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Retaliate, reform, liberalise: the three ways China will respond to new US tariffs

Aidan Yao says it is only natural that Beijing would strike back should Washington impose its next round of threatened tariffs, but it can also be expected to proceed with domestic reforms and a further opening of its market to outside investors, which may ultimately be to its benefit

PUBLISHED : Wednesday, 18 July, 2018, 3:03pm
UPDATED : Wednesday, 18 July, 2018, 10:33pm

The US administration’s proposed tariffs on US$200 billion in Chinese exports have taken Sino-US trade tensions to a new high.

The 10 per cent blanket tariffs will cover an extensive range of Chinese products. The collective economic effects of the US$200 billion, plus the previous US$50 billion, are likely to be worth 0.3-0.4 percentage points of China’s gross domestic product growth.

However, the subsequent hit to exporting companies, plus the reverberation from the financial market correction, could amplify the second-order shock. The news elicited a sharp reaction in markets, with both Chinese equities and the yuan tumbling.

Though the tariffs are not yet a done deal, Beijing is expected to alter macro policies in three ways.

First, once the final list of tariffs is determined, Beijing is likely to fire back. China has a smaller universe of goods it buys from the United States (US$130 billion last year) but can match the value of tariffs by imposing a higher tax rate than 10 per cent. This would create a reciprocal shock for the US economy.

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Also, bear in mind that even without China’s retaliation, the US will inflict pain on itself with its new round of tariffs. According to China’s General Administration of Customs, more than 12 per cent of the top 100 China-based companies in terms of US trade are actually American companies.

About 70 per cent are non-Chinese firms, with Taiwanese names accounting for more than 30 per cent. This reflects China’s entrenched position in the global supply chain, underscoring the global ramifications of the US-China trade disputes.

Second, the rising trade risk will add to the urgency for domestic policy changes. The interaction of an export slowdown and accumulating domestic growth pressure will strengthen the case for more policy fine-tuning.

The People’s Bank of China cut the reserve requirement ratio last month to mitigate liquidity risks created by deleveraging and the new asset management law. Since then, easing signals on regulation of wealth management products, anti-pollution and deleveraging have all surfaced.

Beijing has also dispatched its inspection team to check on the fiscal positions of local governments. In contrast with previous years, the team will find that local authorities have underspent relative to their targets. Instead of running a deficit, with net spending of around 2.4 trillion yuan (US$359 billion) – or 2.6 per cent of GDP – the government has accumulated a surplus of almost 400 billion yuan this year.

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This austerity, combined with the tightening of private-public partnership projects, has been the root of the tumbling infrastructure investment. Should downside economic risks deepen, fiscal firepower should be unleashed.

While both monetary and fiscal stimulus can be deployed, this will not be a case of flooding the market with liquidity and re-enacting a massive infrastructure build-up, which would undo the good work on deleveraging and consolidating local government finances, still the main thrust of Beijing’s risk management operation.

Unless domestic conditions worsen to such an extent that they pose a systemic threat, the government should be able to keep its composure by fine-tuning policies, not outright easing.

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Finally, Beijing is expected to further liberalise its market and economy to diversify trade and strengthen domestic demand. If the Sino-US trade dispute has a silver lining, it must be the urge for China to accelerate structural reforms.

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Internally, recent developments (for example, sanctions against ZTE) have revealed China’s Achilles’ heel in technological development, creating an urgency for domestic firms. More fiscal support, along with a strengthening of intellectual property rights protection, could help China accelerate its rebalancing towards tech-driven growth.

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On the external front, Beijing has accelerated market liberalisation. By opening up the domestic financial system, cutting tariffs and reducing hurdles for foreign direct investment (FDI), China is embracing more, not less, interaction with the outside world, unlike the protectionist US.

Ironically, the latest data shows that FDI from the US to China jumped almost 30 per cent year on year in June, suggesting that some companies (for instance, Tesla) are looking to invest more in China to circumvent Trump’s tariffs.

A trade war is unequivocally bad for global trade. But with an economy rebalancing towards domestic consumption and tech-driven growth, China could use it to its advantage.

Aidan Yao is senior emerging Asia economist at AXA Investment Managers

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