How would a change in US trade policy impact China?

Chetan Sehgal, lead portfolio manager at Templeton Emerging Markets Investment

Trade was an important topic in US President Donald Trump’s presidential campaign and concerns about protectionist measures have remained at the forefront since his election. The US is a large net importer of goods and China alone is responsible for roughly 60 per cent of the US trade deficit. 

However, the overall trade balance surplus of China is not that high and that must be viewed in context. A big portion of the imbalance is due to imports of American-branded products such as the Apple iPhone which is designed in California but assembled in China from components manufactured in many countries skewing the overall trade numbers. We hope this is considered before levying tariffs as any protectionism measures initiated by the US could likely have an impact on Chinese exports to the US and impact the global supply chain. 

China still needs to improve in terms of intellectual property and non-tariff trade barriers and in recent congress meetings it has pledged to do more in this respect. Policy responses in some cases may have lagged the fast economic development, but the commitment to compete on even terms remains resolute as it has increased its investments in R&D and is one of the largest applicants of patents globally. 

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Recovery in the global and US economies led Chinese exports to grow about 8 per cent in 2017, ending two consecutive years of decline. This helped support the overall performance of China’s economy and allowed the Chinese government to scale back stimulus, accelerate supply-side reform and deleverage the SOE (state-owned enterprise) sector. We expect this trend to continue in 2018, but a US trade policy change could adversely impact China’s exports and we could see a slowdown in Chinese reforms in the short term. 

Structurally, China is rebalancing its economy and is also actively diversifying away from the US as a key export destination. At present, exports to the US as a percentage of China’s GDP is only 5 per cent and has been on a downward trend. This is significantly lower than that of other countries. We believe that trade disruptions will likely impact China only in the short term and may help speed up China’s efforts to upgrade its economy with additional investment in the service and higher-value added manufacturing sectors. 

Looking ahead, we view the main drivers for Chinese equities to be an improving earnings outlook, higher dividends to shareholders, a fading risk of currency devaluation and further implementation of supply-side and state-owned enterprise reforms. We are, however, mindful of US trade policies, faster-than-expected US Federal Reserve rate hikes (which could lead to a stronger dollar), and higher bond default rates if systemic liquidity tightens.

Chetan Sehgal is lead portfolio manager at Templeton Emerging Markets Investment Trust.

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