Intro

Our Global Head of Fixed Income and Public Policy Research Michael Zezas and Chief Asia Economist Chetan Ahya discuss the potential impact of U.S. tariffs in China and beyond.

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Michael Zezas: Welcome to Thoughts on the Market. I'm Michael Zezas, Morgan Stanley's Global Head of Fixed Income and Public Policy Research.

Chetan Ahya: And I'm Chetan Ahya, Morgan Stanley's Chief Asia Economist.

Michael Zezas: Today, we'll talk about what U.S. tariffs would mean for Asia's economy.

It's Tuesday, January 28th at 8am in New York.

Chetan Ahya: And 9pm in Hong Kong.

Michael Zezas: Chetan, a week into the new Trump administration, I'm eager to talk tariffs with you. You and I came on the show before the U.S. election to discuss the potential impact of new tariff policies on China's economy in particular. And now that President Trump has taken office, he's been vocal about levying tariffs in a lot of places, including on China. The policy underpinning all of that appears to be a tariff review under the America First Trade Policy. That suggests to us that he's developing options to impose tariffs with China as a focus, but there's still time before implementation -- as these legal options are developed. That's in line with our base case; but investors have been talking a lot about the idea that maybe these tariffs never go on.

What's your view here? And why do you think ultimately we are headed to a place where tariffs go higher?

Chetan Ahya: Well, I think if you just look at the press comments that the president has made at the same time, if you read through this America First document, we sort of think that there are five avenues under which tariffs can go up on China.

Number one is the recommendation from the America First policy document that the agencies in the U.S. will have to study how the large trade partners, which are running trade surpluses with the U.S. are managing their trade practices. Number two, a para in the America First document, which is suggesting that the trade agreements that US and China signed in 2018-19, how is China dealing with the commitments under that agreement?

And number three is the clause which is currently exempting imports into the U.S. under [the] de minimis rule of imports under U.S. $800 per bill being allowed to import without any tariffs being imposed. And what the document is suggesting is to assess what is the potential revenue loss occurring to the government, and how can they plug that. Number four is a potential tariff action with the sale of a social media company. And number five, a potential tariff action which is linked to the fentanyl issue.

So, as you can see, there are a number of avenues under which tariffs can go up on China and therefore we kind of keep that in our base case that tariffs will go up on China.

And Mike, some investors are also optimistic and thinking that there is a possibility of a new trade deal being taken up by U.S. and China. What do you think are the chances of that?

Michael Zezas: I think they're quite low. So, you mentioned five areas of potential dispute that the U.S. might want to use tariffs as a way of dealing with -- and I think that speaks to the idea that the bar is pretty high for China to avoid tariffs relative to some of the other negotiations the U.S. wants to engage in with other trade partners. Or maybe said differently, if the America First Trade Policy is pointing the U.S. at closing goods, trades, deficits, and improving security and making sure that it's not engaged with trade with other countries that are harming national security -- it seems that there are more of those activities going on between the U.S. and China than with other trade partners. Closing, for example, a $300 billion goods trades deficit would seem to be just really, really difficult within the structures of the economy.

So, if we're right, and the chance of tariff de escalation with China appears to be slim, do you think Beijing, for example, might use renminbi depreciation to mitigate some of those economic risks?

Chetan Ahya: Well, yes, we do think that China’s policymakers will allow depreciation in [renminbi] when tariffs are being imposed. However, we also think that the depreciation this time that they will allow will be less than what they did in 2018-19. And China has already been facing some capital outflows; and allowing a large depreciation could bring self fulfilling situation of more capital outflows and even sharper currency depreciation pressures.

Michael Zezas: Beijing also started introducing stimulus measures last fall to boost the Chinese economy. Would tariffs disrupt this policy?

Chetan Ahya: Certainly in our base case, despite the policy stimulus measures that China is taking, we think that overall growth in China will be lower in 2025 meaningfully. And more importantly in our view, China’s biggest challenge is deflation and tariffs will only exacerbate deflationary pressures.

Michael Zezas: And so, we're talking a lot about China here, but obviously there's a risk of tariffs being applied to a broader set of U.S. trading partners in Asia. Now that's not our base case. We think ultimately the focus will be on China because a lot of those trading partners will be able to come to agreements with the U.S. to limit potential future tariffs; but of course, there's a considerable risk that we're wrong. As we mentioned this America First Trade Policy is developing a wide range of options to levy tariffs across multiple geographies and multiple products. So, if that were to come to pass, Chetan, what is it that other Asian governments might be able to do to mitigate the impact from higher tariffs?

Chetan Ahya: First of all, this will be significantly negative for region's growth outlook. And there are two ways in which [the] region will get impacted. Firstly, because of the fact that China will be facing tariffs and China's growth will slow down, it will also have spillover effects for the rest of the region. At the same time, as you mentioned, there is a possibility that there are bilateral disputes opened up with other economies in the region. And so that will also add to the downside pressure for [the] region's growth.

In terms of what they can do to offset this downside; we think that region's central bank will take up monetary easing and at the same time the governments will expand their fiscal deficit. But both of those measures will not be enough to fully offset the downside from tariff increase.

Michael Zezas: Makes sense. Chetan, thanks for taking the time to talk.

Chetan Ahya: Great speaking with you Mike.

Michael Zezas: And as a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us wherever you listen and share Thoughts on the Market with a friend or colleague today.