Moody’s Investors Service says that it does not believe that China can satisfy US requests to reduce its trade surplus with the US by $200 billion by 2020 without causing significant disruptions to its economy.

Moody’s also does not believe that doing so would be acceptable to Beijing, as the measures that it would need to take to achieve Washington’s goal would be incompatible with the Chinese government’s policy objectives.

Moody’s conclusions are contained in its just-released report, “Government of China: Demands in US-China trade and technology negotiations unlikely to be met; uncertainty to weigh on investment”.

On 4 May, trade talks between the US (Aaa stable) and China (A1 stable) concluded in Beijing without significant progress.

Neither government has publicly declared its latest demands but, according to widespread media reports — confirmed by the US-China Business Council as accurately representing the Trump administration’s position — the US requested that China cut its trade surplus with the US by USD200 billion by 2020.

Moody’s believes that the required adjustment to trade flows would be implausibly large for China Reducing its trade surplus with the US by

USD200 billion would bring it back to levels last seen in the mid-2000s, reversing trade flows that have built up over the past 10-15 years

Such a rapid shift generally involves a very sharp slowdown in GDP growth and imports by the deficit country, which is not the objective pursued by the US.

More broadly, the US requests that have transpired relating to industrial policy, investment and intellectual property are at odds with China’s focus on innovation-led movement up the value chain.

A $70 billion cut per year in exports from China to the US

The implied adjustment in the trade surplus of around USD70 billion per year over 2018-20 would be substantial, whether it happened primarily through lower exports from China to the US, or higher imports into China from the US.

To narrow the surplus entirely through lower Chinese exports of goods and services to the US, they would need to fall by around 15% a year, compared with a 3.6% rise on average over the past five years.

And, to narrow the surplus entirely through higher Chinese imports of goods and services from the US, they would need to rise by more than 27% a year, compared with 5.2% on average over the past five years.

Such a significant swing in trade flows between the two countries seems achievable only if the authorities implement dramatic changes in tariffs and duties to alter current business and consumer behavior.

It would also assume that China is willing to accept the related costs and challenge to domestic policy imperatives.

From the point of view of China’s policymakers, such changes would contradict current industrial policy, which aims to boost innovation and value added in the economy.

This, in turn, increases the value of exports and strengthens capacity for domestic production to compete in areas such as capital equipment and consumer goods.

The narrowing of the surplus is the most specific of the US demands

Washington is also reported to have requested that Beijing immediately end subsidies linked to its “Made in China 2025” industrial policy, reduce import tariffs to match those of the US, remove investment restrictions, and strengthen intellectual property protections and enforcement.

Moody’s also notes that as the negotiations continue, the US and Chinese demands will evolve. However, prolonged uncertainty about the extent to which either both countries want to see current or future demands met and, as a result, about the measures they may implement to achieve these evolving objectives could negatively impact investment and growth in both countries.

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