SINGAPORE (July 9): US President Donald Trump will travel to Brussels on July 11 and 12 for a North Atlantic Treaty Organization summit. The members of NATO include six of the seven countries that comprise the G7. The last time he met with his European allies and Canada, Trump unleashed a Twitter storm and exacerbated a trade war. On July 1, the European Union indicated it may impose tariffs on US$300 billion ($410.4 billion) worth of US auto and auto parts, in retaliation to the US threat to levy a 25% tariff on EU imports.

Since the G7 summit on June 8 and 9, the US dollar has strengthened against nearly all of the US’ trading partners. And, among the top four countries with which the US has a trade deficit, the US dollar has strengthened the most against the renminbi.

Could a weaker RMB help shore up China’s export industries in the event of widespread tariffs implemented by the current US administration? Lukman Otunuga, research analyst at FXTM, says: “The [RMB’s] steep depreciation in recent days has fuelled speculation over China’s weakening the local currency in preparation of a potential global trade war. While the RMB’s depreciation could mitigate some of the negative effects of trade tariffs imposed by the US, it could spark fears of a currency war. It must be kept in mind that the RMB’s decline has been mostly based on external factors — namely, global trade fears and a broadly stronger US dollar.”

A 25% tariff will be imposed on US$50 billion of Chinese exports to the US on July 6. In January, the US announced tariff rates on imported washing machines and solar panels. China announced it would impose tariffs on US imports in April on items such as soy beans. Since China is retaliating, the US plans to impose a 10% tariff on a further US$200 billion of Chinese imports in a tit-for-tat. And an additional US$100 billion of Chinese imports could be subject to yet more tariffs.

In 2017, the US imported US$505 billion of products from China, and exported US$130 billion of goods to China. In other words, the US is likely to impose additional tariffs on almost all of China’s imports.

In a report dated June 29, Credit Suisse says: “Investors are concerned that the RMB might depreciate further in the near future because: 1) China may let it depreciate gradually as a tactical move in its trade war with the US; and 2) in the process of deleveraging, China tends to maintain “prudent and neutral monetary policy”, so it is reluctant to increase its interbank interest rates. “If there are more US Federal Reserve rate hikes in September and December, China may not follow with a tightening and the RMB could weaken more thereafter.”

Chinese counterattack

If the RMB continues to weaken to offset some of the impact of these tariffs, the US could label China as a currency manipulator. Trump did this during his presidential campaign in 2016, market observers point out. China’s retaliation is most likely to extend beyond goods to trade in services and to the operation of US companies on mainland China.

On the flip side, China is the largest owner of US Treasuries. As at April 30, its US dollar reserves amounted to US$3.12 trillion. Whether China would retaliate by not buying US treasuries or even selling treasuries, causing US yields to spike, remains to be seen. But this is a weapon in China’s formidable armoury.

China is also a large investor in the US market. In 1H2018, however, Chinese companies completed acquisitions and greenfield investments worth only US$1.8 billion — a drop of more than 90% from 1H2017 and the lowest level in seven years, according to the Rhodium Group, which tracks Chinese foreign direct investments (FDIs) into the US.

“The pace of newly announced transactions remained similarly depressed,” the Rhodium Goup said. According to Rhodium, cumulative 2018 net Chinese FDI in the US is negative if one includes asset divestitures: Chinese investors sold US$9.6 billion of US assets in the first five months of 2018, mostly driven by deleveraging pressures from Beijing. With these divestitures, China’s net US direct investment would be a negative US$7.8 billion.

Impact of weaker currency

The weaker RMB has other implications for the Chinese economy and markets, and also for Asian currencies and economies.

First, strategists are somewhat sanguine about RMB weakness. “We do not think policymakers will engage in proactive devaluation like they did in 2015. While the RMB was arguably deemed overvalued then, it is not the case now. Moreover, we believe the market is too bearish on China’s economic fundamentals, and data in the coming months could beat expectations,” Citi says in a recent report.

Still, the US bank expects continued RMB weakness. “With the CFETS [China Foreign Exchange Trade System] index still at a two-year high, the People’s Bank of China [PBOC] can tolerate some moderate RMB weakness. Further 2% to 3% depreciation (to between RMB6.70 and RMB6.80 to the US dollar) is possible if unfavourable factors intensify such trade tension escalation,” Citi adds.

Net exporters would, of course, benefit if export revenue is higher than import cost. Net importers would obviously suffer. Companies with US dollar net debt would suffer financial loss. Companies that report in Hong Kong dollars are likely to be negatively affected. Their earnings per share would suffer foreign-exchange (forex) translation losses. Citi expects that China as a whole would benefit because it has a current account surplus at 3% of GDP.

“Recent years have shown that the short-term need for an acceptable growth rate is more important than longer-term plans for deleveraging, so China is likely to loosen monetary policy if barriers to its exports are implemented. Despite its credit bubble, China has policy tools to offset temporary disruption to trade,” notes a Bank of Singapore report.

There is some concern about the bond market. A weakening RMB raises financing costs for mainland companies with US dollar bonds. On June 27, China’s National Development and Reform Commission released new guidance on developers’ offshore bond issuance. Developers will be prohibited from using funds raised from offshore bond issuance to finance property investment and working capital. Instead, new offshore bond issuance will be allowed for only repayment purposes. Credit Suisse reckons that developers will accelerate new launches (more supply) to reserve more cash while investment in land acquisition and construction is likely to slow down.

Impact on cyclicals, banks

The decline in the RMB has triggered equity market selloffs, especially for cyclical sectors. Citi says transportation, utilities and materials have high forex exposure, whereas exporting companies such as those in textile and tech hardware could bene fit from RMB weakness.

Based on the companies that Citi covers, 10% of revenue is generated from overseas and 6% of these companies have non-RMB interest-bearing debt. “We estimate that every 5% RMB depreciation against the US dollar results in a 1% decrease in RMB-denominated earnings per share, on top of the currency conversion losses to the HK dollar or US dollar for offshore listed equities.”

To inject liquidity into the system and support bank lending while maintaining control on non-bank and off-balance sheet credit growth, PBOC announced on June 24 that it would lower the reserve requirement ratio by 50 basis points for most banks, effective from July 5. According to PBOC, this will release RMB700 billion in liquidity, including RMB500 billion for the Big Five banks and 12 joint stock banks to support a debt-to-equity swap as well as RMB200 billion for the Postal Savings Bank and city and rural commercial banks to support micro SME financing.

Interconnected supply chains

The most obvious impact on Asia is the tech supply chain, where Taiwanese companies produce parts for companies such as Apple in places such as China. The other mega-supply chain is for automobiles and this was highlighted in a memo from the US Motor & Equipment Manufacturers Association to the US Department of Commerce. MEMA pointed out that suppliers provide 77% of the vehicle value. To put this into perspective, a typical vehicle contains more than 30,000 components. Vehicle suppliers manufacture materials, parts and systems for a wide range of customers, including new vehicle manufacturers such as original equipment manufacturers, and suppliers that MEMA has categorised in tiers, from Tiers 1 to 3.

These suppliers also manufacture for the vehicle aftermarket, which includes the parts and materials needed for vehicle maintenance and repair. Parts made for after-market service are for all vehicles, from passenger cars, sport-utility vehicles and pick-ups to heavy-duty vocational trucks, semi-tractor trailers and military tactical vehicles.

“The supply chain, their customers and the jobs they support are highly interdependent. Like a stone in a pond, one small change to the chain can cast off multiple ripple effects. The vehicle industry has repeatedly witnessed the narrow threads that bind its successes and prevent its weaknesses,” MEMA says in a memo to the US Department of Commerce.

In China, the RMB’s drop against the US dollar could have an overall negative impact on its automobile industry. Chinese auto ventures such as BMW Brilliance Automotive and Beijing Benz Automotive Co, which import about half of their components from Europe and elsewhere, are likely to face downward pressure on margins.

Economist expects global GDP growth to slow

Taimur Baig, chief economist at DBS Group Research, says it is about time to think about the tail risk of an all-out trade war. He defines this as a 15%-to-25% tariff on products traded between China and the US.

The impact for 2018 is likely to be limited to 0.25% of GDP growth for both economies and likely to be far greater in 2019. Baig calculates that there could be at least 0.5% downside on both economies. “Considering that China grows at 6% to 7% and the US at 2% to 3%, we believe the damage would be greater to the US than on China,” he says.

Although there is a US$375 billion trade deficit with China, the US is fighting a trade war on multiple fronts, and the retaliation falls on the same number of Americans every time.

China faces numerous challenges, too, as it deleverages its economy. “Our Nowcast framework shows only a mild slowdown in 2Q (we are tracking 6.7% growth), but there is a general sense of unease, manifesting in higher borrowing costs, a weaker RMB and an investment slowdown,” Baig says.

Déjà vu?

Trade is the backbone of the global economy. The problem with temporary disruptions is that it is likely to cause growth to slow. Economists have not used the word recession yet. But surely they are aware of the Smoot-Hawley Tariff Act of 1930. The tariffs under the act were the second-highest in the US at that point. The act caused retaliatory tariffs by the US’ major trading partners. Over the course of the next couple of years, US exports and imports halved, exacerbating the Great Depression.

Countries in cross hairs of tariff wars


Stocks on the frontline of a trade war

Companies across the board will be affected by the US trade tariffs and China’s retaliatory tariffs, which come into effect on July 6.

If trade has plateaued, and slows, the most obvious sector to be affected is logistics. In Singapore, most of the industrial real estate investment trusts have a warehouse component. These four— Mapletree Logistics Trust, Frasers Logistics and Industrial Trust (FLT), Cache Logistics Trust and EC-World REIT — are pure logistics REITs. HPH Trust is also trade-related, as it owns ports.

HPH Trust and EC World REIT are in the centre of the storm, with all their assets in China and Hong Kong.

FLT’s Australian portfolio is likely to be relatively resilient. It acquired a A$1 billion ($1 billion) European portfolio in Germany and the Netherlands. The EU is a target of the current US administration’s ire. US President Donald Trump said on Fox News on July 1 that the EU was possibly as bad as China.

Some 9% of MLT’s valuation is from China, based on its enlarged valuation of $6.816 billion. As at March 31, 71% of Cache Logistics Trust’s valuation was from Singapore and 28% from Australia; Singapore accounts for 79% of gross revenue, and Australia 21%. Australia is likely to provide some stability to Cache’s portfolio.

Countries with small open economies such as Singapore, where the trade to GDP ratio is about 400%, are likely to be more vulnerable in the event of a trade war, and logistics REITs will not be the only companies affected.


Asia awaits impact on its exports

Asia has built up the world’s largest electronics industry cluster. According to HKTDC Research, China is the world’s largest electronics producer. In 2015, for instance, the value of its electronics output was US$700 billion, accounting for a 38% share of the global electronics output. US electronic output value was a mere US$240 billion.

Electronics is also the single-biggest product category in Asian trade. Based on statistics compiled by HKTDC Research, from 2001 to 2016, the value of electronics exports from Asia jumped from US$537.3 billion to US$1,758 billion. Electronics exports comprise one-third of exports from Asia, and include a huge selection of electronic parts and components and semi-finished goods, as well as a wide range of finished products such as mobile phones, computers, audio-visual entertainment items and other consumer electronics. The advanced Asian economies of Japan, South Korea, Taiwan and Singapore are also in this tech value chain, as they are important global sources of high-end semiconductors and other key parts and components.

More than half of Asia’s electronics trade is classified as intra-Asia trade, and this proportion keeps rising. Among the region’s electronics exports, the share of products from individual economies going to other Asia economies has steadily increased from 52.3% in 2001 to 63.7% in 2016. The largest export sources are mainland China, Asean and Hong Kong, and they are also the biggest Asian markets for electronics exports, comprising mostly parts and components as well as semi-finished goods.

Electronics products, in particular those such as semiconductors, electric vehicles and advanced medical items, are included in the US trade tariffs on China.

This story first appeared in The Edge Singapore (Issue 838, week of July 9), which is on sale now. To subscribe, click here