There’s a strange thing about the fire and fury US President Donald Trump is planning to wreak on certain “friendly countries”: these allies don’t seem to care and neither have they shied away from the battle. For years and years, China did not get involved but now across the developing world, Beijing has been engaging in mediation diplomacy — a style of conflict resolution where it's the sole or principal moderator — to protect its assets and gain recognition as a respectable superpower.

Trump imposed heavy tariffs on Chinese goods of estimated worth of $34 billion in what seems to be a further attempt to dwindle roughly $500 billion of Trade Deficit. The move did not come as a surprise to many economists considering Trump’s Modus Operandi. It all comes into life at the start of the year 2018, when Trump imposed tariffs on Solar Panels and Washing Machines, and later the same year on Steel and Aluminum. Along with China, countries directly affected due to this tariffs include Canada, Mexico and European Union Countries. China has already replied with imposing tariffs on American Exports worth $34 billion, the same amount of tariffs on Chinese Exports. However, there is a noticeable difference between the tariffs imposed by the two countries on each other.

Chinese goods affected by tariffs constitute 52% intermediate goods, while for US goods it is 32%¹. If the tariffs are imposed on intermediate goods, assemblers in the home country will shift the cost burden to consumers but if tariffs are imposed on finished goods, there is a possibility to increase the market share of home grown players. Hence, many economists argued that Trump’s tariffs are badly designed even from the point of view of someone who shares his crude mercantilist view of trade.

But, tariffs are being buoyed by a strong economy that is giving Mr. Trump more latitude that otherwise might pose too much risk. China imported $130 billions of US goods last year, less than one-third of the value of US imports from China². That means in an all-out, tit-for-tat trade war, China may have to retaliate using other measures that tariffs. That is why it will only be a speculation to try and understand the real reason behind the Trump starting the trade war.

In terms of pure numbers, however, $34 billion risks can be considered insignificant when compared to $20 trillion and $15 trillion economies of the US and China respectively. But these tariffs are inflicting damage on many industries affecting farmers and small scale manufacturers, while the situation threatens to escalate and eventually affect hundreds of billions of goods.

The economic numbers since US president’s inauguration has been steady. Official Numbers state that U.S. economy have beaten the expectations and added 200,000 jobs in June, 2018. Democrats often argue that this positive trend began under the presidency of Barack Obama. However, Republicans correctly point out that it continued in Trump’s economy. In a way, tariffs are keeping the promises he made to his voters but as economists suggest that there are clearly winners and losers in trade wars and more often than not consumers are the ones that bear the brunt.

“The longer the scenario continues, tariffs will generate more volatility in financial markets,” Atsi Sheth, a Moody’s Managing director said Friday. “If they Also weaken consumer sentiment and moderate corporate investment in the US and elsewhere, the second order impact of tariffs increases would be to dampen currently robust global growth momentum.” While Trump has argued trade wars are good and easy to win, most economists would say they are universally bad and easy to lose. Mark Carney, the governor of Bank of England, warned last week that further escalation of Trump’s trade disputes would hurt the American economy most, with a potential to lower US economic growth by about 5%. The governor warned the American economy would suffer a 2.5% drop in GDP as a result of falling trade volumes alone over three years, should the White House increase US import tariffs by about 10 percentage points on all of its trading partners. The world economy would take a hit to GDP of just over 1%, while there would be a smaller impact on the EU and the UK³.

India is better placed than most of its peers if the ongoing trade war between the U.S. and China dominates investor sentiment over the next six-seven months, according to Bharat Iyer, head of India equity research at JPMorgan. If the trade war were to intensify — and that’s a big if — there is a possibility that a diminished US-China trade engagement could have positive results for countries such as Brazil and India from a trade perspective, at least in the short run. In case of soybean, for instance, one of the key items in the list, there could be a cascading impact in terms of openings for India to enter other markets, according to the Soybean Processors Association of India.

The bulk of China’s annual soybean import of around 100 million tonnes is for domestic consumption; the rest is used in the manufacture of soybean oil and meal for export. If the levy hits China’s import, exports could be dented, a space that India could potentially fill to meet the demands of other countries.

A big worry for India could be the indirect impact — the potential cascading inflationary impact of the decision in the US itself. Within the US domestic economy, higher tariffs on a range of imported products escalate the threat of higher consumer prices, caused by importers passing on their increased costs of raw material. This could force the Federal Reserve to frontload its interest rate glide path — raise rates faster than it would have done otherwise. An increase in interest rates in the US has implications for emerging economies such as India, both for the equity and debt markets. The Fed is so far on track to raise interest rates at least two times this year; market analysts, however, say Fed Chair Jerome Powell could potentially raise rates faster to prevent the US economy from overheating.

The Fed is also slated to pursue its scheduled reversal of the easy money policy of the last decade. The central bank had said in September 2017 that it would start shrinking its balance sheet by selling treasury bonds and mortgage-backed securities that it accumulated after the Lehman Brothers crash in 2008, in order to inject liquidity in the market.

From the current $20 billion a month ($12 billion of Treasury securities that are being allowed to mature each month without being replaced, alongside another $8 billion of mortgage-backed securities), the sale of such securities is slated to go up in the future, according to details available from the January 30-31 meeting of the US Federal Open Market Committee⁴. With this, the Fed would gradually wind down the $4 trillion in holdings that it acquired during the phase of quantitative easing.

Even a minor disruption in US financial markets can have major implications for India. The three external risk factors — higher tariffs, rising interest rates, and elevated bond sales — come at a time when the domestic banking system is grappling with a renewed stress of bad loans. The Indian economy, especially financial markets, will need to brace itself for significant volatility and stress from the combined effects of global and domestic challenges.

On the flip side, preferential benefits to Indian exports under US Generalised System of Preferences (GSP) and America’s higher tariffs on Aluminium and Steel were discussed in a meeting with The Trump Administration recently. Also, under Asia Pacific Trade Agreement, China had said it would either cancel or lower the tariffs on 8,549 types of goods from India, Bangladesh, Sri Lanka and Laos⁵.

This Trade War may not be easy to win but it could concoct a divine blessing for India if everything comes off well. It is optimistic to say the least, considering the complexity of overall economy and external factors as well, but a hopeful Indian always dreams of a Serendipity.

References:

1: www.nytimes.com

2. www.bloomberg.com

3. www.theguardian.com

4. Indianexpress.com

5. economictimes.indiatimes.com

ninad.v2019@iimbg.ac.in

Trade War - Simply Win Or Lose?