From an Asian perspective, there are three new US policy directions (under President Trump) that are relevant to China’s growth, policy and reform outlook this year: Trade restrictions against China, protectionism, isolationism.
China’s possible reaction (I): Allowing the renminbi to drop sharply as retaliation is unlikely, in my view. At this stage, Beijing’s overriding policy objective is stability. The PBoC’s policy is to keep a stable trade-weighted exchange rate, not large currency devaluation. A sharp drop in the RMB would give the wrong signal to structural reform. It would also create international chaos, leading to a “lose-lose” situation.
China’s possible reaction (II): Dumping US Treasury bonds are also unlikely because such an action could trigger selling by other players, many of whom are already starting to question the outlook of the US’s twin deficits. Massive selling of US Treasuries would hurt Chinese reserves valuation significantly.
China’s possible reaction (III): Trade retaliation is very likely. It would also likely stretch the trade war with the US by hitting US FDIs in China. The US has significantly more FDI in China than China has in the US (Chart 1). Chinese overseas FDI has likely peaked in 2016 in the short-term due to increasing capital control. So the FDI gap between US and China will remain large. This means that the US would be hurt more by China’s retaliation than it could hurt China. This also implies that the US does not have much leverage over China in a trade war.
The bad impact of Trump’s protectionism on China
In addition to hurting RMB sentiment and Chinese growth, a more far-reaching impact of US trade protectionism would be on China’s economic rebalancing process (Chart 2). Consumption-led growth is struggling to gain traction. The private-sector has lost its “animal spirits”, leading to sharp decline in private investment growth. Further weakening of the external sector implies that state-led investment will have to rise sharply to sustain China’s growth. This will delay China’s structural rebalancing.
The good impact of Trump’s isolationism on China
Trump’s plans to withdraw from the international free trade engagements and potential change in the US’s Asia strategy will give space for China to expand. In particular, this isolationism of the US is potentially conducive for Beijing’s implementation of the Belt & Road (BAR) plans, esp. in SE Asia. Our research1 has shown that China is likely to focus first on SE Asia (esp. ASEAN mainland) for expanding its economic and investment influence under the BAR initiatives. A reduction in American influence in the South China Sea is music to China’s ears.Download to read more