Phase 1 Trade Deal – What it means for world markets and India?

The long awaited Phase 1 of the trade deal did finally happen on January 15, 2020. Both the US and China have already clarified that this is only the first step and that the actual contours of the full deal will have to evolve over a period of time.

Jan 16, 2020 11:01 IST India Infoline News Service

The long awaited Phase 1 of the trade deal did finally happen on January 15, 2020. Both the US and China have already clarified that this is only the first step and that the actual contours of the full deal will have to evolve over a period of time. However, the Phase 1 deal is likely to set the tone for the next phase. While Trump was personally involved in the deal, it was significant that Xi Jinping stayed away from participating in the signing of the deal. What does this deal mean for world markets and for India? But, first a quick look at what triggered the trade war and the urgency to sign the deal.
 
How the trade war started and how it looks to end?
The reasons for the beginning of the trade war are well documented. Donald Trump was unhappy with the huge trade deficits that the US was running with China and blamed it on government subsidies and weak intellectual property rights in China. To reverse this situation, the US started imposing penal tariffs on Chinese imports from March 2018 onwards. The following chart gives clarity.
Trend of annual US China Trade Deficit
Data Source: US Census Bureau

Despite the higher tariffs, US trade deficit shot up in 2018 but is estimated to come down sharply in 2019. While that would only mean status quo for the US, at least it looks like an optical victory for Trump. Also, being an election year, Trump cannot afford to allow US macros to weaken. At the same time, China has its own set of problems. Growth has been falling and industrial production has been slackening due to higher tariffs imposed by its largest market, the US. China already has a domestic debt and shadow banking problem to contend with and the last thing they needed was a weakening of growth. It was this combination of interests that triggered Phase 1 of the trade deal.
 
What does Phase 1 of the Trade Deal entail?
As the US and China have underscored, this is only the stepping stone for the subsequent phases of the deal. Here are the deal highlights.
  • China will commit to buy an additional $12.5 billion of agricultural goods in year 1 and $19.5 billion in year 2 under the terms of the Phase 1 trade deal. This will be over and above the $24 billion of agri exports that the US was already making to China in 2017.
  • In return, the US would reduce the tariffs by half from 15% to 7.5% for Chinese goods imports to the tune of $150 billion. The US also commits that no fresh tariffs will be imposed on Chinese imports during the pendency of the Phase 1 of the deal. However, the US has ruled out total rollback of incremental tariffs.
  • The deal will eventually aim to take US exports to China to a level of $200 billion which is nearly 50% more than the current levels. Even if you provide for higher agricultural exports to China, it remains to be seen what will be the actual practicality of such a high target for US exports to China.
  • The Phase 1 of the deal is largely silent on sensitive issues like Chinese government subsidies to manufacturers, Yuan management, intellectual property rights, technology transfers, security issues, status of Huawei, etc. Interestingly, as part of Phase 1, the US has also removed China from the list of currency manipulators.
 
What does this Phase 1 deal mean for world markets and India?

For the global markets, this will give hope that the two largest economies in the world are finally moving towards a truce. For India, the implications are numerous.
  • It reduces the macro risk associated with continued uncertainty over global trade, specifically because Indian exports and total trade have been on a downtrend yoy.
  • The trade deal will also mean that China would go ahead with its fiscal and monetary stimulus package and that will be positive for Indian commodity manufacturers.
  • Above all, the deal brings back risk-on money into emerging markets and Indian markets will be the major beneficiary of the deal as FPIs plump for EM debt and equity.
 
The only risk at this point of time is that the trade deal could push up oil prices. However, in the current scenario, with the US likely to increase its liquids output to 20 million bpd by Q4, any sharp spike in price looks unlikely. That could be the real good news for India!

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