How will the US-China trade war affect global markets and Indian equities

There is little doubt that this trade war will affect global trade adversely

China and the US are engaged in a full-scale trade war as both sides lob threats of new trade tariffs at each other and implement them. The latest round of tit-for-tat tariffs by the United States and China has intensified the global debate about whether the world is facing a mere trade skirmish or heading rapidly toward a full-blown trade war. But what is really at stake may be even more fundamental. Either accidentally or by design, Donald Trump’s administration may have paved the way for a “Reagan moment” for the international trade regime. In the 1980s, US President Ronald Reagan initiated a military spending race with the Soviet Union that ended up altering the global balance of power in ways that affected many countries worldwide.

These actions exacerbate tensions over the Trump administration’s imposition of tariffs on imports from other countries, including some of America’s closest allies (such as Canada, Mexico), and its threats to withdraw from the World Trade Organisation, which impacts the rules-based system regulating cross-border flows of goods, services, and capital.

According to analysts, the direct impact of the tariffs, even if 25 per cent were to be imposed on everything the US imports from China, will only reduce Chinese growth by 0.5 per cent. But the warfare could spread to other countries and to areas beyond trade. However, the Chinese have sought to calm fears among US businesses that they would take recourse to unnecessary inspections, product quarantines, administrative punishments and regulatory delays to harass them. But there is no saying what direction the future could take. The “qualitative” measures that the Chinese threatened to take would not be easy to pin down. The second and third order impact of the trade war is difficult to estimate given the differences in growth stages of countries, their priorities, their political set-up etc.

China being the largest consumer of base metals, the current development should have a negative impact on the prices of base metals. Gold is a safe haven and should benefit though with a lag. It is not necessary that in the backdrop of trade tensions, lower base metal prices will be good for Indian corporates as revenues of companies will be adversely affected.

Crude oil too will bear the brunt, depending on the severity of the impact and the resultant slowdown in global growth. China could secure crude oil from alternative sources such as West Africa which has similar quality as US crude, the US would find it hard to find an alternative market as big as China. However, if crude oil prices fall as a result, then other things staying the same, it will benefit India’s macros. However, if lower oil prices are caused due to a full-blown trade war, its positive impact on the economy can get negated/limited due to other negative developments such as weaker confidence and/or disruption in global trade.

While it remains uncertain as to how this retaliatory tariffs game between US and China will play out, there is little doubt that it will impact global growth and investments across borders. The integration of supply chains both domestically and globally has meant that any trade measures implemented on a single country or sector will likely extend beyond the direct impact on demand. Impact on global growth can be measured by the inter-dependencies among different sectors of the economy and to what extent the output of one sector becomes an input in another sector.

Indian equity markets could see the impact of this war in different ways. For one, suppliers from across the world may dump their products into India (representing a large market) at a lower price to maintain their utilization levels, benefitting importers. Exporters, however, could face the brunt of falling global trade. Currency direction will determine as to how far the above setback for exporters is compensated by a weaker Rupee. Inflation could fall; however given the vastness of the Indian markets and its demographic structure, the possibility of recessionary conditions setting in seem remote unless the trade war situation extends beyond a few quarters. Uncertainty on the impact of growth rate in corporate earnings could temporarily bring down the EPS estimates and the P/E ratio, resulting in some transitory weak period for our markets.

The author is the head of retail research at HDFC securities.