Risk of escalation of trade frictions temporarily eased—Comments on the results of China-US trade talks at G20

The leaders of China and the United States met in Buenos Aires on December 1. Wang Yi, China’s state councilor and foreign minister, said that the Chinese and US leaders reached consensus to stop imposing new tariffs. Wang Shouwen, China’s vice commerce minister and deputy international trade representative, gave more details about the consensus reached by China and the US on trade at the G20: 1) the US’s tariffs on US$200bn worth of Chinese products will remain at 10% after January 1, 2019; 2) both parties decided not to impose new tariffs on other products; and 3) for the 25% tariffs currently in place, China and the US will step up negotiations in the direction of cancelling them.

The White House said in a statement that: 1) President Trump has agreed to leave the tariffs on US$200bn worth of Chinese products at the 10% rate on January 1, 2019, and not raise them to 25% at this time. 2) China will agree to purchase a not yet agreed upon, but very substantial, amount of agricultural, energy, industrial, and other products from the US to reduce the trade imbalance between the two countries, and has agreed to start purchasing agricultural products from US farmers immediately. 3) President Trump and President Xi have agreed to immediately begin negotiations on structural changes with respect to forced technology transfer, intellectual property protection, non-tariff barriers, cyber intrusions and cyber theft, services and agriculture. Both parties agree that they will endeavor to have this transaction completed within the next 90 days. If the parties are unable to reach an agreement at the end of this period of time, the 10% tariffs will be raised to 25%.

The risk of a sharp decline in China’s exports to the US in early 2019 is eased. If the US raises its tariffs on US$200bn of Chinese goods from 10% to 25% as originally planned, the impact on China’s exports to the US would be similar to those from the already imposed 25% tariffs on US$50bn of goods and 10% tariffs on US$200bn of goods. US imports of Chinese goods on the US$50bn tariff list already declined 17.1% YoY in September, while imports of goods on the US$200bn tariff list still increased 20.7% YoY in the month. If the tariffs on the US$200bn of goods are left at 10% or even cancelled, the risk of a sharp slowdown in China’s exports to the US should be eased.

The risk is reduced or delayed for industries that may be significantly impacted by US tariffs on US$200bn of Chinese goods, such as furniture, electronics and machinery. Having classified US imports from China according to China’s industrial classification, we found that the tariffs on US$50bn of goods only cover a few industries such as general equipment, special equipment, transportation equipment, while the tariffs on US$200bn of goods cover more and broader industries. If the tariffs on US$200bn of goods are raised to 25%, we estimate more than half of China’s manufacturing industries would see the average tariff rate on their exports to the US rise by more than 10ppt. Taking into account the US’s share in China’s exports and the export dependence of China’s industries, we found that the furniture, electronics and machinery industries are more affected by the tariffs on US$200bn of goods. If the tariffs are not further raised, the potential impact on these industries will be significantly reduced or delayed.

China may resume imports of soybeans, crude oil and other goods from the US. China has basically stopped importing soybeans, crude oil, sorghum and other goods from the US in the past few months (even crude oil is not on the tariff lists). As the northern hemisphere enters winter, the US becomes the main harvest region for soybeans in the world. The CICC commodity team estimates that if China does not import US soybeans and reduces feed protein content, her annual soybean shortage would be about 4.6mn tonnes. Since China imported 32mn tonnes of soybeans from the US in 2017, if China resumes soybean imports from the US, the domestic soybean supply and demand relationship would be reversed. An increase in China’s imports of agricultural and energy products from the US will likely put downward pressure on domestic inflation and reduce China’s imports from other regions.

The consensus reached gives the two countries 90 days for trade negotiations, but there is still uncertainty in the negotiations. While the easing of trade frictions is likely to boost domestic market sentiment in the short term, the evolution of trade frictions still depends on the results of future negotiations. In addition to proposing that China purchases more US goods, the US also demands “structural changes with respect to forced technology transfer, intellectual property protection, non-tariff barriers, cyber intrusions and cyber theft, services and agriculture”. In an optimistic scenario, trade frictions can be further resolved after the 90-day negotiation period. However, the possibility of frictions escalating again cannot be ruled out.

Domestic economic policies still face challenges. External demand dragged China’s GDP growth in 1–3Q18 down by 0.7ppt, while domestic demand contributed 7.4ppt to the growth. Looking ahead, global economic growth may decelerate. Even if trade frictions do not escalate, external demand may still weaken. In terms of domestic demand, real estate may become a drag on economic growth next year. The CICC real estate team expects property sales in GFA terms and real estate development investment in 2019 to shrink 10% and 5%. Although China will likely increase its fiscal spending and infrastructure investment, the support from fiscal policy may not be able to offset the impact of weaker real estate and external demand if more tax cuts are implemented at the same time. In addition, monetary policy needs to strike a balance between stabilizing domestic demand and stabilizing exchange rate. Real estate policy also needs to strike a balance between stabilizing property prices and stabilizing economic growth.