Not satisfied with the progress of ongoing negotiations with Chinese trade representatives, President Donald Trump introduced fresh tariffs on Chinese goods on Aug. 1, putting additional pressure on the Chinese economy.
The new tariffs, if implemented, would add up to a 10 percent tax on $300 billion of Chinese imports beginning Sept. 1. That’s in addition to the 25 percent tariffs previously levied on another $250 billion of Chinese goods.
Perhaps not coincidentally, Trump’s announcement came a day after the Federal Reserve cut benchmark interest rates by 25 basis points in what was described as a “maintenance” cut, as the Fed reiterated the strength of the U.S. economy, especially relative to developed markets in Europe and Asia.
China’s Ministry of Commerce declared on Aug. 2 that it was “strongly dissatisfied” with the threat of new tariffs and vowed countermeasures in retaliation.
The news hit China’s currency, which reached its weakest levels of 2019. The USD–CNY (onshore) cross settled at 6.94 per U.S. dollar on Aug. 2.
Similarly, Chinese stocks also cratered on the same day. The Shanghai Composite Index fell 1.4 percent to 2,867.84 on Aug. 2 and was down 2.6 percent on the week. The Shenzhen Composite fell 2.3 percent on the week.
New Stimulus Measures May or May Not Come
As with prior tariff escalations, China could ramp up stimulus to shield its fragile economy from additional economic slump, especially if Beijing wants to stay in the ballpark of its desired 6 to 6.5 percent official GDP growth.
China’s official GDP figures for the year through June was a run-rate of 6.3 percent. Calculations by Citigroup analysts estimate that new tariffs would shave GDP growth by 0.5 percent and while Standard Chartered economists think GDP will shrink by 0.3 percent.
This week will provide more clarity as China is set to release a slew of July data, including for China’s Forex reserves (Wednesday, Aug. 7), July trade balance as well as imports and exports activity (Thursday, Aug. 8), and Consumer / Producers’ Price Index (Friday, Aug. 9).
“The external side has been weak, and that has obviously been exacerbated by the U.S.–China trade friction. So, in order to offset that negative effect from the external side of the economy, there needs to be corresponding investments or activity which support domestic demand,” Timothy Moe, chief Asia-Pacific strategist for Goldman Sachs, told CNBC on Aug. 2.
China can go to the tried-and-true stimulus measures it has called upon so many times already, such as infrastructure spending, tax cuts, and reducing the reserve requirement ratios at banks.
But Beijing may take a more wait-and-see approach this time. The new tariffs may not be carried out—there’s another month to go—and it may not want to spend all of its bullets, especially as a very protracted trade war looks increasingly likely.
Beijing Will Play the Long Game
China will likely retaliate, but its methods are unlikely to be drastic as it plays the long game—its goal right now is waiting to see how the 2020 election plays out.
But Beijing will introduce retaliatory measures, if only to appease domestic hardliners. Some measures it could take include announcing tariffs on U.S. exports to China, reducing “rare-earth” metals exports, and excluding some U.S. companies from doing business in China.
Chinese regulators announced on May 31 that Beijing was formulating a list of “unreliable entities” as a form of retaliation—it’s unclear when or if this list will be introduced.
“We believe China will deliver each retaliation methodically, and deliberately, one by one,” wrote ING Greater China analyst Iris Pang in a note. “We believe China’s strategy in this trade war escalation will be to slow down the pace of negotiation and tit-for-tat retaliation.”
“This could lengthen the process of retaliation until the upcoming U.S. presidential election.”
Nonetheless, it will be a painful waiting game for China and its stock market. Experts see continued weakness ahead.
“We recommend not to buy [Chinese equities] on a dip,” Morgan Stanley strategists wrote in a note to clients on Aug. 2.
Further, Morgan Stanley Asia equity strategist Laura Wang warns that “there is a high chance for the announced 10 percent tariff to become effective on Sept. 1,” on the basis that “fundamental disagreements remain, making the benefits of escalation appear greater than cooperation to both sides.”