US-China trade tensions: Fitch says further tariff escalation would hamper global growth

May 13, 2019 (LBO) – The US decision to increase tariffs to 25 percent on an additional 200 billion dollars of imports from China marks a significant escalation in US-China trade tensions, and highlights the risk of a protracted trade war beyond our current assumptions, the Fitch Ratings said.

The rating agency, however, said the recent decision had been assumed under Fitch Ratings’ 2019 base case and does not alter our Chinese or global growth forecasts even though this could have spill-over effects to countries other than China and the U.S.

Full Statement:

The U.S. decision to increase tariffs to 25% on an additional USD200 billion of imports from China had been assumed under Fitch Ratings’ 2019 base case and does not alter our Chinese or global growth forecasts. However, the decision marks a significant escalation in U.S.-China trade tensions, and highlights the risk of a protracted trade war beyond our current assumptions. This could have spill-over effects to countries other than China and the U.S.

Fitch’s global growth forecasts have included an assumption that U.S.-China trade tensions would be persistent and escalate in 2019, including the specific U.S. tariff scenario that was put in place overnight. The scale of the additional tariff shock – the increase is equivalent to about 0.2% of Chinese GDP – is relatively modest. The ultimate impact on the Chinese and U.S. economies will depend on the response both by policymakers and consumers.

A shock on this scale could be relatively straightforward for China to offset through marginal additional policy easing. We already forecast Chinese growth to fall to 6.1% this year from 6.6% in 2018. This partly reflects confidence effects linked to trade tensions, but the impact of earlier monetary tightening on domestic demand is more significant, and recent Chinese economic data has been slightly stronger than expected.

U.S.-China trade talks are continuing, and the U.S. has not made any official proposal to further extend tariffs on Chinese imports. However, the risks of additional escalation outside our base case have grown.

The U.S. imported USD540 billion of goods from China in 2018. The 25% tariff now being levied on USD250 billion of goods leaves residual imports of around USD290 billion that have not been subject to additional tariffs. Extending the 25% rate to these imports would entail a larger tariff shock, equivalent to about 0.5% of Chinese GDP. This would imply a cut to our Chinese growth forecasts in the absence of a more aggressive domestic policy response.

The latest tariff increase does not have direct implications for China’s ‘A+’/Stable sovereign rating, as policymakers can still reach their 2019 growth target without significantly stepping up stimulus. But if trade tensions eventually lead to blanket U.S. tariffs on all Chinese goods, the potential rating impact could be greater, as it may tempt the authorities to abandon their restrained approach to policy easing, and adopt credit stimulus measures that exacerbate the country’s already significant financial vulnerabilities.

How China responds will also be significant for the global macroeconomic outlook. Chinese goods imports from the U.S. totalled USD120 billion in 2018, so China would be unable to impose commensurate retaliatory tariffs as happened in July 2018. However, China could retaliate in other ways, most likely via non-tariff barriers. We think the Chinese authorities are unlikely to pursue sharp currency depreciation, as it could re-trigger capital outflow pressures, although the currency may weaken through the higher tariffs’ impact on market sentiment, as happened in 2018.

Risks of rising trade tensions are not restricted to the bilateral U.S.-China relationship. For example, the U.S. president is considering a Section 232 report submitted by the U.S. Department of Commerce in February, which could be adopted to justify imposing auto tariffs on national security grounds. This would particularly affect the U.S.-EU bilateral trading relationship, broadening trade tensions, potentially leading to retaliatory measures, and adding to global growth hurdles.