US-China Tensions Likely to Result in Slowdown of Capital Flows to Emerging Markets

By Didhiti Ghosh, Bureau Chief (Kolkata), Indian Observer Post

Kolkata/Mumbai/London, May 19, 2019: India Ratings and Research (Ind-Ra) demonstrate that the rise in trade tensions between the US and China could lead the latter to guide its exports towards Emerging Markets (EMs). In the past, China has showcased such tendency and dumped its products at predatory rates in many markets including India. This could potentially disrupt the demand-supply dynamics in the Indian domestic markets, especially for products such as electronic goods, iron and steel and organic chemicals.

A fall in Chinese exports to the US could potentially put downward pressures on the Chinese Yuan. A likely devaluation of the Yuan could stimulate a competitive depreciation in the Indian rupee, failing which the competitiveness of Indian exports could be affected.

Chinese exports accounted for about 18% of the total US imports in 2018, representing 2.34% of the US GDP. Given the substantial share of Chinese imports in comparison with the size of the US GDP, lower imports or a rise in the cost of imported goods could stimulate inflationary pressures in the US. This could provide a fillip to the US credit market yields, which in turn could push up discount rates and reduce the arbitrage opportunity for US investors, resulting in weaker foreign portfolio investment (FPI) flows to EMs including India.

As highlighted in Ind-Ra’s FY20 Corporate & Capital Market Outlook, a continued shrinkage in the Chinese trade surplus is likely to transform China from an exporter of capital to a net importer of foreign capital.

Therefore, Ind-Ra expects the combined effect of higher capital flows into China and a rise in inflation in the US to crowd out and impinge upon flows into EMs.

Any slowdown in Chinese exports to the US on account of the recent imposition of tariffs on Chinese goods could result in a commensurate rise in Chinese exports to other EMs. With Chinese industrial production continuing to grow at around 5% and Chinese exports to the US contracting persistently, over the last few years, Chinese exporters have started penetrating into alternate markets. Hence, imports by other Asian EMs from China grew 20.70% in 2018 vis-à-vis 12.75% in 2010. This has been catalyzed by the Chinese manufacturers’ ability to undercut domestic manufacturers in these markets, resulting in lower market share for the domestic players in the EMs. 

With the Chinese industrial production continuing to grow at around 5% persistently, imports by other Asian EMs from China grew to 20.70% in 2018 (2010: 12.75%), thereby reducing the number of shares for domestic players. This risk is further exacerbated by the benign domestic demand conditions, coupled with weak capacity utilization levels in China. Ind-Ra expects the contraction in Chinese trade flows to the US is likely to result in the dumping of key commodities such as electronic and electrical components, steel, chemicals, plastic products and other intermediate goods.

Furthermore, the analysis predicts that India’s share of imports from China in total imports of steel, polymer and capital goods could potentially increase as Chinese exports to the US start losing traction. The impact could percolate through lower international prices, thereby putting pressure on domestic prices due to a diversion of supply from China to other importing countries. The agency expects demand-supply dynamics in these sectors to get skewed unfavourably over the medium term. Nonetheless, the impact is difficult to quantify at this point in time and will be contingent on the Chinese production & capacity utilization levels, global demand-supply scenario and a host of other evolving factors.

Reports show that in 2018, the US imported goods worth 540 USD from China. Past week, the US raised tariffs on the import of 200 USD Chinese goods from 10% to 25%. In response, China hiked tariffs on 60 billion USD worth of products imported from the country.

Image Courtesy: Blokt

(DIDHITI GHOSH is an India Columnist at La Agencia Mundial de Prensa, USA, and is the Bureau Chief of Indian Observer Post based in Kolkata. E-mail: didhiti.24@gmail.com | LinkedIn: https://bit.ly/2H6gNAv).