US$200 billion tariff announced, what should China Do?

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David Ng

THE Trump administration on Tuesday announced a list of another US$200 billion worth of Chinese goods that could be subject to 10 per cent tariffs, ranging widely from home appliances and machinery to apparel and furniture.

While we have taken a view that President Donald Trump’s trade threats against China could well be credible, this announcement has come earlier than we expected.

As the proposed tariffs will undergo a two-month review process, with the public consultation period ending on August 30, the implementation could be as early as September.

As the US had surprised the market by escalating the announcement of the US$200 billion tariff list, it has likely pushed both sides closer towards a potential ‘full-blown’ trade war. We think the Chinese government will likely reevaluate its strategy. Since the ‘trade war’, which officially started on July 6, we had believed that the Chinese government’s view has been “a strong counterattack and a battle to stop the war are the best choices”.

Therefore, we took a view that “China would pursue a tit-for-tat strategy in the earlier stages”, despite its willingness to make concessions to avoid a trade war.

In view of the increasingly hawkish US stance, with the risk of a trade war moving from threats to reality, we see three possible strategies that the Chinese government is likely deliberating.

Strategy 1 (tit-for-tat): China could continue its current tit-for-tat strategy by staying firm on a full scale retaliation with both qualitative and quantitative measures while continuing its open market and reform agenda, as outlined by President Xi Jinping in April 2018.

Strategy 2 (no retaliation): China does not follow up with more retaliation to avoid a further escalation of the trade war and minimises the negative impact from tit-for-tat actions.

Instead, China could focus on domestic reforms and development, while accelerating opening-up and addressing other US demands, which are also in China’ own interests.

China could further lower import tariffs, and even possibly implement ‘zero’ tariffs.

While such a view has been popular among leading academics since March, we note increasingly similar views voiced since mid-June calling for the government to change its strategy.

Strategy 3 (controlled retaliation): China could continue its hawkish line but actually retaliate on a controlled and selective basis (assuming that the Trump administration goes ahead with the tariffs on US$200 billion plus US$300 billion imports) without fully matching US’ measures in scale or intensity. This way, China would not appear to have yielded to the US but could try to mitigate the negative economic impact from tit-for-tat actions.

Meanwhile, we think China will continue its open market agenda, improve its relationships with other trading partners, and address some of US’ demands to reduce the pace and intensity of any further escalation of the trade war.

Which ever strategy China may pursue, the bottomline remains that the market will face a period of turbulence and investors should brace for impact as we could see pockets of sell-down activities in certain asset classes.