Trade War and its impact on stocks, bonds and currencies

The trade war is on and in full earnest. It actually got triggered off on July 06th when the US tariffs on the first set of Chinese imports to the extent of $34 billion kicked. While the two countries are already trying to work out a solution, the impact is likely to go up to $200 billion by September and to $500 billion by December this year. The last time the world saw a tradewar was in the 1930s when every nation was trying to promote domestic industries by imposing tariffs on imports. It became increasingly difficult to find export markets, so countries started to drop the value of their currencies (devaluation of currency) and the trade war soon degenerated into a currency war. That is exactly how the trade war eventually led to the Great Depression of the 1930s.

Why the US has a problem with China

image003 300x175 Trade War and its impact on stocks, bonds and currencies

Data Source: US Census Bureau

While US have threatened most of the EU and NAFTA nations with tariffs, the real target was obviously China. After all, the US was running a $375 billion annual trade deficit with China (graph above) and that was something Trump always had his eyes on. Trump had romped to power promising to cut down the huge trade deficit that the US ran with China, rest of Asia, Canada and Mexico. In case of China, Trump actually went a step further. He announced tariffs specifically targeted at China and these were intended to impact nearly $50 billion worth of Chinese imports to begin with.

What if it becomes a full-fledged trade and currency war?

It could have 4 possible repercussions globally. It remains to be seen whether things will actually degenerate to that level but that is a distinct possibility. Let us look at the 4 possible repercussions.

  • China will hit at the core voter constituency of Donald Trump; the US soybean farmer. These could be expanded more aggressively in the months ahead.
  • China’s counter tariffs will have a major impact on jobs in the US as most US exports are job generating. More so, at a time when the US economy growth is just coming back!
  • The Chinese Yuan could trigger a deliberate currency war to push more vulnerable nations to the brink. Impact on INR cannot be ruled out.
  • China does not have too much deficit to control and hence the US could be the bigger beneficiary of these tariffs.

What this trade war could mean 5 things for India:

The real trouble for countries could be if contagion spread. Here are 5 ways in which India could get impacted by the US-China trade war…

  1. The sharp crack in commodity stocks was due to growth fears. The IMF has warned that projected global growth rate at 3.9% could be negatively impacted by a trade war. Industrial Metals like copper, aluminium and zinc could be big losers as they predicate on industrial demand.
  2. Trade deficit could be the biggest casualty. Monthly trade deficit is beyond the $16billion per month. The forex reserves may be adequate to cover just about 9 months of imports. A trade war will widen the trade deficit, make imports more expensive.
  3. When inflation moves up, it has the tendency to push up the inflation expectations. Inflation expectations are the key to interest rates and as a result the RBI may be constrained to increase the repo rates. The two rate hikes in June and August are indication of that.
  4. The INR could come under pressure in the global currency markets. There is a limit up to which the RBI can manage the rupee. When every country starts imposing higher tariffs on imports, they also try to boost exports by weakening the currency.
  5. Finally, there heightened risk of corporate bankruptcies as an outcome of these trade wars. Indian companies could get squeezed between two extremes. The prices of inputs will go up due to higher import costs but it will be hard to pass on the costs.

The last word on this subject is yet to be said. But it looks like if there is a full-fledged trade war then India is unlikely to be spared.

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