A growing number of governments seem to be falling into line with a more aggressive and protectionist US.
As well as renegotiating the North American Free Trade Agreement (Nafta) and tweaking his country's trade deal with South Korea, US President Donald Trump has now pressured Japan into bilateral trade talks for the first time.
The world’s largest economy is using its heft to striking effect, with the threat of tariffs on US imports of cars being particularly effective in bringing recalcitrant governments to heel.
In the runup to the US midterm congressional elections on November 6, Trump can now focus on “winning” his trade war with China. But at what cost to emerging markets in the short and long term?
Trump looks determined to wear any blowback on domestic firms as the tit-for-tat with China escalates. One day after the US announced tariffs on roughly $200 billion of Chinese imports, China retaliated with a tariff list of $60 billion US imports, with additional tariffs ranging between 5% and 10%.
He is negotiating from a position of strength. The US economy is growing strongly, to the point that the Federal Reserve is raising interest rates to prevent it overheating.
A stronger dollar and rate hikes are curtailing the policy flexibility of embattled emerging markets, particularly those hooked on US dollar-denominated debt.
The Bank for International Settlements said in April that US dollar-denominated debt outside the US hit $11.4 trillion at the end of last year, versus euro-denominated debt at €3 trillion. The surge was driven by unprecedented issuance of international debt securities at an annual clip of 22% in the second half of 2017.
Fed Chairman Jerome Powell in May batted away arguments that US monetary policy is responsible for money flows in and out of emerging markets, so policymakers from Indonesia to Argentina can’t expect any respite as US rates continue moving upwards, likely by another three hikes before the end of next year.
The IMF estimates that emerging economies excluding China could yet face debt portfolio capital outflows of up to $100 billion, which would broadly match the outflows seen during the global financial crisis.
So escalating trade tensions come at a particularly tricky time for emerging markets. For many emerging Asian countries, China and the US are their biggest trading partners. Global and intraregional supply chains also crisscross their economies.
On Monday, IMF managing director Christine Lagarde flagged a possible downgrade of the fund’s 3.9% global growth forecasts for 2018 and 2019, citing the risk that trade disputes may exacerbate China’s slowdown and hurt emerging markets.
Index compiler MSCI’s move just last month to consult investors on a possible increase in the weighting of China A shares in its benchmarks could also be met with some pushback if index-tracking investors are no longer keen to pile into the world’s second largest economy as it slows.
LONGER-TERM
Longer term, China is likely to accelerate its own bilateral negotiations with other smaller economies, particularly in Southeast Asia, to help offset some of the overweening pressure of the US. The tables could well be reversed in the future too, given many economists predict that China will likely overtake the US to become the world's largest economy by around 2030.
Under the policy umbrella of its amorphous Belt and Road Initiative, China will vigorously pursue cross-border payments denominated in renminbi and support multilateral institutions headquartered in China, such as the Asian Infrastructure Investment Bank. Emerging market governments will feel pressure to pick one side over the other.
Further ahead, we could well see a more divided world. Japan’s abandonment of its previous adherence to the multilateral framework of the Trans-Pacific Partnership in favour of bilateral talks with the US is illustrative.
That is to everybody’s loss. The IMF has estimated that working together to shave 15% off trading costs for services would help to lift the total GDP of the G20 by more than $350 billion this year, which would be like adding another South Africa to this group of leading developed and emerging countries.
So as the IMF and World Bank prepare to kick off their annual meetings in Bali next week they will likely bemoan a more balkanised world where working together to de-escalate trade disputes has largely fallen out of fashion.
