Sherillyn Raga (Senior Research Officer, ODI)
5 July 2019
Last weekend, the G20 Leaders discussed a range of important global economic issues from innovation to climate change, among many others. Of particular interest to many, however, was how the G20 Leaders might apply political pressure to halt the ongoing US-China trade tension, given its impact in and beyond G20 member countries. This blog examines how a prolonged trade war might spillover to non-G20 low and middle income countries through lower global demand, changes in bilateral trade patterns, possible dumping and changes in relative exchange rate positions, and hence prospects for economic transformation. To address the possible consequences of the trade war, regulators should consider calibrating targeted sectoral interventions and forward-looking policy toolkits, diversifying external trade and investment partners, and building fiscal and balance of payment space moving forward.
Trade war spillover channels: short-term risks, medium-term implications
While the G20 Leaders Declaration emphasises the importance of a “free, fair, non-discriminatory, transparent, predictable and stable trade and investment environment”, the Leaders were unable to convince Presidents Trump and Xi to end their protracted trade dispute. Given the size of these two economies, persistent trade tensions will inevitably disrupt growth and prospects of economic transformation in the following ways.
Moderated global demand and activity
A worsening of the trade war and an increase in retaliatory tariffs will drive up prices of imports and goods with intermediate imported inputs, consequently lowering US and Chinese consumption. The US and China alone are responsible for 22% of global imports and contribute 40% to global GDP. Lower US and Chinese consumer demand will thus drive down export production and investments abroad, reducing overall global income and activity. This is reflected by the deceleration in global economic growth which coincided with the imposition of US and then Chinese tariff increases in 2018, from 3.8% in the first half to 3.2% in the second half of 2018.
The IMF estimates that the current trade spat will cost 0.5% of global GDP in 2019. If the planned US-China tariffs are extended to all traded products from both countries, the IMF expects that global output will be further reduced by 0.3% in 2020. Continued weak global performance and outlook can disrupt the momentum in high-productivity exports, foreign direct investment and global value chain (GVC) firms, thereby affecting the process of economic transformation globally.
Change in bilateral trade patterns
While the global economy will lose out in net terms from the US-China trade war, Chart 1 shows some exporters are well placed to gain temporarily. For example, US imports from Vietnam rose by 40% year on year (yy) over the year to January – April 2019, while US imports from China fell by 13% during the same period, according to the Financial Times. In particular, as of the second quarter of 2019, processing of industrial products and manufacturing is Vietnam’s fastest growing sector at 9.15% growth yy, followed by services at 6.9%, and agriculture at 2.9%–an indication of how the trade war is accelerating the movement of Vietnamese resources to high productivity sectors. Overall, the ADB estimated that if the US-China trade war escalates further, Vietnam could potentially gain up to a cumulative of 2% of GDP in the next 3 years primarily because Vietnam exports many of the Chinese products affected by the US tariffs. Cambodia’s garment manufacturers were also assessed to gain from the trade war, and this may have contributed to the 32% yy growth in the value of Cambodian export goods in 2018. While statistics are pointing to gains for Cambodia and Vietnam, analysts suggest these gains may be short-lived because of domestic risks, such as Cambodia’s high labour costs, lack of business-supporting infrastructure and relatively lower productivity as well as the risks surrounding Vietnam’s real-estate boom and higher dependency on foreign capital.
Meanwhile, China’s imports from the US sharply moderated to 0.9% growth in 2018 from 14.2% growth in 2017. China’s tariffs targeted mostly US agricultural products such that trade diversion is evident in the 63% quarter on quarter growth of China’s largely soybean imports from Brazil in the last quarter of 2018. Even prior to the US-China trade war, Brazil was a top global soybean exporter. In anticipation of added demand from China, Reuters reports that Brazil’s soy plantations have expanded by 2 million hectares, while sugar cane land have shrunk by nearly 400,000 hectares. Brazil is consequently at risk of“de-industrialisation” as a result of shifting its resources to agriculture. Since this shift is focused heavily on soybeans, the absence of vertical and horizontal diversification could make the Brazilian economy vulnerable.
China’s export oversupply and dumping in developing countries
If the changing bilateral patterns have led to the sourcing of tariff-affected imports from sources other than China and US, then who will consume American agricultural exports and Chinese intermediate manufactured goods? In the US, soybean prices have become much cheaper and those that cannot be exported are mostly stored. The government has also earmarked US$12 billion to help its farmers weather the fall-out. But what about excess supply from China?
One possibility is to offer China’s excess exports to other markets at very competitive prices, including below the price at which these products could have been sold in the Chinese market (i.e., dumping). Supply of relatively cheaper imports not only increases a country’s trade deficit, but importantly, also pushes consumers away from relatively expensive domestic counterpart products. This depresses prices in the import-competing sector, creating a trigger to lay off employees or shut down operations if firms cannot absorb the impacts of competition. This is already happening in India, where an Indian Parliamentary report from July 2018 estimated that dumping of Chinese solar panels resulted in a loss of 200,000 jobs. The report also suggested that an increase in Chinese import shipments across various sectors has forced several micro, small and medium-sized enterprises to exit the market—a setback to India’s target of stimulating its manufacturing sector to at least 25% of GDP.
Exchange rates and risks of financial market contagion
The US has a trade deficit with China (i.e., US imports more than they export to China). At least by magnitude and in the medium-term, the decline in tariff-affected US imports from China will more than offset the loss in US export revenues due to China’s retaliatory tariffs. This will narrow the US trade deficit and induce dollar appreciation. A stronger dollar will strain payment of foreign-denominated debt, especially for countries that already have high levels of debt. As of May 2019, 6 out of the 7 LICs considered to be in high debt distress and 12 out of 25 LICs considered to be at high risk of debt distress are in Africa.
Conversely, the Chinese Renminbi (RMB) is expected to weaken with the decline of export receipts from the US. This is reflected by movements in the real effective exchange rates in July 2018 when US and China first began to raise tariffs (Chart 2). A weaker RMB makes Chinese products more competitive compared to the rest of the world. This puts pressure on other emerging market currencies to depreciate, especially value chain suppliers to China and Chinese competitors. Given the high exposure of East Asian countries to China and their relatively flexible exchange regimes, currencies in the region have been able to absorb the shock and closely followed the movement of RMB against the US dollar (Chart 3).
However, if tariffs are extended to all traded products between China and US, further depreciation in East Asian currencies will dampen investor appetite for emerging market assets in general. As investors reallocate their portfolios amidst trade uncertainties, fast-moving capital would first be withdrawn from investments in high-risk markets (mostly in LICs) and moved to safe havens. In the case of South Africa, the stock market index lost more than 3% and the Rand depreciated by 4% month-on-month in May 2018 following the US’ hike in tariffs for US$200bn worth of Chinese imports. If global business optimism continues to decline, capital may also flow out from government bonds and FDIs—investments that are critical for sustaining public services and creating jobs in many LICs.
How to address the effects of the US-China trade war in the poorest economies?
An effective, rules-based international trading system would prevent such trade disputes and unfair practices. But as the G20 Summit outcome suggests, even an economically powerful group such as the G20 leaders can barely put pressure on Presidents Trump and Xi to change their respective sovereign policies on trade. With no strong signal of an end to the trade war in sight, we suggest the following approaches for low and middle income countries:
Calibrate a targeted and forward-looking policy approach. While it is tempting for developing economies to weaken their currencies to counteract possible competition or dumping, caution is important. Apart from raising exports, a weak currency also drives up import prices, and this move can be inflationary for net-food importers, a grouping which includes many countries in Africa. Public policies should support productivity-enhancing exports and manufacturing sectors that are directly affected by the trade war. Such policies could include expanding credit lines or providing incentives to sustain operations and investments in technology and skills amidst the trade war. The use of forward-looking policy toolkits such as macroprudential regulations and capital flow management are targeted approaches that can also reduce specific vulnerabilities in the financial sector.
Diversify external partners. China is increasingly becoming a major trading partner, source of FDI, and creditor to governments in African and less developed Asian countries. For these countries, it is unsurprisingly hard to manoeuvre policy options economically and politically, for example, for Uganda to raise the issue of dumping against China. One solution is to balance sources of growth, capital and trade through other bilateral and regional partners. In the case of Africa, boosting partnerships with countries and groupings beyond the US and China, including the African Union/African Continental Free Trade Area and Commonwealth is a starting point.
Build buffers. Developing countries and LICs are structurally diverse and hence external shocks affect economies differently and through various channels. Moving forward, a very effective strategy to shield a country from the unintended consequences of non-economic disturbances is to have buffers (e.g., ample foreign reserves, healthy fiscal balance position) that provide space for monetary and fiscal policies to support high productivity domestic sectors and ensure economic transformation is not derailed by unfavourable external (and in the case of this trade war, also political) developments.
 This scenario is more probable at least in the short-term while traders from both sides are holding decisions (e.g., whether they will relocate, divert trade, or change preferences) and government do not intervene heavily in the foreign exchange market.
Photo: Flags of the G20 nations. CC BY-NC-ND 2.0.