While much of the attention over the past few months have been on the Iran war and oil prices, the world of trade is navigating a number of structural changes that extends far beyond the Middle East. On one hand it’s the latest wave of Trump tariffs that we spoke about last week and on the other hand, it’s the ‘trade battle’ between the European Union and China. On the backdrop of a heavily volatile global landscape, international trade has been under somewhat pressure and countries are increasingly looking to reduce dependance and adjust trade imbalances that could potentially come back to bite them sometime down the line.
In such a context, how the EU and Chinese decide to play this out remains key not only to the domestic players of the two regions but also to those who lie in between those supply chains that connect the East and West.
What’s the big worry?
Immediate concerns of the EU – similar to the US – is circled around the massive trade imbalance China runs against the bloc which has resulted in increased competition, forced de-industrialization and a number of different issues both lawmakers and businesses in the EU have had to deal with. The EU’s trade deficit with China roughly doubled in five years from 2020 to 2025. In 2025, China’s trade deficit with the region reached a record USD 1.2 Trillion! It was a massive eye-opener for the bloc as ALL member states recorded a trade deficit with the country for the first time. The trend continues into this year as well. According to latest figures, China’s June trade surplus with the European Union reached a record USD 32.9bn, up 27% from a year earlier.
From Europe’s perspective, the core issue is China’s industrial “overcapacity.” China is ramping up production capacity across a number of industries including electric vehicles, batteries, solar technology, critical minerals, and advanced tech enforcing increased competition for EU businesses. Specific countries face specific issues that have put domestic players under pressure. For instance, despite traditionally excelling in the capital goods sector, German manufactures are now under constant pressure as a result of Chinese manufacturing prowess coming into the space. Italy’s metalwork and machinery industry is also facing severe competition and have continuously called for better measures to protect domestic firms.
What looks to be EU’s strategy?
Driven by heavy state subsidies and large-scale production advantages, Chinese companies’ expanding presence in Europe has unsettled European businesses and pushed policymakers in the bloc to respond.
At the last EU summit, leaders gave the European Commission a mandate to develop a diversification instrument aimed at reducing European businesses’ reliance on foreign suppliers for critical goods. Discussions of “global economic imbalances” – a euphemism for the China problem – was a key topic in the recently concluded G7 summit as well. Denis Redonnet, the European Commission’s chief trade enforcement officer says that both structural and contingent trade protection measures have and will be implemented to curb the surge in Chinese imports including anti-dumping and anti-subsidy investigations alongside so-called ‘safeguard’ measures aimed at protecting EU businesses. Tariffs – particularly on Chinese EV’s and closely monitored quality standards continue to play a central role in EU’s protectionist measures.
How may China respond?
China enters into this landscape under heavy scrutiny – not only by its trading partners but also by international organizations such as the IMF and World Bank who have kept a close eye on its structural balances over the years. As a result, the country is also looking to re-shape its economic engine by taking various measures to boost domestic consumption and better navigate its growing surpluses. Alongside the battle against EU, Beijing is also having to deal with high pressures stemming from US as well.
Looking at how the country may respond to the measures taken by the EU, similar to how they did with the US, tariffs seem to sit at the bottom of the retaliatory ladder. Another prominent step taken by the Chinese are the heavy export controls imposed on rare earth minerals - a market that China dominates accounting for roughly 70% of global mining, and 90% of the world’s refining capacity AND could possibly bring European automotive and defense production to a halt within a matter of weeks!
However, given how high-level talks have progressed and the context in which the global trade landscape stands right now, it appears that even though the possibility exists, any extreme measures are just too costly for any party involved.
What does this mean for Sri Lanka?
For Sri Lanka – similar to many players who lie in between these East-West supply chains, the specific policy and trade measures taken by both China and EU could bring about a number of different and new opportunities and costs. For instance, as the EU tightened access to its market through tariffs, export controls and trade defense tools, the possibility of Chinese products flooding local markets is something domestic players might need to keep an eye out for. Similarly, new opportunities and developments may surface particularly to those players who are connected to global trade routes as countries increasingly look to reduce dependency and diversify trade with the intention of long-term sustainability.