China's Strategic Responses to Higher Tariffs

Our Global Head of Fixed Income and Thematic Research Michael Zezas and Chief Asia Economist Chetan Ahya discuss how the upcoming US elections might impact economic policies in Asia.

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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 Thematic Research.

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

Michael Zezas: Today, we'll talk about what the US election means for Asia's economy.

It's Wednesday, October 9th at 10am in New York.

Chetan, we're less than a month now from the US election, and when I think about what it means for Asia, perhaps the most immediate and direct impact would be via tariffs.

Now, our colleagues have already addressed some of this on the podcast, but I'm eager to hear your thoughts. And in the case of a Trump win and a significant tariff increase on China, how big of an impact do you think this policy would have on China's economy, and what particular areas of the economy might be most affected?

Chetan Ahya: Well, Mike, I think firstly the tariff numbers being floated, i.e. that if it is 60 per cent, it would mean an increase in tariff of about 35 percentage points over an existing number, which is at 25 per cent. So, the amount of tariffs that we're talking about this time are larger than what we saw in 2018-19. And in terms of implications, of course, it will depend upon exactly what is the magnitude of tariff that is being imposed, but we definitely think there will be a significant downside to China's growth; and we expect an increase in deflationary pressures.

Just to give you a bit of perspective of what happened in 2018-19, tariff resulted into China's growth slowing by a full percentage point from 6.9 per cent to 5.9 per cent; and at the same time, we saw that there was downward pressure on China's inflation dynamic. And the timing of tariffs this time does not seem to be great. China is going through an existing challenge of debt deflation loop. And we've seen that China's GDP deflator, which is a broader measure of prices, has been in deflation already for about seven quarters now. And so, in this context, tariffs will further add to its deflationary pressures and make that macro situation much more complicated.

Michael Zezas: Got it. And so, how do you think China might respond if it becomes the target of higher tariffs?

Chetan Ahya: So, we think China's policy makers could take up three sets of measures to mitigate the impact of tariffs.

Number one, there will be, of course, depreciation in its exchange rate, which will be offsetting some part of the tariff increase effect. And so, for example, the weighted average tariff increase was about 18 percentage points during 2018-19, and the RMB depreciation was about 11 per cent. So, there was a significant offset of that tariff increase by currency depreciation.

Number two, China could continue to take its effort to rewire trade flows and supply chain. So, for example, in 2018-19, we've seen a significant rewiring of exports from China to the US via Vietnam and Mexico, and we think this time that could be expanded to some more economies.

And number three, China also resorted to focusing on new markets, i.e. some of the other emerging markets other than US. And at the same time, they focused on introducing new export products; like in the last cycle, they focused on solar panels, lithium batteries, EVs, and old generation chips. So, in effect, they will try to expand their market base from US into other emerging markets. And at the same time, they will be focusing on new products to ensure that their market share in global goods exports is maintained.

So, Mike, we've been discussing the potential impact of a Trump win. But how would a Harris White House shape trade policy, vis-à-vis China and rest of Asia?

Michael Zezas: Yeah, I think a Harris White House would represent a lot of continuity with the Biden White House's approach toward Asia and China, specifically when it comes to trade. That is to say, there's a lot of support for continued use and expansion of non-tariff barriers – things like export controls, and inbound and outbound investment restrictions. And there's less interest in using higher tariffs than what we already have as a tool.

So, you can expect that. And I think you could also expect there to be kind of a broader reach out to develop economic relationships with Pan Asia as a means of enabling some of the transition that multinational companies would need to rewire their supply chains.

But if we take as a given that that might be Harris's approach to trade policy, Chetan, what's your outlook for Asia if she wins in November?

Chetan Ahya: Well, if Harris wins, that would eliminate the key risk to region's outlook in form of significant tariff implementation. And in this case, we expect status quo to our Asia forecast. And we would maintain our constructive outlook for the large economies in the region. And within the group, we think India and Japan are best positioned from a structural standpoint. While China, we were concerned about the debt deflation loop, but with the recent set of policy measures, we think that the risks are now more balanced as far as China macro-outlook is concerned.

Michael Zezas: Got it. Well, Chetan, thanks for taking the time to talk. This is obviously a very important topic as we get closer to the US election.

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.