Collateral damage from the Sino-US trade conflict

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Although the focal point of the current trade tensions is between China and the US, collateral damage to other Asian economies is mounting, and clearly has risk implications for regional asset allocations. In particular, Asia’s export-oriented economies are not immune to tighter US dollar liquidity stemming from the risk aversion arising from the Sino-US tariff impositions and retaliations. One indicator of financial stress is the year-to-date decline in Asian currency values against the dollar (exhibit 1).

Exhibit 1: Change in nominal exchange rates against the USD from Jan-August 2018 (%)

Source: CEIC, BNP Paribas Asset Management (Asia), data as of October 2018

A slowdown in global growth due to the Sino-US trade conflict would lead to a loss of demand for emerging market (EM) exports. A recent market study[1] finds that in Asia, the GDP growth rates of Singapore, Malaysia and Thailand are the most sensitive to shifts in G3 (US, Europe and Japan) growth. China is essentially unaffected due to its large continental economy and the availability of domestic stimulus tools.

Collateral fallout

However, the very existence of the bilateral trade dispute between China and the US could have significant effects on regional economies through the global supply chain channel[2]. The potential collateral damage can be estimated by stripping out the foreign value-added content (averaging about 40%) in China’s gross exports and reassigning them back to its original source countries to assess their ultimate export exposure to the US.

This means that when China’s exports to the US drop due to the trade tiff, exports from these countries will also fall. We estimate that six of the top 10 most-exposed countries are in Asia (exhibit 2). The damage to China is only limited. From an asset allocation risk management perspective, ceteris paribus, markets with the highest US-China exposure would tend to be hit the hardest.

Exhibit 2: Final exposure to the US compared to direct exports to the US (2016)

 

Note: final exposure of exports that cater for US domestic demand, excuding goods that are re-exported from the US to third markets. Source: UN Comtrade, Eurostat, OECD-WTO TiVa database, IMF, national statistics, CEIC, BNP Paribas Asset Management (Asia), data as of October 2018

A recent market study[3] also found that of the most US-exposed Asian countries, the industries that could be hit the most severely by US trade measures are textiles, leather and footwear in Vietnam, computers and electronics in Taiwan and Malaysia and chemicals and petroleum products from Singapore.

Impact from contagion

The escalation of Sino-US trade tensions has raised risk aversion, as investors reassess the economic fundamentals of EM and ponder which markets might be susceptible to financial contagion as the trade shock unfolds. The principal economic fault lines under scrutiny include a country’s current account balance, fiscal balance, external debt and inflation. When a negative shock hits, a country will likely fall into crisis or suffer from financial contagion when it has a combination of a twin (current account and fiscal) deficit, a large foreign debt and high inflation triggering a loss of confidence.

China has none of these macroeconomic problems. Its current account is in surplus, inflation is subdued, its fiscal deficit is small at around 3% of GDP, and its foreign debt is less than 15% of GDP (compared with its FX reserves of 25% of GDP). Most importantly, the renminbi is not convertible, so its financial contagion risk is very small.

The three most vulnerable major Asian economies are India, Indonesia and the Philippines due to their twin deficits and relatively high inflation. But their foreign debts are relatively small (exhibit 3 and Table 1). While Malaysia has a large foreign debt, it runs a sizable current account surplus and has low inflation.

Exhibit 3: APAC EM Macro-stress indicators (2017)

Source: CEIC, UBS, BNP Paribas Asset Management (Asia), data as of October 2018

Table 1: APAC EM Macro-stress indicators (2017)

 

Source: CEIC, UBS, BNP Paribas Asset Management (Asia), data as of October 2018

Overall, the Asia Pacific region’s emerging economies have solid fundamentals, although their asset markets are still susceptible to selling pressures from a rise in risk aversion. Every Asian currency in our analysis has fallen against the US dollar since the beginning of this year (see Exhibit 1), with the three twin-deficit countries falling the most, followed by China (which had a current account deficit in Q1 2018).

Crucially, our research shows that the correlations of the movements between the renminbi and major Asian currencies have increased (at the expense of their correlations with the US dollar and the euro) in recent years[4]. This suggests that if the trade tensions continues to exert downward pressure on the renminbi, Asia’s currencies will also face more depreciation pressure.

Volatility set to linger

Currency swings like these, especially in the course of only a few months, tend to cause market volatility and prompt a tightening in overall financial conditions as liquidity flows out of the region towards safe haven markets, or regional authorities hike interest rates to calm the FX market, or both. This means that the resultant tighter credit, wider credit spreads and sputtering equity markets in Asia will likely linger as the Sino-US trade conflict intensifies in the short term.

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[1]ASEAN: Trade War Drags Growth Forecasts Lower”, UBS APAC Economic Perspectives, 18 July 2018.

[2] See also “Chi Time: Implications of Sino-US Trade Frictions”, 23 February 2018.

[3] “The Impact of US Trade protectionism Centring on China”, Asia Special Report, Nomura, 23 March 2018.

[4] See “Renminbi Displacing the US Dollar by Stealth”, Chi Lo, BNP Paribas Asset Management, 3 January 2013.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher than average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity, or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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Chi Lo

Senior Economist for China

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