The phase-one deal needs re-negotiation
The negative impact on Chinese consumption resulting from the Covid-19 shock means it is near impossible for China to fulfill its 2020 import commitment of buying an additional USD200 bn of US goods and services, including USD 36.5 bn US agricultural goods. China had pledged to do this in the phase-one deal. China’s merchandise and agricultural imports from the US totalled just USD 27.5 bn and USD 5.1 bn, respectively, in first quarter 2020.
Of the four major
categories among China’s imports from the US, energy and services have fallen
precipitously. There is little hope of any significant revival in the coming
months because; 1) oil prices have plunged and; 2) no tourism is possible in the
near to medium term. Meanwhile, US
merchandised exports to China will be constrained due to the economic lockdown.
China did start buying more US agricultural products in the last quarter of 2019 amidst its supply shortage. Sustaining this pace of purchases will be difficult due to the disruption of both demand and the supply chains.
Assuming China’s demand rebounds at a fast pace for the rest of this year, it would import another USD 15 bn from the US. That would bring annual agricultural imports from the US to over USD20 bn, still far short of the target at USD36.5 bn.
So the phase-one deal will need to be re-negotiated. On the economic front, there are no strong grounds for the Trump Administration to retaliate, as the US’s trade deficit with China has fallen sharply since the trade war (see Exhibit 1). However, its deficit with the rest of the world has risen. Shifting blame to China’s role in the pandemic becomes a political (pre-election) strategy to divert attention.
What will Trump do?
Given the political incentive, President Trump may not be bluffing when he threatens to impose more tariffs as the “ultimate way” to make China pay for the cost to America of the coronavirus outbreak. But his latitude for doing so is limited as he will have to steer a course between penalising China and hurting US growth and markets in the run-up to the US presidential elections (in early November).
If the phase-one deal is to be re-negotiated, there are in my view, a few possible options:
- Mr. Trump could restore the tariff rate of 15%, which was cut to 7.5% in the phase-one deal, on the USD 120 bn worth of Chinese imports.
- He could impose tariffs on some Chinese imports that do not have a major impact on US aggregate demand, such as Chinese medical and pharmaceutical products (which totalled USD3 bn or 0.6% of US total imports in the 12 months to February 2020).
- The US Administration could impose sanctions on Chinese officials and entities who, according to its view, are responsible for mishandling the Coivd-19 outbreak.
- It may also step up measures on pushing US companies to repatriate assets and relocate back to the US from China, thus speeding up the decoupling from the Chinese economy.
- A more aggressive measure would be to impose restrictions on Chinese investment in the US or Chinese ownership of US assets and businesses and on US companies’ dealings with China.
The last option highlights the escalation of the Sino-US tech war, which in my view is a mutation of the trade war, stemming from this Covid-19 crisis. The pandemic has not slowed the US from pushing for more measures against China’s tech industry. The tech war is a long-term trend that will not subside even though the trade war risk may ebb and flow.
The White House created a “Committee for the Assessment of Foreign Participation in the United States Telecommunications Services Sector” under Executive Order 13913 on 8 April 2020, whose mandate is to discourage US firms from working with Chinese firms, not only in the United States but all over the world. More crucially, this new Committee has a heavy focus on national security, with the Attorney General as its Chair and the Secretary of Defence and Secretary of Homeland Security as permanent members.
National security lays in the heart of the sharp economic and political differences between China and the US. The establishment of this Committee essentially blocks Huawei and ZTE from the US tech carrier market where many potential customers receive federal grants. The national security hawks in the Trump Administration have now another powerful apparatus to restrict China’s access to US technology and the US tech market.
In the short-term, if the trade tension worsens, the People’s Bank of China (PBoC) could tolerate more renminbi weakness driven by market forces (i.e. by intervening less in the market). The tech war is likely to continue to escalate in the post-Covid-19 environment, even though the trade war may pause.
The Chinese reaction to this long-term challenge is to strive for self-reliance, i.e. decouple from the US. This trend has indeed begun. Huawei has already defied US pressures and continue to survive by building new smartphones and developing 5G base stations without using US chips. Its latest smartphone Mate 30, released in November 2019, which competes with iPhone 11 contains no US chips. Huawei has moved away from American parts at an unexpectedly fast speed. US companies are facing a growing substitution risk in the Chinese market, especially in lower-priced phones.
China’s drive to shake off its dependence on US parts goes beyond smartphones. Huawei can now build 5G base stations, which are a key part of the infrastructure needed for the high-speed network, without US components. Huawei’s strategy is simply switching to other, especially European and in-house, chip suppliers. NXP Semiconductors of the Netherlands and HiSilicon (Hauwei’s in-house chip design firm), have been the biggest winners so far at the expense of big losses by the American firms, including Qualcomm, Intel, Qorvo, Skyworks Solutions, Broadcom and Cirrus Logic.
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