Victims of a looming trade war

The election of Donald Trump has not triggered any major financial tensions in the main emerging markets. Nevertheless, the dollar has strengthened, which should delay the easing of monetary policies. More worryingly, emerging economies will be the direct or collateral victims of the trade war promised by the incoming United States administration. They will face a double shock: a sharp slowdown in global trade and the re-routing of Chinese exports. The first shock is bound to be recessionary or even inflationary. The impact of the second is not clear cut as it hinges on the types of Chinese exports (complementary or competing) and, most of all, on their link with direct investment.

The election of Donald Trump has darkened the outlook for emerging countries. In the very short term, the impact is mainly financial. Since 4 November, the exchange rates of the main emerging countries have depreciated by a median of 1.5% against the dollar, with Central European currencies the hardest hit, in line with the euro’s 2.8% depreciation against the dollar, the Chilean and Mexican pesos (both -2.7%), the Thai baht (-3.1%) and the South African rand (-3.6%). Since October, portfolio investment flows from non-residents to the main emerging countries have dried up, with the exception of a few countries that have continued to attract bond investors. However, government bond yields in local currency and CDS spreads have remained stable. If they remain at this level, currency depreciations are unlikely to accelerate inflation again on a long-term basis. But they could delay the easing of monetary policies.

Protectionist spiral: A global recessionary effect

More worrying in the short to medium term, the announced increased protectionism in the United States and the risk of retaliatory measures from China and the European Union are reducing the prospects for global growth, and therefore for emerging countries, via the negative impact on international trade. The Trump administration is planning to raise the existing import taxes by 10 percentage points on all products imported from all countries except China, and by 60 percentage points on Chinese products. According to the CEPII, a French center for research and expertise on the world economy1, if other countries were to apply equivalent import taxes in return2, the recessionary impact by 2030 (compared with a scenario without increases in tariffs) would be -3.3% on global exports and -0.5% on global GDP. China and the US would obviously be hardest hit with a 1.3% contraction of their GDP. According to a study published by the Peterson Institute for International Economics (PIIE)3 using a different methodology4 the negative impact on the US GDP (assuming retaliation by other countries as well) would be in the -0.9%/-1.3% range5. The impact would be -1.2% for China (in the China-specific scenario). In the CEPII study, Canada and Mexico, protected by the USMCA, would benefit greatly from the improved price competitiveness of their exports. In the PIIE study, it would be the opposite; the two countries would suffer more from the increase in tariffs than the other countries since they would be hit harder given their large commercial links with the US.

For the rest of the world, the CEPII simulation concludes that the impact would be negative but limited. The impact on India’s GDP would be lower than 0.5%. In the PIIE study, against all odds, the impact of countries’ GDP is even slightly positive, despite the overall inflationary impact. The authors do not provide explanations in their article. Compared with the CEPII study, the negative impact of protectionism on world trade seems underestimated in our view. The fact remains that a trade war will have a recessionary effect for all countries (to a lesser extent, perhaps, for Canada and Mexico).

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