21 Aug 2018

Since the turn of 2018, a series of measures initiated by the Trump administration has triggered an ugly trade battle on several fronts. The United States (US) has not only locked horns with numerous countries across the world but also against the WTO and the multilateral trading system as a whole. Trump’s zero-sum world view of global trade is suggestive that this ongoing battle is here to stay.

US versus Rest of the World

With the US going down the path of aggressive unilateralism, several countries, including Mexico, Canada, India and China, have struck back to safeguard their own interests.

The European Union (EU), for instance initially threatened to respond with tariffs on US$7.1 billion worth of goods from the US, a part of which was implemented in June. However, the EU and the US appeared to have brokered a temporary deal, whereby the EU has promised to step up soybeans and liquefied natural gas imports from the US while the US in return would refrain from slapping a planned 25 percent tariff on imports of European cars.

Canada announced tariffs on about US$12.8 billion in American goods which took effect on July 1. Emerging markets like Mexico headed in a similar direction, targeting US products worth more than US$ 3 billion. India also raised import duties on US nuts and other items.

Reactions from Japan has been rather mild so far but there are signs that they may take a more aggressive stance too in the near future. Korea, however, in an effort to pre-empt joining the battle, has offered concessions in their Free Trade Agreement (FTA) with the US by agreeing to open up their auto market in return for being exempted from steel tariffs.

China’s reaction has been the most watched as the US measures are aimed at that country. Initially, China increased tariffs on about 128 US products by up to 25 percent. The US subsequently focused on China’s intellectual property (IP) practices accusing them of IP theft and proposed tariffs on about 1300 industrial technology, transport and medical products from China worth US$50 billion. Simultaneously, China has strategically attempted to offer better market access to competitors of American firms in China from the EU and elsewhere.

The retaliation cycle has continued to date, with the latest salvo from the US being that it will impose an additional 10 to 25 percent tariffs on US$200 billion worth of Chinese imports and China following suit by releasing a list of $60 billion in U.S. goods that Beijing intends to hit with retaliatory tariffs. Notwithstanding the Trump administration’s fallacious fixation about trimming down US trade deficits as the reason behind slapping import tariffs, the US tariff barriers targeted at China are likely to affect a significant share of products and firms that are part of global supply chains. About 95 percent of them focus on parts and components or on capital goods like machinery used in domestic production in the US, whereas China’s tariffs on US imports appear to be predominantly on agriculture products, lumber and renewables.

Trade to Currency Wars?

To make matters worse, there are growing concerns that the ongoing trade war could descend into a broader currency war. Indeed, in the August 1st post monetary policy press briefing, the Reserve Bank of India (RBI) Governor, Urjit Patel, noted that "the trade skirmishes evolved into tariff wars and now we are possibly at the beginning of currency wars.”

The recent weakening of the Chinese Renminbi (RMB) to its lowest level in over fifteen months against the US dollar (and to a lesser extent on a trade-weighted basis) has fuelled speculations that China is intentionally devaluing the RMB to counter the impact of rising US tariffs. An RMB depreciation may likely offset some of the tariff impacts but there are worries that it could create a “domino” effect with other countries following suit. Indeed, President Trump tweeted about his belief that currency manipulation was pervasive across the rest of the world, taking away the competitive edge of the US.

However, it is far from clear as to whether the RMB depreciation can be deemed deliberate. The weakening could well be in part due to a hike in US interest rates as well as China’s own efforts to ease its monetary policy through injecting more liquidity into its troubled banking system in the broader context of its softening economy. Even if currency movements are being driven by cyclical policy divergences and bearish sentiments due to an intensifying trade war, it remains to be seen if China will actually intervene to prevent its currency from falling further – something it did in 2016 when faced with a similar situation and what it has consistently favoured whenever there have been signs of currency instability more generally.

If a series of depreciations were to occur in the region, it could likely destabilise countries in Asia both due to imported inflation and the relatively high levels of US dollar denominated corporate debt accumulated by many Asian firms, not unlike the case of other emerging economies like Turkey whose currency has taken a battering in recent days. Although several Asian economies are better placed than Turkey in terms of the foreign exchange reserves buffer needed to absorb such shocks, Turkey’s vulnerabilities and a looming crisis have stoked fears of a possible contagion. The worst scenario being that if a currency war turns into a currency freefall in Asia, interest rates will need to rise to stabilise the currencies, leading to significant economic slowdown.

Despite the global economy being quite buoyant, the IMF and others have emphasised that one of the biggest downside risks to this positive scenario is the prospect of an impending global trade conflict. As Maurice Obstfeld, the outgoing IMF chief economist observed recently, trade turbulence could derail this recovery prematurely, with escalating commodity prices pushing up inflation, hurting consumers, disrupting global supply chains and dampening private sector confidence while increasing uncertainty amongst businesses.

First to feel the pain?

Asian economies that are significantly export-dependent as well as those that export intermediate goods to China such as Taiwan, South Korea, Malaysia and Singapore will likely be most impacted in the first round. If the tit-for-tat trade war is escalated and prolonged, it could lead to a notable disruption of supply and distribution chains and one can expect a consequent decline in foreign investments. If such an event occurs, then all countries in Southeast Asia that are heavily dependent on foreign direct investment (FDI) like Singapore will be especially negatively impacted in the second round.