On 10 May, the US administration increased tariffs on $200 billion of Chinese imports to 25% from 10%. In response, China has said it will take retaliatory action. These developments will weigh on global economic growth.
It is believed that trade negotiations between the US and China will continue, and that a deal in some form will be eventually reached. However, the risk of a complete breakdown in trade talks has certainly increased.
The tariff increase is a significant setback in the trade negotiations the US and China have engaged in during the past one and half years. It adds to existing uncertainty around the global trading environment and comes as growth in the global economy had appeared to be stabilizing. The rise in tensions between the US and China will contribute to a renewed slowdown in systemically important regions of the global economy, not only through the trade channel but also through the impact on sentiment and risk aversion.
Global financial markets have been buoyed in recent months by the prospects of an end to monetary-policy tightening in the US and optimism about a resolution of trade talks between the US and China. An abrupt breakdown in trade talks, if that were to occur, will inject considerable policy uncertainty, increase risk aversion and lead to an abrupt repricing of risk assets globally. Tighter financial conditions will return and, notwithstanding the dovish policy stance of the US Federal Reserve, will pose a negative confidence shock that drags down global growth.
Economic growth in both the US and China will be hurt by the imposed tariffs. The tariffs will act as a tax on US businesses and households, and temporarily raise inflation.
In China, increased US tariffs will have a significant negative effect on exports amid an already slowing economy (Exhibit 1). Further policy easing will mitigate only some of the impact, particularly on the outward-oriented private sector made up of small and medium-sized companies with limited shock-absorption capacity. And increased uncertainty and weaker business sentiment will hinder private investment decisions.
The tariffs are expected to have a negative effect on most Chinese companies either by the direct impact on their exports or the indirect impact through the domestic supply chain. In particular, the Chinese high-tech sectors such as electronic products, communications equipment/hardware, and advanced microelectronics/chipset technology are likely to be adversely affected as they have high exposure to the tariffs and the restrictions that the US applies on these tech sectors.
The US aerospace, automotive, agricultural and energy sectors are all likely to be adversely affected as China adopts a deliberate policy of trade diversion in response to the US tariffs.
The export-oriented economies of Asia may be particularly exposed to the risk of global and regional trade downturns. And given the importance of both the US and China as sources of export demand and investment, export-oriented Asian economies may find it challenging to navigate between two increasingly hostile trading partners.
In the longer term, the deterioration in the trade relationship between the US and China will lead to increased fragmentation of the global trading system and may weaken the rules-based system that has underpinned global growth for the past several decades. Greater inefficiency in production and supply chains will reduce global growth potential.
This report is taken from Moody's Investors Service.
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