In her State of the European Union address this year, EU-Commission President Ursula von der Leyen stressed the need to rethink the European Union’s foreign policy agenda and to intensify cooperation with democratic nations (“the core group of our like-minded partners: our friends in every single democratic nation on this globe”) (Von der Leyen, 2022). Latin America plays an important role here. Thus, in the near future, the agreements with Chile, Mexico, in addition to the one with New Zealand, are to be ratified and the negotiations with Australia and India are to be advanced (ibid.). In concrete terms, this means modernising the trade part of the EU-Chile Association Agreement, ratifying the EU-Mexico Association Agreement and the free trade agreement with New Zealand. Furthermore, a comprehensive engagement strategy is to be pursued in Latin America, in cooperation with the G7, especially the USA (ibid.). Latin America thus fulfils two geopolitically important criteria for the European Commission: almost all states are democratically governed, and it is rich in raw materials, also illustrated by the action plan on the EU’s resilience to critical raw materials.
This article focuses on the economic importance of EU trade with Latin America. In total, the EU exported goods worth almost 2.2 trillion Euro to third countries in 2021. Of these, goods worth 114.9 billion Euro were exported to Latin America. This contrasted with imports from Latin America worth 98 billion Euro, resulting in a trade surplus with Latin America of 16.9 billion Euro from the EU’s perspective. As Figure 1 shows, the EU trade balance with Latin America has always been positive in the years since the global financial crisis (from 2012).
In relation to EU exports, Latin America thus plays a comparatively minor role with a share of 5.3% of total in 2021 (Figure 2). By far the most important destination region for EU exports were European third countries, which accounted for 34.5%, followed by Canada and the USA with 20%, China with 10.3% and Africa with 6.7% of the total. Other important export partners by volume are Japan with 2.9%, Korea with 2.4% and India with 1.9% of the total export volume to third countries.
Compared to 2011, the share of EU exports to Latin America in total EU exports actually fell slightly from 5.7% to 5.3%. While the volume of trade with Latin America has grown by around 23.9% since 2011, total EU exports increased by 34.3% (Figure 3). By comparison, exports to China and Canada and the US grew particularly strongly, each increasing by around 77% over the same period.
Within Latin America, the European Commission’s prioritisation reflects the relevance of Chile and Mexico for European export markets. Mexico is the European Union’s most important trading partner in Latin America, followed by Brazil (included here in Mercosur) and Chile (Figure 4).
The negotiations on the EU-Mercosur Association Agreement have been concluded, but the agreement itself is currently “on ice”. From the EU’s point of view, the main obstacle to the ratification of the Association Agreement have been reservations about environmental protection. In Brazil, which dominates the Mercosur group, environmental protection has been weakened on many levels under the Bolsonaro government, and deforestation and the further development of the Amazon region have been promoted. In concrete figures, this means that in 2021 alone, more than 13,000 km² of rainforest (which is more than the area of Tyrol) was cleared, and in 2022 even more. The agreement would take such environmental reservations into account, but as Grübler at al. (2020) conclude, that a trade agreement cannot be a better instrument for enforcing environmental commitments than an environmental treaty. Whereby such clauses are not new in themselves. Environmental clauses in free trade agreements in general have increased significantly since the 1990s (Meinhart, 2022).
With Brazilian President-elect Luiz Inácio da Silva, a new window of opportunity to ratify the agreement could open up. During his election campaign, he announced his goal of concluding the agreement within six months of his re-election, but also him wanting to renegotiate parts of the agreement. At the COP27 summit, as well as previously, he emphasised that combating deforestation in the Amazons will have the highest priority. His credibility in this respect is demonstrated by the significant reduction in deforestation under his presidency from 2003 to 2010. With a view to the European Parliament elections in 2024, where a deal seems unlikely during the election campaign, a window of opportunity opens up for both sides in 2023. The EU’s foreign trade policy is certainly facing a conflict of goals between geopolitical and trade policy interests and the goals it has set itself for the Green Deal. Latin America is a good example of this, with the great economic importance of agricultural and raw material exports on the one hand and the EU’s need for raw materials on the other. Almost 41% of Latin American exports are currently accounted for by raw materials such as rare earths and agricultural goods, and a further 17.8% (as part of the production of material goods) by the production of food and animal feed (Figure 5). In contrast, more than 95% of European exports to Latin America are material goods. The most important sectors from the EU’s point of view are machinery and vehicles as well as chemical and pharmaceutical products.
Latin America is thus relevant for the supply of critical raw materials to the European Union. For example, the European Commission expects EU demand for rare earths, currently dominated by China, to increase fivefold by 2030, and even eighteenfold for lithium. According to the EU Action Plan for Critical Raw Materials Resilience published in 2020, the European Union sources rare earths almost exclusively (98%) from China (European Commission, 2020). In contrast, for lithium, which is particularly important for battery production, Chile is the world’s largest producer and the most important supplier for the European Union (ibid.) Mexico, for example, is the largest non-Asian processor of bismuth and Brazil, likewise among the main producers of several critical raw materials. In the race with China, Latin America accordingly already plays an important role, whose relevance for the EU – especially also in the context of the current geopolitical changes – will increase.
References:
European Commission. (2020). Communication of the European Commission to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions Critical Raw Materials Resilience: Charting a Path towards greater Security and Sustainability COM(2020) 474 final, Brussel.
Grübler, J., Reiter, O. und Sinabell, F. (2020). EU und Mercosur – Auswirkungen eines Abbaus von Handelsschranken und Aspekte der Nachhaltigkeit. WIFO Monatsberichte 11/2020.
Meinhart, B. (2022). Greening Trade? Environmental Provisions in Trade Agreements. FIW- Policy Brief, (55).
Von der Leyen, U. (2022). Lage der Union. Rede. https://ec.europa.eu/commission/presscorner/api/files/document/print/de/speech_22_5493/SPEECH_22_5493_DE.pdf
Bernhard Moshammer is Economist at wiiw. His research focuses on European economic and political-economic issues. He has previously worked for the Austrian Federal Chancellery on EU affairs and on housing policies at the Austrian Chamber of Labour. He holds a degree in Economics from the Vienna University of Economics and Business and an M.A. in European Interdisciplinary Studies from the College of Europe, Natolin Campus in Warsaw, Poland.
Since the start of 2022 the euro depreciated by some 15%, beginning the year at 1.14 USD per EUR and declining below parity towards 0.97 recently. One major factor causing this decline can be viewed as truly exogenous: the war in Ukraine was unexpected and resulted in several rounds of sanctions imposed on Russia, with sizeable negative repercussions on the EU’s export volumes and impairments for active foreign direct investment (FDI) of EU-firms in Russia. The EU received a second blow through rising energy prices. Many member countries showed a high dependence on Russian gas and oil, and the Russian government deliberately used its position to generate uncertainty in spot as well as futures gas markets leading to severe risk premiums after sanctions and countervailing measures by Russia were going back and forth. Due to its high dependence on Russian energy, the euro area suffered a set-back as a business location, making the euro area less attractive for passive FDI, destroying potential output, and finally leading to a depreciation of the euro vis-a-vis areas less exposed to Russia as a trade partner.
There is a second endogenous source for the devaluation of the euro, resulting from the build-up of inflationary pressure throughout the world economy, except Japan. The US-Federal Reserve Bank (Fed) was first confronted with rising inflation rates since in April 2021 (+4.2% YoY) while inflation in the euro area at that time still remained below target (+1.6% YoY). Both monetary authorities interpreted higher inflation rates as energy driven and transitory but by December 2021 the Fed changed its opinion and corrected its forward guidance from accommodative to restrictive. The Fed first announced to unwind its asset purchase program and started to increase the target rate by March 2022, while the ECB waited until the end of July 2022 to follow suit. By the end of September 2022 the target range for the US-interest rate reached 3% to 3.25% and the euro area‘s main refinancing rate was at 1.25%, creating an interest rate differential of almost 2 percentage points.
Deviations between US and European short term interest rates were a regular feature in the past. Figure 1 shows the interest rate differential between the US-target rate and the corresponding European equivalent from 1985 through 2022. A positive value on the horizontal axis implies that US-rates were above the main refinancing rate in the euro area. The vertical axis shows the exchange rate measured in USD per EUR. The slight negative slope of this cloud indicates that relatively high target rates in the US go along with a strong US-dollar, while a relatively high refinancing rate in the euro area typically involves a strong euro. The red dots in Figure 1 show the development from January to September 2022; the movement towards the lower right hand corner reflects the more aggressive policy stance in the USA together with the appreciation of the US-dollar.
Figure 1 – Relatively higher domestic interest rates support the home currency
Starting from this situation, what can we expect for the rest of 2022 and the following year? The WIFO forecast (Glocker – Ederer, 2022) expects a further tightening of monetary policy in both areas with the ECB acting more decisively such that the interest rate differential will be reduced to around 0.5 percentage points at the end of 2023. Accordingly, the euro will appreciate slightly (green dots in Figure 1), resulting in annual averages of 1.05 (2022) and 1.04 (2023) USD per euro with a trough in fall 2022. This development can be interpreted using the uncovered interest rate parity condition: after the US-monetary tightening, the USD must jump to a lower value (appreciation) in order to keep the interest parity condition valid, thus providing room for a consecutive depreciation which balances higher US-interest rates (Dornbusch, 1976). This adjustment mechanism does not hold empirically, however (Engel, 2014). A time-variable degree of asset market segmentation (Alvarez et al., 2009) or a liquidity premium on the deposit earning higher interest (Engel, 2016) provide alternative explanations.
Does the USD-EUR exchange rate actually jump around announcements dates of monetary policy actions? Figure 2 offers some insight. The lines in Figure 2 depict the exchange rate during the 10 business days before and after a monetary policy meeting, on which either the Fed (green) or the ECB (blue) announced a change in their target rate. To facilitate comparison, I norm the exchange rate for all episodes to unity at the day of the monetary policy announcement, thus a value of 1.02 indicates that the exchange rate was 2% above the level prevailing at the announcement date. The period runs from 16.3.2022, when the Fed published the first rate-hike through 21.9.2022, when the Fed increased the target range to 3% to 3.25%. Because both central banks explicitly use forward guidance, their moves appear to be somewhat expected. While the ECB does not seem able to move markets, the Fed announcements effectively make the dollar stronger, either at the date of the publication or even five to ten days ahead. Whether the ECB policy decision on 27.10.2022 includes some surprise element for the participants on the foreign exchange market, can be tracked in real time in Figure 2 over the next ten business days following the announcement date.
Finally, will there be consequences from the euro’s depreciation on the real economy? Probably price effects will dominate over the forecast horizon. A weaker euro implies higher import prices on intermediates, energy, consumer products, and tourism services in a period already plagued by inflationary strain. Such an environment makes it easier to pass-through higher import prices on to euro area customers. Positive wealth effects related to foreign USD-denominated portfolio investments by Europeans, however, will not compensate the price losses on international asset markets during 2022. Consequently, the potential positive effect on euro area consumption will remain limited. A cheaper euro will boost euro area exports, but at the same time weak foreign demand is likely to be the dominating force affecting international trade flows.
is Senior Economist at WIFO and has been working in the Research Group “Macroeconomics and European Economic Policy” since 1994. From 1999 to 2002 he was editor-in-chief of WIFO-Monatsberichte (WIFO Monthly Reports). He is an expert in the Austrian Fiscal Council, lecturer at the University of Vienna and head of the Working Group on Economic Statistics and National Accounts of the Austrian Statistical Society. He works on issues of risk diversification, funded pensions, the European Monetary Union and econometric applications in the field of macroeconomics.
The international economic environment has deteriorated significantly since the beginning of 2022, mainly due to the knock-on effects of the Russia-Ukraine conflict, and the outlook for the global economy and global trade has clouded considerably. The energy price shock and the massive price hike, as well as uncertainty about the availability of gas, are causing dislocations above all in material goods production and exacerbating supply-side shortages due to supply bottlenecks and the aftermath of the COVID 19 pandemic. Consumer confidence and corporate production expectations are falling worldwide, most sharply in the euro zone.
Domestic manufacturing and, in particular, exports proved to be very robust in the first half of 2022 in the face of the negative influences of massive increases in raw material and energy prices, labor shortages, supply bottlenecks and high uncertainty. Austrian merchandise exports expanded strongly in the first half of 2022, with extremely dynamic growth in Q1 2022, which – despite the onset of the Russia-Ukraine crisis in March 2022 – continued only slightly weaker in Q2 2022. The growth of exports of goods reached 19.2% at current prices (nominal) and 14.1% at constant prices (real) by June 2022. The widening gap between the nominal and real trends reflects rising export prices. Austria’s goods export performance was hardly outperformed by any other EU country. Germany, France and Italy recorded significantly lower growth, but goods exports of many smaller European comparator countries, such as Sweden, Finland or the Netherlands, also grew more slowly than in Austria.
Industrial intermediate goods (“processed goods”) have so far made one of the highest contributions to growth in total merchandise exports. This was a consequence of still stable industrial production through increased production in stock with key trading partner countries in order to escape threatened shortfalls in energy supplies and further price increases. The equally high contribution to growth made by Austrian machinery exports was due in particular to strong demand from the USA. The high order backlog in the German capital goods industry also contributed to growth in Austria’s machinery exports. The contribution from energy and raw material exports was mainly price-driven rather than due to an expansion in export volumes. The otherwise important Austrian automotive and automotive supply industry made hardly any contribution to export growth. This is closely related to the crisis in the German automotive industry.
Leading indicators, which remained at a high level until the end of Q2 2022, now also point to a sharp slowdown in export momentum in Austria in the second half of 2022. In the WIFO Business Survey, exporters continue to assess order books from abroad as predominantly positive, but the share of positive reports has declined significantly since June 2022. Export expectations have been significantly scaled back for the first time since the COVID-19 crisis, and negative expectations for export business predominate. As a result, the outlook for new export orders for the remainder of the year is much more subdued. In Q3 2022, export growth should still be fed by the high order backlogs of previous months and diminishing material bottlenecks in domestic production. In the further course of the year, the negative consequences of the Russia-Ukraine crisis are likely to have an increasing impact on Austrian exports of goods. Austria’s strong ties with the CEECs and Germany, which are particularly affected by the current crisis, will contribute to this, as will the expected decline in production in Austria’s manufacturing sector due to high energy prices – especially natural gas prices. This effect is amplified by the loss of international competitiveness, especially in non-European exports – currently, European and Austrian industry faces gas prices about seven times higher than those in the U.S., for example, and competitive advantages for exporters due to the devaluation of the euro hardly outweigh this. However, the direct negative effect of energy prices on manufacturing in Austria is likely to be somewhat weaker than in Germany, especially since the natural gas intensity of Austrian industry is somewhat lower.
The forecast assumes that there will be no official business closures due to the COVID 19 pandemic in Austria or in key trading partners that would affect the export industry until 2023. It is also assumed that the Russia-Ukraine war will continue and that the sanctions against Russia will remain in place. It is not assumed that Russia will completely halt natural gas supplies to Europe, but uncertainties, especially regarding price developments, are assumed to remain and thus the level of natural gas prices will remain high. In this environment, some of Austria’s main trading partners are facing a sharp economic slowdown, which will lead to recession in 2023 in Germany, Italy and CEEC. The revisions in the international economic outlook since the beginning of the year have been enormous, shaping the forecast picture of all major international organizations (European Commission, OECD, IMF, World Bank) and reflecting the increasing distortions of the Russia-Ukraine conflict and the strikingly higher world market prices of energy and raw materials. As a result of the cooling of the global economy in 2023, the problem of bottlenecks in supply chains should subside. The situation is also expected to ease for freight rates in international transport and for the prices of crude oil and industrial raw materials.
Under these changed conditions, Austrian export momentum will decline sharply, especially at the end of 2022, but supported by the extraordinarily good performance in the first half of 2022, will lead to annual growth in goods exports of around 8%, almost matching the previous year’s growth (2021: +9.3%). At 10.0%, import prices will rise much faster than Austrian export prices (+5.9%) in 2022. The high world market prices for raw materials, energy and intermediate goods thus cause a strongly negative terms-of-trade shock, which is further amplified by the depreciation of the euro. As a result, the Austrian trade balance will be burdened this year with a negative price effect of around € 8 billion. Positive volume effects due to a smaller increase in import volumes than in export volumes will dampen this negative effect, so that the trade balance is expected to deteriorate by a total of €4.3 billion in 2022 to a deficit of approx. 17 billion in 2022.
Im Jahr 2023 erreicht das österreichische Marktwachstum auf Basis der schwachen internationalen Importprognosen für die
In 2023, Austrian market growth will only reach around 0.4% based on weak international import forecasts for its trading partners. Above all, the gloomy economic outlook for Austria’s most important export markets in the euro area and the increasing deterioration in international competitiveness make it increasingly difficult to maintain market shares, especially in energy-intensive and important parts of the Austrian export industry (chemicals, steel, paper). Exports of goods in 2023 are stagnating, as are imports. The terms of trade, i.e. the ratio of export to import prices, will continue to deteriorate in 2023, to a much lesser extent than this year, but the negative price effects will nevertheless remain the main reason for the further increase in the trade deficit in 2023 by €2.6 billion to €19.7 billion.
is Senior Economist in the research area “Industrial Economics, Innovation and International Competition” and has been working at the Austrian Institute of Economic Research (WIFO) since 1992. From 2013 to 2016, she was Deputy Director of WIFO. She studied economics at the University of Vienna and received her PhD from the University of Innsbruck. Stays abroad at renowned universities in the USA (University of California, Los Angeles, and Stanford University) have accompanied her career since then. Her research focuses on the empirical analysis of international trade issues, including foreign direct investment. The preparation of the foreign trade forecast is one of her regular activities at WIFO.
