How the trade dispute with the US is affecting economic risks

04 February 2019

An uneasy truce between China and the United States (US) on trade is unlikely to result in a trade deal, as little progress has been made on addressing key issues such as protection of intellectual property. The trade dispute will weigh on headline growth in China, although the government is expected to pursue accommodative monetary and fiscal policy.

Security Environment

While relations between China and the US have deteriorated in recent quarters, an open conflict between the two states in the South China Sea is not likely. China appears to have completed the majority of its construction activities across the South China Sea, having built military facilities on a number of reefs. 

However, US and European ships operating in these waters are likely to be shadowed by Chinese vessels, increasing the likelihood of an unintended confrontation. 

For example, in September 2018, the USS Decatur and a Chinese destroyer nearly collided. China also continues to have territorial disputes in these waters with Vietnam and the Philippines, as well as with Japan in the East China Sea.

Foreign nationals operating in China may face a risk of arbitrary detention. The risk is particularly elevated for Canadian citizens, as diplomatic relations between the two countries have deteriorated since December 2018 when Canada acted on a US extradition request, detaining Meng Wanzhou, the Chief Financial Officer of Chinese firm Huawei. 

Since then, China has detained two Canadian nationals under national security laws. Any detention is unlikely to be completely arbitrary, but minor infringements are likely to receive stringent punishments. 

China may also retaliate against nationals from additional countries, with state-run media indicating in January 2019 that China would respond to the arrest in Poland of a Huawei employee for suspected espionage.

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Trading Environment

China and the US have forged an uneasy truce in the ongoing trade conflict, with the two parties meeting for trade talks in January 2019. Following talks it was reported that China had promised to purchase a substantial amount of US products, with a view to completely eliminating its trade surplus with the US by 2024. 

However, it is unlikely that deeper structural issues, such as Chinese protection of intellectual property (IP) or government support for state-owned enterprises, will be addressed in the near-term, preventing a long-term deal on trade. A re-escalation in the trade conflict therefore remains possible, and trade barriers are expected to remain in place in 2019.

The trade dispute will partly contribute to decelerating economic growth in China, as export demand slackens. Real GDP growth is forecasted at 6.2% in 2019, after growth fell to 6.4% y-o-y in Q4 2018, the slowest rate of growth since the 1990s. 

Trade uncertainty will also weigh on private consumption, as weaker manufacturing activity drives job losses. However, efforts to restrict activity in the shadow banking sector are also having an impact on headline economic performance, as credit growth has become more limited.

Economic headwinds will ensure that the Chinese government pursues accommodative monetary and fiscal policy in order to support investment and accelerate the country's transition from a low-cost manufacturing economy. Measures may include cuts to the 1-year benchmark lending rate, cuts to value-added tax and further income tax deductions. 

However, looser policies will increase pressure on bond yields and weigh on the yuan, which is likely to see further depreciation in coming quarters.

Investment Environment

China is undertaking measures to open up its economy to foreign investment, to provide greater support to growth and enable a move up the value chain. This is likely to include strengthened IP protection. 

Many investors have cited China’s weak IP laws as a key area for concern, with China’s IP practices one of the issues cited by the US when it began investigating Chinese trade practices in August 2017. The US alleges that the Chinese government has supported or co-ordinated the theft of US IP for decades, forcing foreign firms to cede IP in order to access Chinese markets. 

China has made some limited progress on IP, proposing a new law in December 2018 that would ban companies that have stolen technology from issuing bonds or accessing financing. The government has also indicated that it will pass a foreign investment law to protect the IP of foreign companies. However, China is likely to fall short of US demands on this issue, and reports from trade talks in January 2019 indicate a lack of progress

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*** Chinese sovereign credit risk deals are rare, and any oil related deals will push pricing higher, towards 1.5% - 1.75% p.a.

In this month's Risk Outlook, we also provide a detailed forward looking assessment of developments within the security, trading and investment environments for DR Congo, Tanzania, Mozambique and Ecuador, all of which have been the subject of recent enquiries from JLT's client base.

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