SINGAPORE (Mar 4): With the US Federal Reserve getting cautious on raising rates and China pump-priming its economy, many of the big risks confronting Asia appear to have been contained.
Investors also have high expectations of one of the most important issues facing Asia — relations between China and the US. Will Chinese President Xi Jinping and US President Donald Trump reach an accord that actually resolves their two countries’ trade dispute? And, if so, what are the implications for the rest of Asia?
A substantial deal on trade is increasingly likely
Trump’s announcement that he would delay the further increase in tariffs he had threatened to impose on Chinese goods is a sign that weeks of high-level talks have been productive. Further confirmation of the positive trend came in the form of the planned summit meeting between Xi and Trump in March — it is unlikely that the two leaders would have agreed to meet unless there was a very good chance of an agreement. Chinese Vice-Premier Liu He and US Trade Representative Robert Lighthizer seem to have prepared the ground for a deal. So, while unresolved issues remain, they are not likely to be too difficult to overcome.
There is thus a high probability of a reasonably substantial trade deal emerging in a few weeks’ time. This is because both sides see it to their advantage to agree to a deal.
- It appears that China has been prepared to make concessions it had not been ready to make last year. Trump has indicated that the agreement that was taking shape would cover contentious issues such as how China managed its currency. China has also been willing to discuss structural issues in its economy, such as its industrial policy, technology transfers, agriculture, services, treatment of state enterprises as well as foreign investors and intellectual property protection. Xi is willing to make these concessions because he has realised that the Chinese economy could falter in the face of a trade war. He is also, rightly, confident that his political dominance will allow him to overcome any nationalist reaction to compromising with the US.
- The Americans, too, appear to have been willing to offer China enough incentives to allow them to make these concessions. Some media reports claim that American and Chinese negotiators may even have found ways to compromise on technology issues such as the US campaign against China’s telecommunications giant, Huawei Technologies. Indeed, Trump revealed that he was not comfortable about efforts by some in the US to pursue “blocking out” China’s 5G technologies. He commented instead that he would rather the US win the technology race through fair competition.
Of course, some things could still go wrong. In particular, Trump could find anti-China hawks lobbying hard against making concessions to China. For instance, several senior officials in the White House, including Secretary of State Mike Pompeo and National Security Advisor John Bolton, are keen to maintain the pressure on China through such measures as a ban on US companies purchasing gear from China’s tech giants such as Huawei. The hawks could also insist that an agreement could only be sealed if China agreed to enforcement mechanisms and penalties against itself for not adhering to the US’ terms. It is possible that China could find such demands too onerous to accept.
Still, our view is that Trump wants an agreement so as to demonstrate to his electoral base that he is delivering on his election mandate. It is likely that he will overcome such opposition as there is within his team.
Short-term relief for Asia
In other words, we will soon have a trade agreement that will prevent an escalation of the tit-for-tat trade measures that both sides were engaging in last year. With a trade war averted, business confidence around the world will improve. This will help release spending that had been deferred because of the huge uncertainty that the US-China trade tensions had created. Investment in new production capacity that had been kept on hold will be released and new orders for manufactured goods should rise to the benefit of Asian exporters.
This uplifting of business confidence would be especially helpful for China, whose economy has been in a more precarious condition. As we can see from the surge in Chinese stock prices in recent days, prospects for a large swathe of the Chinese corporate sector will improve with a trade deal. The Chinese economy has been responding only slowly to the increasingly aggressive stimulus measures that policymakers have been implementing — one reason being the lack of confidence in the corporate sector arising from fears of a trade war. With confidence particularly in China’s private sector restored, the stimulus packages are likely to be more effective.
As Chinese demand for imports rises in response to this recovery, prices of economically sensitive commodities exported by Asian countries should rise — such as thermal and cooking coal (Indonesia and India), rubber (Thailand, Vietnam, Indonesia and Malaysia) and base metals such as copper, nickel and aluminium (Indonesia and the Philippines).
Moreover, with markets already anticipating that the Chinese economy would regain traction, downward pressures on the Chinese renminbi have reversed and the currency has appreciated. This has relieved the pressure on emerging Asian currencies, which have also moved up smartly in recent weeks. With the external pressures contained, central banks in the region will be under less pressure to raise rates and some may even choose to cut rates — as India has already started to do.
Are there any downsides to this potential deal?
The bad news is that trade tensions will not go away with this deal. In some ways, they may even worsen.
The reason is that the Trump administration will feel vindicated that its aggressive trade tactics had worked. If even the powerful Chinese can be battered into submission by tariffs and other pressure tactics, why not employ them against other trading partners? We believe that the European Union (EU), Japan and the East Asian exporting nations are at risk.
Take the issue of tariffs on the automobile sector. The US Commerce Department has just submitted a report to Trump on whether the US’ high dependence on imports of automobiles and related parts is a national security risk. Trump now has 90 days to decide whether to act upon the recommendations, which media reports claim include tariffs on fully assembled vehicles and possibly components as well. The EU has promised immediate retaliation against US exports to the EU if Trump goes ahead and imposes tariffs on vehicle imports.
Japan will also come under pressure as it begins negotiating its bilateral trade agreement with the US. Similarly, the less powerful Asian economies will face increasingly tougher pressure from the US side. Countries such as India and Indonesia, which pursue inward-looking strategies, could be the first to feel the heat. Others who run external surpluses, such as Malaysia and Thailand, could also feel pressure, particularly if, like Malaysia, their currencies have been weak in recent years.
The broader risk is that the US’ success in using pressure tactics in bilateral trade negotiations shifts the global trading regime away from one in which multilaterally agreed rules prevail, which helps protect smaller nations from bullying by their larger trading partners. The smaller nations in Asia would be very big losers from such a shift.
Another reason to be wary of the likely US-China deal is the extent of trade diversion that might result. In the course of negotiating with the US, China has promised to increase its imports from the US by close to US$1 trillion ($1.35 trillion) over the next five years. Such a massive amount of import growth is unlikely to be the result purely of expansion in Chinese needs. More likely, the increased imports will come at the expense of other large exporting nations — such as the EU, Japan and East Asia. For example, we could see more Boeing aircraft being purchased by China rather than Airbus ones. Similarly, a massive increase in Chinese imports of agricultural goods from the US is almost certain to arise out of displacing exports by other large agricultural economies such as Brazil.
What about production relocation out of China?
As trade tensions rose between the US and China, one silver lining for other Asian countries had been the increased pace of production being relocated out of China. Sure, this process began well before any upsurge in trade tensions — as a result of rising costs in China as well as technological changes that made it viable to bring some production back to developed economies.
But, in the past year, the intensifying fear that US protectionist measures against China made producing in China for export to the US a risky business has clearly spurred a faster pace of relocation. Vietnam was by far the biggest winner from this relocation but Thailand, Malaysia, Bangladesh and Cambodia were also beneficiaries, as was Mexico.
Will greater amity between the US and China end such production relocation? The answer is probably some relocation will be deferred or cancelled, but we suspect that the bulk of it will continue.
This is because the trade deal will not end the strategic competition between the US and China. Remember that differences over trade were only one part of a bigger picture — one where a rising China was reclaiming its rightful place as a major world power and potentially displacing the US from its pre-eminent position of global leadership. This competition is evident in the clashes over technology, such as the American pressures on China’s global technology firms such as ZTE Corp and Huawei. It is also evident in the growing American determination to push back against China’s seizure of territories in the South China Sea and in providing support for Taiwan. Only last week, we again saw US naval vessels sail through the Taiwan Straits in a none-too-subtle warning against Chinese moves against Taiwan.
The continued strategic pushing and shoving between the US and China will not go away. And that means that prudent companies will need to diversify their production bases from the current over-allocation to China. Production relocation will continue to benefit Asian economies.
The bottom line
Once a trade agreement is concluded, we should see rising business confidence generate a revival of demand in the global economy, which will benefit trade-dependent Asian economies. This is a real and very material positive.
However, Asian exporting nations should get ready for more US trade pressure and continue to build their resilience against the deleterious effects of rising protectionism.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy
This story appears in The Edge Singapore (Issue 872, week of March 4) which is on sale now. Subscribe here
