Hungarian debt more expensive.
Turning to its external accounts, Hungary had a large external deficit in 2022 as a result of the energy crisis (-8.3% of GDP) but posted a current account surplus in 2023 (0.2% of GDP) as inflation and the weak forint suppressed domestic demand.
Chinese investment has come at just the right time to stabilise Hungary’s external balances and revive growth. The country hopes to harness the influx of FDI to develop a strong new manufacturing sector focused on exports and move up the value chain towards activities with a larger R&D component. Alongside these foreign direct investments, Hungary continues to secure funding from Beijing for infrastructure that will help Chinese products access the European market: a planned Budapest rail bypass linking the east of the country, where new Chinese production facilities are located, with Western Europe was announced during the Chinese president’s visit. Meanwhile, a rail link between Belgrade and Budapest, financed by a $2.1 billion loan as part of the BRI, is still under construction2. Lastly, as the Hungarian government puts the finishing touches to the renationalisation of Budapest airport, the big three Chinese airlines (Air China, China Southern Airlines and China Eastern Airlines) have reportedly shown an interest: they would like to use it to develop direct links with China for their air freight operations. Hungary has thus opted to act as a bridgehead for Chinese industry within the EU…
Yet Hungary remains primarily reliant on the European Union, both for its public investment programmes – notably to finance its energy transition – and in terms of trade. But recent years have brought increasing tensions with the EU. These relate not only to Hungary’s institutions (respect for the rule of law, judicial independence, freedom of the press, corruption) but also to geopolitics (NATO expansion, support for Ukraine and its accession to the EU, sanctions against Russia). As a result of these disagreements, the EU has made the release of a portion of European funding for Hungary (worth 18% of GDP) subject to conditions3. The stance adopted by the Orbán government, which oscillates between working to undermine European institutions and pursuing a bargaining strategy, thus poses significant risks. While rating agencies appear relatively optimistic that European funding will eventually be forthcoming, there are two main factors that could encourage Orbán to adopt a tougher stance: (i) domestic politics in Hungary and (ii) new European allies who could exercise their influence following the European elections in June. While Hungary’s relationship with China is not currently central to its quarrels with the EU, a number of factors (US elections, Chinese trade practices, the relationship between China and Russia) could lead to a hardening of EU-China relations.
On top of this, Hungary is also reliant on Russia. The government says its official stance towards Russia, in light of its energy interests, is neutral. Yet, despite some efforts to do without Russian gas, Hungary’s decision to press ahead with a Russian-built nuclear power station to help it navigate the energy transition creates major vulnerabilities that will play out throughout the construction process and beyond.
Our opinion – Hungary’s multi-alignment with Europe, China and Russia means it runs the risk of being multiply dependent. Yet the European Union is still the Hungarian economy’s most vital partner in all areas (fiscal and commercial, in the short, medium and long term). Its relationship with China is thus a development choice that carries risks. Should a scenario of geopolitical hardening come to pass, these risks would quickly crystallise. For example, Hungary’s European and US allies could attempt to impose a forced realignment. Meanwhile, the possibility of Donald Trump – a staunch ally of Viktor Orbán – winning a second term as US president in November 2024 is a much more uncomfortable proposition for the Hungarian government than might currently appear to be the case.
China: the increase in US import tariffs is first and foremost a political issue
The decision was not long in coming: after saying he was considering imposing new tariffs on some Chinese imports, last week Joe Biden revealed which products will be affected. Addressing an audience of trade union leaders, the US president condemned China's deceptive trade practices and said higher tariffs on $18 billion-worth of Chinese goods – around 4% of total Chinese imports into the US each year – had been "carefully targeted at strategic sectors" to enable US companies to consolidate their market position.
These measures come on top of a long list of tariff and non-tariff barriers imposed since the trade war broke out between the two countries in 2018. The Peterson Institute for International Economics, a research organisation, estimates that 66% of Chinese exports to the US were already subject to customs duties averaging 19.3% before these latest announcements. The signing of the Phase 1 agreement and the election of Joe Biden did nothing to smooth the waters; indeed, condemnation of China's trade practices is one of the few areas of bipartisan agreement in the US.
Unsurprisingly, with the US presidential election just six months away, the products affected are among the most emblematic of China's output of manufactured goods: solar panels, electric vehicles, batteries and semiconductors as well as steel and aluminium, on which the Trump administration had already imposed import tariffs. Although the US trade deficit with China has fallen since 2018 – as has China's share of total US imports, down from 19% in 2018 to 14.8% in 2023 – it was still high in 2023 at around $280 billion. Above all, it seems those countries that have benefited from the reconfiguration of supply chains, chief among them Mexico – which, since 2023, has regained its place as America's biggest trading partner – and Vietnam, are also serving as intermediary platforms that help Chinese products circumvent import tariffs and restrictions, rather than genuine loci of production.
Aware of this circumvention, US authorities have so far not taken any particular steps to ascertain just how much Chinese added value is transiting through third countries. The North American Free Trade Agreement (NAFTA, between Canada, the US and Mexico) is due to be renegotiated next year and this could pave the way for more checks, especially if Donald Trump wins the presidential election.
The new import tariffs apply to products and sectors targeted by the Inflation Reduction Act, where US authorities are pursuing a strategy of reindustrialisation, starting with the entire electric vehicle industry (from critical minerals through to finished vehicles and batteries), which has been the main focus of media attention over the past few months.
While the increase in import tariffs on Chinese electric vehicles is the most impressive measure, it is primarily a defensive move: Chinese inputs account for scarcely 2% of total US electric vehicle imports. US authorities, which are still struggling to bring inflation to heel, have been careful to ensure that higher import tariffs – usually passed straight on to end consumers – will not lead to a fresh upturn in consumer prices.
For example, the measures concerning minerals exclude those of which is China is a critical and essential supplier. Meanwhile, China’s solar panel industry is so price-competitive that higher import tariffs are unlikely to stop Chinese products being cheaper than their American and European counterparts.
However, if the European Union were to apply a similar tariff to electric vehicles, this would hit China much harder: in 2023, the European market accounted for nearly 40% of Chinese electric vehicle exports. Images of thousands of cars at the Port of Antwerp-Bruges highlight the scale of the offensive by Chinese manufacturers, for whom the European market has become a vital outlet for selling off surplus production and rebuilding their margins and cash positions, severely eroded by the price war that has been raging between manufacturers over the last few months.
While Xi Jinping repeated during his visit to France that "there is no such thing as China's overcapacity problem", Commission President Ursula von der Leyen took a harder line, saying the European Union could not accept "unfair trade" resulting from huge subsidies and would "not hesitate to make firm decisions" to "protect its economy and security".
The conclusions of the report commissioned by the European Commission on subsidies in China's automotive sector are due to be unveiled on 5 June and could result in higher import tariffs as early as July. With sales of electric vehicles already slowing in both China and the European Union, that would be a significant setback for Chinese manufacturers. Ursula von der Leyen did, however, say European tariffs would probably be "more targeted" than those imposed by the United States. If the increases were of the order of those that usually follow this type of investigation, import tariffs would rise from 10% to 20% – enough to hurt but not completely wipe out the price-competitiveness of Chinese vehicles.
China hit back by announcing that it had launched an anti-dumping probe, first into wine-based spirits like cognac – mainly targeting France – but also into polyoxymethylene copolymer, an engineering plastic used in phones, vehicle parts and medical equipment. China also opened the door to potential tariffs on agricultural products, including in particular dairy products subsidised under the EU’s Common Agricultural Policy (CAP), even though it does not produce enough food to feed itself and remains heavily reliant on imports in this sector.
Although China’s minister of commerce has announced that China "opposes the unilateral imposition of tariffs which violate World Trade Organization rules" and "will take all necessary actions to protect its legitimate rights", in reality it has less room for manoeuvre than this rhetoric suggests. In 2018-2019, China retaliated by imposing higher import tariffs on US products, starting with energy commodities (oil, propane) and food commodities (soya, cotton, fruit and vegetables, etc.). Fifty-eight percent of US products are already subject to tariffs averaging 21.1%.
The remaining products are mainly high value-added industrial goods (aircraft, machine tools, semiconductors) of which there are sometimes few substitute suppliers. Even though inflation is much less of an issue in China than the rest of the world (China’s problem is more how to escape deflation), hiking import tariffs on these highly specific products could cause difficulties for parts of China’s production industry.
Another potential option would be to reimpose and tighten restrictions on exports of metals and rare earths, on which the US remains reliant. These measures were mainly aimed at countering multiple bans imposed by the US to prevent patents and technologies linked to the semiconductor sector being transferred to China and enabling the country to catch up in this area.
Lastly, China could manipulate its exchange rate to boost its competitiveness and offset price rises resulting from import tariffs. However, this option appears to lack plausibility. While China’s central bank has allowed the yuan to depreciate against the dollar over the past few months, which has also helped support exports, it seems unlikely that it would take deliberate action to further weaken its currency, especially in an interest rate environment that is highly unfavourable for China. Yuan depreciation could also trigger fresh capital outflows.
Our opinion – In the US, taking a firm stand against China has become an election issue. By announcing his intention to increase tariffs on all Chinese imports to 60% if he were to win the election, Donald Trump forced Joe Biden to clarify his position on the issue and take further action. While the measures announced by Biden have been carefully targeted so as to (i) maintain continuity with previous measures, (ii) target sectors already covered by the Inflation Reduction Act and (iii) limit, as far as possible, the impact on inflation for US consumers, most importantly they pave the way for Europe to take a firmer stand. With the conclusions of multiple investigations into Chinese subsidies in various sectors (wind power, solar panels, electric vehicles) not expected for several months, the EU could decide to increase import tariffs in the next few weeks.
In the mid-1980s, when the US trade deficit with Japan was at an all-time high, the US succeeded in forcing Japan to allow the yen to appreciate (the Plaza Accord of 1985) and Japanese car manufacturing sites to relocate to the US. The issues surrounding China are similar but the context has changed, with a purely economic rationale eclipsed by geopolitical issues of a more global nature. Joe Biden is also showing his environmentally friendly credentials by saying he wants the US to be able to control the chain of production linked to the climate transition. But if Donald Trump were to return to power, this could herald a renewed and more violent trade war and a return to basic protectionism with little regard for climate issues.
What on earth does the South Pacific have to do with Azerbaijan?
Diplomatic relations between France and Azerbaijan have deteriorated over the last few months. However, it is to no Western state’s strategic benefit to have a prolonged disagreement with Baku, as is demonstrated by the cautious diplomacy in play over Armenia: with Azerbaijan both the key to the Caucasus and a critical link in Europe’s energy security chain, this is a region where geopolitical realism rules.
Baku is “meddling” and this meddling is “extremely harmful”. So said Gérald Darmanin after a New Caledonian separatist elected official signed a memorandum of collaboration with the Azerbaijani Parliament. Then there is the involvement of Tavini Huira’atira (formerly the Polynesian Liberation Front) in the Baku Initiative Group, created to “stand against colonialism”, which also counts among its members separatists from French Guiana, Martinique and Guadeloupe. As for Corsica, the Azerbaijani Parliament has quite simply called for its independence. In short, all this merely highlights the deterioration in relations between France and Azerbaijan, with Baku accusing Paris of having taken Armenia’s side after Azerbaijan invaded Nagorno-Karabakh and selling ground-to-air defence equipment to Armenia last October (it also accused India of supporting Armenia) – just as Baku was carrying out joint military exercises with Turkey near the Armenian border. Since then, a Frenchman has been detained, diplomats have been expelled and France’s ambassador to Baku has been recalled. Azerbaijan’s diplomatic relations with the United States have also deteriorated to the point where the US Congress was recently rumoured to be planning sanctions (non have materialised to date). This threat no doubt played a part in the subsequent release of a political prisoner and the resumption of telephone consultations between Washington and Baku.
Security, stability, connectivity?
Regardless of the diplomatic choices of a country ranked in the bottom third globally for civil liberties (by both Reporters Without Borders and Transparency International), it is to no Western state’s strategic benefit to have a prolonged disagreement with Baku, as is demonstrated by the cautious diplomacy in play over Armenia: with Azerbaijan both the key to the Caucasus and a critical link in Europe’s energy security chain, this is a region where geopolitical realism rules.
The government in Baku has long seen its strategic geographical location – at the crossroads between Turkey, Iran and Russia – as an asset, dreaming of Azerbaijan as a regional centre for trade with hopes of one day graduating from having the economic profile of an emirate to that of a hub. Even the World Bank is convinced, forecasting that trade will treble between now and 2030, provided existing obstacles – in particular corruption, administrative inertia and traffic congestion – are removed. It must be said, however, that Azerbaijan has never yet managed to turn this ambition into reality. But there are two game-changers that could act as geoeconomic catalysts. One is the war in Ukraine, which has highlighted the importance of circumventing Russia. The other is the conquest of Nagorno-Karabakh and, above all, peace talks with Armenia, which could dispel the threat of conflict.
Country risk: two key questions
It remains to be seen whether Baku will succeed in creating an oasis of stability in a geopolitically tumultuous region (with Georgia in particular meriting close monitoring) and whether the strength of its geographical position will be enough to offset the institutional inertia that has hampered the country’s development thus far. These are the two questions that will frame country risk assessments. Meanwhile, Azerbaijan’s sovereign profile is secured by its external surpluses, its public debt, equivalent to less than 30% of GDP, and its record buffer of $56 billion from SOFAZ, the State Oil Fund of the Republic of Azerbaijan. This cash cushion will also enable the country to fund investment in Karabakh. In fact, with net currency assets estimated at 67% of GDP, Azerbaijan is the leader in its sovereign peer group: as far as its sovereign debt profile is concerned, you have to look really hard to find anything to worry about. The focus of risk analysis is not quantitative, then; rather, it is on the informal areas of diplomatic relations, reputational risk and the government’s ability to not only mark out a development trajectory but deliver on it.
Despite its oil and gas wealth, Azerbaijan’s growth potential (around 2% a year) remains constrained by high levels of corruption, centralised administrative and political control and rising military expenditure – propelling the country from 16th to 9th place in a global ranking of economic militarisation1 between 2017 and 2022. With the economy vulnerable to volatility in its energy income, the need to diversify remains, though it has become more resilient to shocks (volatility is one of the weaknesses in its sovereign rating).
The war in Ukraine has strengthened Azerbaijan’s position as a pivotal country
Baku now has more geopolitical room for manoeuvre, enabling it to pursue a Turkish-style policy of multi-alignment: its 2022 gas agreement with the European Union (a “reliable” partner according to Ursula von der Leyen) has not destroyed its relationship with Russia (with numerous meetings between Gazprom and SOCAR since a Russian gas delivery agreement was struck). But this multifocal diplomacy means Western investors are forced to navigate grey areas that their own governments will not help them manage: reputational risk over the treatment of not only Armenians but also journalists and political prisoners; the risk of sanctions over the country’s relations with Russia; and the risk of geopolitical instability if new borders with Armenia are not agreed. For regional stability to be a credible proposition, regional peace must first become credible. We’re talking about thirty years of conflict… but we’re also talking about the first peace process to be set in motion in a world on fire. That’s no small thing! The fact remains that none of this is properly priced in by rating agencies, which struggle to accurately reflect such geoeconomic complexity.
What makes the situation even more complicated is that everyone is seeking to woo Azerbaijan. This year’s COP29 will act as an institutional shop window for a country that has shown little commitment to transition (with oil and gas accounting for 90% of exports, 48% of GDP and 53% of government revenue). And then there’s the sixth World Forum on Intercultural Dialogue, held in Baku at the beginning of May. Azerbaijan is also a member of the Shanghai Cooperation Organisation and is developing its diplomatic relations with China. Above all, though, Baku is pursuing pan-Turkic diplomacy in Central Asia, as a member of the Organization of Turkic States, and cultivating relations with Ankara, its oldest ally (the first country to recognise its independence) – so much so that its President, Ilham Aliyev, describes the Azerbaijan and Turkey as being “one nation, two states”. Numerous infrastructure projects are in the offing (including a new pipeline to reduce Nakhchivan’s reliance on Iran). The two countries have a shared goal of regional connectivity as a driver not only of growth but also of cultural unity and solidarity in a Turkic world that is increasingly making itself noticed by assert its geoeconomic existence. This emergence of the Turkic world as a geopolitical reality is one of the consequences of global geopolitical fragmentation.
Keeping an eye on the Zangezur corridor…
Between Nakhchivan and the rest of Azerbaijan lies not only Armenia but also the planned Zangezur corridor, which would give Turkey access to Central Asia via the Caspian Sea without having to pass through Georgia or Iran, both of which heavily tax Turkish trucks. The corridor’s strategic importance, previously masked by the conflict with Armenia, is now becoming clear. It is also of interest to Russia, which is keen to strengthen relations with Ankara and gain access to Armenia. Above all, Zangezur is one of the segments of the Middle Corridor that links China to Europe while circumventing Russia, and could play a hugely important role in trade and energy security in the region (i.e. Europe). It is, however, a worry for Iran because it lessens the latter’s economic importance, with some Iranian journalists even dubbing it a “NATO corridor”. It’s also a worry for Georgia, which it bypasses. And it’s a risk to Armenian sovereignty, especially since Baku is reportedly not against the idea of Russian troops guaranteeing its security. All this makes Zangezur a political wildcard that could drive faster regional integration but could also shift the balance of power in an already fragile region.
…as well as the long north-south route
It is therefore vital that Europe monitor these major shifts in regional infrastructure in its energy storehouse, both from east to west and from north to south. With the sort of irony that usually accompanies sanctions, the anti-Russia bloc is speeding up links along three routes that form part of another corridor, between Saint Petersburg and Mumbai, one of which runs through Azerbaijan (the highway to Russia is open). Moreover, India’s foreign minister has indicated that the Houthi blockade of the Red Sea makes this north-south route even more attractive to Delhi. The Middle East conflict is also finding its way into the Caucasus both via Iran and through relations between Baku and its drone supplier, Israel, which it in return supplies with energy. It should also be noted that Turkey has, out of geopolitical realism, reportedly not blocked shipments that pass through its ports on their way from Azerbaijan to Israel.