Wednesday 28 March 2018
US-China trade row – lots of bark, but is there bite?
Wednesday 28 March 2018
An overview – what you need to know
The US Trade Representative’s annual Section 301 report presented on Thursday 22 March 2018 found China to be engaging in unfair trade practices, particularly with regards to the transfer of technology, exploitation of intellectual property rights, and restrictive market access.
In response, the Trump Administration announced punitive trade measures, including a 25% tariff on imports of aerospace, information communication technology product, and machinery from China. The imports in the crosshairs of the new tariffs are worth approximately $US50-$US60 billion, and comprise approximately 11% of total Chinese imports to the US.
The Trump Administration has also signalled it will pursue further disciplinary action through the World Trade Organisation (WTO), and introduce administrative restrictions on inbound Chinese investments in sensitive technologies.
Why the focus on China?
As can be seen in the charts below, there is an imbalance in the China/US trade relationship, with a $US375 billion trade deficit recorded in 2017. Compared to other countries, China is a standout with the largest deficits recorded in consumer electronics and apparel.
US goods trade deficit with major countries (2017)
Products with largest US trade deficit with China (2017)
What are the potential economic implications of this move?
The direct economic impact of the new tariffs are expected to be limited, as the affected products comprise only approximately 2.7% of China’s total exports, of which translates to an estimated 0.1%-0.2% of nominal gross domestic product (GDP). In our view, it is fair to say that relative to the size of China’s economy and total exports, the impact, should it be realised, is not material.
We believe these new trade restrictions against China are more of a signalling tool and negotiation tactic by the Trump Administration as it endeavours to deliver a “better deal” for Americans. This is consistent with much of its rhetoric on the issue of international trade, and its continued focus on negotiating bilateral trade agreements.
How did China respond?
As expected, China quickly announced its own retaliatory trade measures. On Friday 23 March 2018 it imposed a 15%-25% tariff, worth an estimated $US3 billion, across 127 US products, including fruit, nuts, pork and recycled aluminium, and also signalled plans to refer the trade dispute to the WTO.
We believe China’s initial, muted response to the new US tariffs indicates it does not want to see an escalation of the trade tensions, and it is willing to negotiate. In fact, some commentators have noted that Chinese leaders have already taken pre-emptive steps in their rhetoric to de-escalate the situation, such as Premier Li Keqiang’s call for better protections of intellectual property during his speech at the recent National People’s Congress. The importance of retaining healthy relations with the US is clear when you consider current trade; the US represents 19% of China’s total exports, and 8% of imports.
2017 China's exports distribution
2017 China's imports distribution
Impact on the Macquarie Asia New Stars portfolio
The Macquarie Asia New Stars strategy is focused on investing in companies leveraged to the growth of domestic demand in Asia, and is therefore not materially exposed to, nor dependent on, US export revenues.
By our estimates, less than 3% of the portfolio’s exposures have some direct China-US business interest, and if measured in revenue terms the exposure is significantly less than 3%. While we are monitoring the situation carefully, we expect little direct impact to our portfolio of companies.
We acknowledge the uncertainty created by these new trade restrictions will likely increase market volatility in the near term, as the two countries posture their trade strategy ahead of future negotiations. We also see this as an opportunity to selectively capitalise on any security mispricing, and believe our discipline of investing in quality companies with a solid track record of profitability should offer some protection during such times.
The newly announced tariffs are expected to have very limited economic impact, and should be treated rather as a signalling tool by the Trump Administration to indicate it is serious about negotiating new trade terms. By not retaliating in a similar manner, China has shown it is willing to offer some compromise to prevent an outright trade war.
The Macquarie Asia New Stars strategy is focused on the growth of domestic demand in Asia by investing in quality companies with a strong track-record of profitability. An underweight to exporters materially limits our exposure to the China-US trade channel, and while the broader market is expected to be impacted by the situation, we see this as an opportunity to selectively capitalise on any security mispricing.