China – Risk Grows as Trade War Escalates

The US imposed a 10% tariff on another $200 billion worth of imports from China earlier this month, in the latest round of the escalating trade war in which neither side has given any indication that it is considering retreat. The new tariffs will increase to 25% on January 1, 2019, unless a deal is reached before then, which seems unlikely. The total value of Chinese goods now subject to punitive tariffs is about $250 billion, which already far exceeds China’s total annual exports to the US. With US President Donald Trump signaling his willingness to slap punitive tariffs on all remaining Chinese exports (worth approximately $270 billion), Beijing’s response to hostile policy moves by the US will necessarily affect components of the bilateral relationship that go beyond two-way trade.

Recent political reforms in Beijing have greatly concentrated power in the hands of President Xi Jinping, at a time when neither the Republican Party majority in the US Congress nor the president’s White House advisers seem to be willing or able to control Trump’s often impulsive decisions. The lack of constraining forces on both sides increases the risk that the escalation will proceed to the point of causing serious economic damage to both China and the US, with negative repercussions for countries all along the global supply chain.

The Shanghai Composite Index has fallen to a four-year low as investors respond to the growing possibility of an economic slowdown that will complicate government efforts to engineer a soft landing for an economy made vulnerable by a massive debt burden, a problem that will become worse as firms unable to obtain equity financing are forced to take on additional debt.

Vice Premier Liu He, a US-trained economist who heads the new Financial Stability and Development Commission, has emerged as a pivotal figure since his promotion in March 2018. In addition to taking the lead role in trade talks with the US, Liu’s team, which includes Bank of China Gov. Yi Gang and Liu Shiyu, the head of the national securities regulator, has been tasked with spearheading an effort to reform the country’s SOEs.

Liu has previously advocated the sale of partial stakes in state enterprises to private investors, as well as the introduction of private competition in currently closed sectors, including the defense industry. However, Liu is not in a position to debate policy decisions with the president, and to the extent that the new arrangement limits the influence of Prime Minister Li Keqiang over economic policy decisions, it increases the likelihood that any crisis-driven deviation from the current policy course will be in the direction of tighter state regulation and reduced reliance on market mechanisms.

Since 1979, The PRS Group Inc., has been a global leader in quant-based political and country risk ratings and forecasts. This excerpt is from our latest Political Risk Letter publication, for more information please contact us at (315) 431-0511 and sales@prsgroup.com

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