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Will the competing agendas of Xi and Trump cause turmoil in emerging markets? To find the answer to this question, Victoria Mio, CIO China, and Fabiana Fedeli, Head Fundamental Equities and Portfolio Manager Emerging Equities, had meetings with financial leaders, government officials, and think-tank analysts from the United States and China.
Following our meetings, we believe that fears of a negative impact from the policies of the Trump administration on China – and, as a result, on emerging markets - have overstated the actual risk. The risk of a trade war between the US and China has significantly subsided following the Trump-Xi meetings in April, which have opened a path for constructive negotiations.
Sentiment towards both the US and China has substantially changed over the last year. Concerns have increased toward the US, due to the uncertainty about the Trump administration’s future policies. As for China, sentiment has improved from the overwhelmingly pessimistic tones of a year ago. In the meetings, the consensus was that macro fundamentals had improved, although the problems surrounding financial leverage remain unresolved.
Data seems to support this view. The Li Ke Qiang index, which reflects the margin impact of the recent Chinese government stimulus, has been indicating a recovery. Consumption continues to grow quickly. China’s imports jumped 20.3% year-on-year and exports surged 16% in March, the highest in more than two years, but slowed slightly in April. In addition, tighter capital controls, interest rate hikes by the People’s Bank of China plus better than expected economic fundamentals have supported the currency.
In addition, both US and Chinese authorities have significant doubts about the Trump administration's ability to push through tax cuts, higher fiscal spending and looser regulations, which are three key promises of the President’s campaign. The two main reasons for this are the severe level of understaffing of the administration, as many positions are still vacant, and the significant pushback that some of the policy proposals are facing within the US. On the other hand, China’s President Xi’s power appears strong. This will allow him to renew his efforts on reforms, particularly in tackling the high rise of debt in the country.
China continues to portray itself as a supporter of globalization, and Chinese officials put strong emphasis on the Belt and Road Initiative and the Asia Infrastructure Investment Bank. Both initiatives are a result of China’s current foreign policy aim to increase China’s influence on international affairs.
The Belt and Road Initiative covers 69 nations and initiatives in the areas of trade and finance, infrastructure construction, and policy coordination. In order to fund the B&R initiative, China has set up two funding vehicles: the Silk Road Fund and the Asia Infrastructure Investment Bank (AIIB). While the US has not joined the AIIB, the Trump administration sent high level officials to attend the Belt & Road Forum in May, highlighting the more positive climate between the two nations.
Meanwhile China and the US have announced a 100-day action plan, which covers the exchange of goods and services between the two countries and sets a direction for comprehensive trade negotiations. This has significantly diminished the probability of a trade war.
Both sides would have much to lose from a trade war. The US is China’s largest export market, as exports to the US reached USD 410.8 billion, 18% of total Chinese exports, or 3.7% of China’s GDP, in 2015. The impact of a China-US trade war would likely be a demand shock for China. On the other hand, as China is the dominant supplier of many labor-intensive products, a trade war with China would represent a supply shock for the US, and could bring inflationary pressure to the US economy.
Also, China is the US’ fastest growing export market and large American corporates have much to lose if access to that market is made more difficult. In 2016, China’s total retail sales reached CNY 33.2 trillion, the equivalent of USD 5,000.9 billion, broadly comparable to the USD 5,504.1 billion figure in the US. China is expected to become the world’s largest importer in the next one or two years. This provides China with huge bargaining power on the global trade front.
The improved Sino-US relationship could have less desirable consequences for other US trading partners. First, at least in the short term, China could divert some of its imports to the US from other countries, in order to show goodwill in shrinking the bilateral current account deficit. This is likely, for example, for soft commodities such as soybean and grains, and therefore there could be a negative impact on other countries and companies exporting soft commodities to China, such as Brazil, followed to a lower extent by Argentina, the EU, Australia, Malaysia, Indonesia and India.
Second, in order to show that he keeps his campaign promises, Trump might have to look for ‘easier victims’ of his protectionist campaign promises rather than China. This could imply that NAFTA and hence Mexico remain a target as well as non-trade related policies such as the Paris climate accord.