Uncharted Waters: The Effects of the Trade War on China’s Economy

September 3, 2018 admin 0 Comments

The trade war will have a minor effect on China’s immediate growth; however, the full weight of the trade measures will be felt towards the end of 2018 and well into 2019. The side effects of rising business uncertainty, declining market confidence and supply chain disruption may exacerbate China’s preexisting economic challenges. While these are all prevalent concerns, things are far from bleak. In addition to Chinese businesses diversifying their trade channels and the government’s continuous pursuit of growth-fostering policies, other factors such as a devaluing currency and increasing domestic consumption may be able to prevent China from falling into a worse outcome.

Analyzing a country’s diverse economy is hardly ever simple, especially when the said country — as the second largest economy — is engaged in an escalating trade war with the world’s largest.

In order to understand the impact of trade tensions on China’s economy, elements to keep an eye on include the response of domestic enterprises, economic policies pursued by the central government, key short-term indicators and the ability for MNCs to engage in the Chinese market.

China’s economic growth has already been slowing well before the trade war began, with growth rates beginning to plateau two years ago. In addition, credit growth and expanding debt has been a central cause of concern for authorities.

To offset fears of China entering a middle-income trap (where a country’s wealth gets stuck at a certain point), the government has earnestly pursued long-term growth initiatives. One of these initiatives is in domestic high-tech development, encapsulated in Made in China 2025 (MiC2025) — a plan which aims to transform the country into an advanced manufacturing power. This has led to increased scrutiny over China’s growth (and its practices in achieving it), with several US organizations and officials even claiming that MiC2025 poses an existential threat to US technological advantages. As such, the added effect of US tariffs deliberately seeking to limit Chinese technological growth cannot be overlooked.

In regard to currently observable effects, US tariffs have yet to make a direct impact on China’s economy thus far. Recent occurrences such as stock market drops, a weakening currency and the continuing slowdown of growth all point to a more volatile economic outlook, but none of these can be fully attributable to the trade war. Any direct effect will be more prominently felt towards the end of 2018 and certainly in 2019.

With Chinese exports to the US reduced, it is possible for other countries to cut into the share of the US market that Chinese goods currently hold, compounding on shrinking investor confidence. On the flip side, the same applies for US goods entering China. Chinese enterprises have already begun diversifying import sources, most notably in the soybean market (a side effect of the conflict is that smaller, emerging economies will receive greater export demand). Thus far, it appears that Chinese procurement substitutions have been moderately successful.

From the purview of the central government, macroeconomic reforms that have already been laid out will likely be reinforced and accelerated. Along with adhering to long-term plans like MiC2025, efforts such as state-owned enterprise reform, increasing exchange rate flexibility, reducing taxes (corporate and personal) and liberalizing domestic regulations will be closely followed. Policies and guidelines that mitigate unemployment and financial risks will almost certainly be prioritized. It may, however, take some time before the success of these policies can be fully assessed.

As for short-term indicators, there are two that highlight China’s ability to stay afloat in the trade war: the devaluation of its currency and increasing domestic consumption.

First, with the renminbi/yuan projected to fall past 7 against the dollar in 2019, it would make Chinese goods cheaper for US buyers — potentially offsetting the competitive disadvantage posed by tariffs. It is up for debate whether this is market-induced or government-caused. Second, the main engine of the Chinese economy has been shifting from exports to domestic consumption in recent years, with consumption contributing to nearly 78% of 2018’s first quarter growth. The further this shift continues, the less reliant China would be on exports for growth.

To close, the effect on Multi-national Corporations (MNCs) within the Chinese market (or those seeking to enter it) will heavily depend on how they position themselves and what they can offer to boost the Chinese economy. While Beijing has officially taken a friendlier stance towards foreign companies, there nevertheless remains a number of potential obstacles that can be interpreted as retaliation against US companies — in essence, an asymmetric response against US tariffs. US-based MNCs may find themselves subject to additional scrutiny around business operations, as well as delays or even cancellations of deals that involve government approval. These are obstacles that some argue were recently faced by Qualcomm and Facebook. Companies that are based in Europe or elsewhere, in comparison, may find relatively more favorable deals and easier operations.

 

By Lance Yau, Senior Associate at Weber Shandwick Beijing

Data Sources: BloombergCNBCEconomic DailyTrading Economics

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