A full-scale Sino-US trade war would hit GDP in both countries, but China looks ready to ease monetary policy further, which should underpin A-shares as they debut in major indices.
The recent re-escalation of the trade dispute could threaten growth in China (and in the US). Chinese growth had just shown signs of stabilising and now market observers have started to revise down their GDP forecasts again, just weeks after they adjusted them up. We, however, are holding to our forecast for 6.2% growth since this already included the tariff situation (although not a full-scale trade war) when we released the estimate late last year.
China will likely meet an escalation of the risk to growth with more domestic stimulus, but we do not believe it will devalue the renminbi. And investors should keep in mind the impending inclusion by FTSE Russell and MSCI of A-shares in their indices.
Trade-war risk spiked after US President Donald Trump on 5 May threatened to raise the tariff on USD 200 billion worth of Chinese imports from 10% to 25%. The following day, the People’s Bank of China (PBoC) set the renminbi/US dollar fixing at 6.7344, compared to 6.730 on the last trading day before the four-day holiday, which in our view indicated there was no policy intention to devalue the renminbi.
Exhibit 1: Changes in the off-shore renminbi/US dollar exchange rate between November 2017 and May 2019
Source: Bloomberg, 14 May 2019
US threat could blow back on US growth
Trade-war tail risk has risen sharply: from our 10% probability earlier to 20% now. If Mr. Trump decides to go for a full-scale trade war by levying 25% tariffs on all Chinese imports, as he has threatened, it would have a significant adverse impact on global financial markets.
The International Monetary Fund has estimated that a full-scale trade war could cut US GDP growth by 0.6 percentage points and China growth by 1.5. Such a lose-lose outcome should tell the US president that escalation would not be a rational choice.
As said, in reaction to the heightened risk, Beijing is more likely to shift policy back to growth protection than to devalue the renminbi. This would mean more infrastructure investment, further cuts in the reserve requirement ratio (RRR) for banks, and a less hawkish stance on the property sector. In fact, the PBoC announced an RRR cut on 6 May for 1 000 small rural commercial banks to 8.0% from 11.5%, releasing RMB 280 billion of liquidity into the system for targeted lending to the private sector and small and medium-sized enterprises.
Trade war would hurt, but not break, China’s resilience
This move and its timing not only underscore our long-held view that Beijing’s macroeconomic policy has evolved into a structural commitment to economic reform and debt control, but also show that the stock market has been entered into the PBoC’s policy reaction function.
Yes, a full trade war would hurt, but it would not be detrimental to China’s growth, in our view. We still expect non-inflationary moderate growth under continued policy easing in coming months. The changes in the FTSE Russell and MSCI index weights will start at the end of this month and continue for the rest of the the year. The consensus estimate is that these changes will attract about USD 30 billion of passive rebalancing inflows into China. If the trade war risk subsides again, active inflows may follow.
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