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The Year of the wRATh

March 3, 2020 | Expert Insights

Impact of the US-China Trade War 

The rising power of China, economic, technological and military, has been a source of concern to the reigning world power, the U.S. For the last few years, there has been bipartisan cries in the U.S. to "decouple" the American economy from the Chinese.

On Friday, July 6th, 2018, at exactly 12:01 am, the U.S. fired the first shots in a new kind of hybrid war. They weren't missiles or drones, but tariffs worth billions aimed at the core of Chinese National Power-its economy. Consequently, the Chinese manufacturing Purchasing Manager's Index (PMI) showed a slowdown suggesting that small and mid-sized firms were seeing a sharper deterioration. The policymakers tried to address it through special loan programmes and lowered operating costs. The Central Bank of China injected $109 billion into the economy, and in 2019, the yuan was devalued below the landmark seven per dollar threshold. 

Enter the COVID – 19 Shock

However, the coronavirus more than the trade war is speeding up the so-called “decoupling.”  The outbreak disrupted international supply chains with inventories running out as factories remain locked down.   Since the advent of the trade war, the GDP growth had fallen to 6 per cent; the Wuhan Fever has induced further economic harm. 

China’s manufacturing sector is facing a multitude of challenges as virus containment efforts hinder factories' attempt to reopen. Many of the factories that have been granted permission to resume operation face a shortage of personnel and raw material. Those who managed to overcome these challenges have found that trucking, shipping and freight services are thin on the ground. 

Foreign tech brands that had already decided on shifting its factories from China elsewhere due to tariffs and trade tensions have reinvigorated their efforts. For example, Google and Microsoft intend to restart their production from Southeast Asian nations. Amazon, whose e-commerce business relies on the flow of goods between China, the U.S. and other countries, is stockpiling supplier items. 

One thousand six hundred fifteen force majeure slips have been issued by China's Council for the Promotion of International Trade so that affected companies can avoid penalties for not meeting contractual obligations.  The total contract value of these slips is more than $15.8 billion. Twenty-two million businesses — or 90% of all active businesses in China have been affected, which would impact at least 56,000 companies around the world with suppliers either directly or in the first and second tiers.

Consumer spending is critical for the economy and was responsible for   60 per cent of growth last year. Consumer spending on food and drink alone has fallen by about US$59.7 billion.  Caged in homes, online spending, on entertainment and educational services, has spiked and could offset some losses.  The estimated drain on the economy could be as much as 1.38 trillion yuan.

Travel and Tourism is a big money spinner in China.  Tourism contributes to 2.1 per cent of the Chinese GDP and employs 22.5 million directly and 65 million indirectly. The combination of an unprecedented quarantine on people in affected areas of China and restriction on inter-city and international travel has brought the travel industry to a virtual standstill. 

The health emergency could also prevent China from honouring the commitments in phase one deal with the U.S. China had promised to buy at least an additional $12.5 bn worth of farm products in 2020.

Lessons from Earlier Outbreaks

In 2003, the SARS pandemic led to a global economic loss of $40 billion and up to $55 billion during 2009 H1N1 swine flu pandemic. But China’s economy back then was booming at 10 per cent after having joined the WTO and only saw a drop in the second quarter. The economy was also not facing cyclical, structural headwinds posed by slowing population growth. After the SARS epidemic, China adopted a fiscal policy which included tax cuts to help the recovery of affected sectors. China is running large fiscal deficits and has less room to apply a similar stimulus. It has planned to inject $22 billion credit to shore up money markets as well as less stringent borrowing terms for Chinese companies. 

According to Goldman Sachs economists, “past viral outbreaks have typically resulted in short, sharp shocks to economic output," lasting one to three months, with a return to previous levels of activity within two or three quarters.  They predict a lowering of GDP to 5.5 percent down from their earlier forecast of 5.5 percent. It is feared that in case of a longer-lasting epidemic, the slump could be 5 per cent or lower.

The outbreak has led to a sharp hike in unproductive expenditure.  Central banks have allocated $12.6 billion to spend on medical treatment and equipment while banks have cut interest rates in the worst-hit areas. The Bank of China has permitted delay in loan payments in Hubei province.  

Assessment 

  • The trade war erupted due to the American desire for decoupling from the Chinese supply chain. The CONVID-19 epidemic has reinforced the belief not to be dependent upon a single mega supplier like China, despite the short-term economic gains.  Since there is bipartisan support on this issue in the U.S., China may see a greater flight of industry and investment from its shores. "Politics is trumping economics, health, and safety in both countries”. 

  • China is a nation with deep pockets, and even in the midst of the crisis, the principal concern is the government's control of the economy. Historically, China's economy has been very resilient and was able to rebound from setbacks. It is an international creditor, and almost all of its borrowings are in renminbi. The Chinese government is rapidly shifting its focus from fighting the coronavirus to an orderly resumption of economic activity.  The epidemic is showing a definite downturn in terms of new infections in China. If this trend is maintained, the government will be able to get a handle on the economy sooner than was being predicted.

  • The authorities can also pursue more expansionary fiscal and monetary policies, even if such measures are not designed to soften the blows of supply-side shocks.   Although inflation has risen but tightening macroeconomic policy at this point would be counterproductive.

  • China’s focus on soft power, such as education has attracted talented people from across the world. The high-tech scientific research hubs established by China at huge costs have many highly qualified expatriates.  With the spread of the virus, it is not likely for people to take risks, especially since there has been a continuous outbreak of diseases which may impact China’s technological rise.

Image Courtsey: cnet.com