A trade war is terrible for everyone

As the trade war escalates, for the first time in 20 years the world’s second largest economy China has reported a current account deficit of $28.3 billion in the first half of 2018. Close on the heels of additional tariffs of $200 billion on Chinese goods that came into effect from July 31, the Trump administration has announced a new round of tariffs worth $22 billion. China announced retaliatory tariff of $60 billion when Washington implements its threat. In what is being seen as an all-out war, the US and China are engaged in a mutually-destructive trade war that is fast embroiling others. The US had imposed import levies in January on solar panels and washing machines, and in March on steel and aluminium. They attracted retaliatory tariffs on US exports from its NAFTA partners Canada and Mexico, and from the European Union. India joined these trading partners in retaliating against the US tariff hikes on steel and aluminium by raising import duties on a variety of goods including almonds, apples and some metal products. It is a $241 million measure that matches the amount of steel and aluminium import duty imposed by the US.

In International Monetary Fund’s (IMF) estimation, the rising trade tensions between the US and the rest of the world could lower global growth by as much as 0.5 per cent by 2020, or about a $430 billion loss to GDP worldwide. IMF contends that although all economies would suffer from an escalation in the trade war, the US would become “the focus of global retaliation” with a relatively higher share of its exports taxed in the global markets.

Warning that the broad expansion for the world economy that began about two years ago has plateaued, the IMF stated, “the greater use of protectionist measures could dampen investor sentiment, disrupt global supply chains, slow the dissemination of productivity-boosting technologies and raise the price of consumer goods”.

There is a view that if the trade war were to intensify there is a possibility that the decrease in US-China trade could have positive results in the short term for countries such as Brazil and India. The Soybean Processors Association of India estimates that as a significant volume of China’s soybean imports goes into the manufacture of soybean oil and meal for export, if the retaliatory duties on US soybean hit China’s imports, its exports could be dented, and India could potentially step in to meet the demands from other countries. 

This, however, is a myopic view. In the long run, this would result in a higher inflationary and low growth global scenario. The cascading inflationary impact of the trade war would hit the US economy, which would have a deleterious effect on the Indian economy. With the rise in consumer prices — on account of higher tariffs and the impact of its announcement last September that it would start shrinking the balance sheet by selling the $4 trillion treasury bonds and mortgage-backed securities that it had accumulated since the 2008 meltdown — the US Fed may front-load its interest rate glide-path raising rates faster to prevent the US economy from overheating. The external risk arising from the developments in the US would have a bearing on the Indian economy at a time when the domestic banking system is grappling with the renewed stress of bad loans. The Indian economy, especially the financial markets, will need to prepare for significant volatility and stress from the combined effects of global and domestic challenges. The US Fed will contain inflation through interest rates. Even as yields in the US markets have been rising since the middle of 2016, this move could result in a faster rise in yields than anticipated.

The impact is manifest in the Indian government securities market falling for the past seven months on cues of rising US yields and projections of increased local inflation. When yields rise, bond prices fall. Rising interest rates in the US could mean a potentially volatile ride for India’s equity market.

A trade war would hurt everyone but the US is likely to face the most severe impact of what it has unleashed. Already, the global economy is moving away from being US-centric. EU’s exports to Asia in the last decade have been growing almost twice as fast as its exports to the US. In 2017, exports from EU to Asia were bigger than that to the US. While Asia’s exports to the EU in 2017 was still slightly lower than that to the US, it has been growing rapidly making the EU more important to Asia, according to the IMF. From the perspective of market size, Asia today is far more important to the EU than the US, and the EU will soon be more important to Asia than the US.

Asia’s market size for imports reflects its vibrant and growing consumer markets, growing in terms of purchasing power. Measured by estimates of private consumer expenditure, Asia today is almost as big as the US but it is growing at twice the rate, with China’s private consumer expenditure growing at an average of 13.8 per cent a year in the last decade, over four times faster than in the US. Not surprisingly China is now the largest market for a number of countries such as Australia, Brazil, Russia, South Africa, South Korea and Indonesia, and this list is growing. If the current growth rate trend of imports in the US and China continue, by 2021 China will surpass the US to become the largest market for imports in the world. The US-induced trade war is creating new impetus for the EU and Asia to speed up the opening of their markets to forge closer economic ties, as everywhere outside of the US there is a new sense of urgency to fast-track regional free trade agreements. How well and how quickly India aligns its strategies to benefit from these developments will determine the country’s position in the emerging new world.
The author is a former finance secretary, government of India. He is currently chairman, CUTS Institute for Regulation and Competition

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