RaboResearch - Economic Research

Trade wars: A Global Game Of Wrestling, And India’s ‘Thumb War’

Economic Comment


Also published on Bloomberg, June 28, 2018

Let’s get ready to rrrrrrrrumble

Donald Trump is the kind of man that enjoys a good game of wrestling. There is an infamous video on youtube that shows how Trump takes down the CEO of an American wrestling company. Warning here: this pulp is barely watchable, but it is even more astonishing that it is starring the current president of the biggest economy in the world…

After months of de-escalating trade tensions, President Trump decided to put on his lycra costume and mask once more and remarkably changed his rhetoric on trade. For starters, not many expected the Trump team to actually press ahead with the installment of 25% steel and 10% aluminium duties on its closest trading partners Canada, Mexico and the EU. Moreover, the embarrassing mud-throwing between the US and Canada in the aftermath of the G7 summit certainly does not bode well for the ongoing NAFTA renegotiations. And recently, the tensions reached a boiling point with the US releasing a list of 1,102 Chinese products worth USD 50bn, that will be subject to duties of 25% starting in July. China has vowed ‘punch back’ and to reciprocate these measures. This has induced Trump to up the ante in this game of wrestling by stating that another USD 200bn of 10% US tariffs loom if China were to retaliate his 50bn package, and if China responds again, that will become USD 400bn. If one does the math, we are talking about USD 456bn worth of goods that the US has threatened to target with tariffs, which is practically 90% of all Chinese goods shipped to US shores. In short, the developments in the past few weeks have brought us close to the brink of a global trade war.

India’s joins the scuffle

So where does India fit in? In a previous column we already argued that countries like India could end up being caught in the middle of the current trade spat. And India indeed has joined the game of global wrestling by announcing retaliatory measures against the US duties on Indian steel and aluminium. Admittedly, the current situation looks more like a game of thumb war, as the Indian package only targets 30 US export items (including almonds, apples, phosphoric acid and Harley-Davidson motorcycles) worth USD 240 million. Moreover, India has already offered to step up its US import with 1,000 civilian aircrafts over the next decade and also increase its American oil and gas purchases. This surely sounds like slapping someone in the face and immediately apologizing. 

Figure 1: Indian policy uncertainty index hasn’t budged
Figure 1: Indian policy uncertainty index hasn’t budgedSource: www.policyuncertainty.com, Macrobond, Rabobank
Note: for India the index reflects counts of articles in important newspapers (e.g. The Economic Times, the Hindustan Times, Tikes of India) containing terms directly related to economic policy uncertainty.

Let’s also not forget that the US has limited motivation to start a direct trade war with India, as the country is far from responsible for the 850bn trade deficit that the US currently runs with the rest of the world. Moreover, India is considered to be an important ally from a geopolitical point of perspective and recently showed some muscle against China in the Doklam plateau dispute. This most certainly should have pleased the more hawkish anti-China advisors in the Trump team, such as Peter Navarro and John Bolton. The limited impact of a potential trade war on India might explain why the response of the so-called economic policy uncertainty index to rising trade tensions has been so much more profound on the global level than on the Indian domestic front (figure 1).

Getting to the core of the matter…

Although we believe Trump won’t have any intention to put India in his protectionist crosshairs any time soon, the indirect damage of the current string of events might be felt elsewhere: dampening investor sentiment (figure 2). After a short period of recovering portfolio investments, outflows in June are again on the rise over fears of an escalating global trade war (see IIF). This could certainly weigh on the INR going forward and result in upward inflationary pressure, amid already rising pressure on the back of increasing US rates and elevated oil prices. Together with unfavorable base effects, we expect headline inflation to skyrocket this summer (figure 3). Moreover, core inflation took off to 6.2% in May, the highest level in four years. Although it is too soon to conclude that the RBI has fallen behind the curve, in hindsight we were perhaps not that far off with our call in February that a hike was warranted. And although we expect that the RBI is not keen to raise rates the upcoming month, we think it will be forced to do so, as it will have to keep rates in check with the Fed. Indeed, Trump is not the only one loving a good brawl; Jerome Powell is taking on every central banker in emerging markets…

Figure 2: Portfolio investment on a downward trend
Figure 2: Portfolio investment on a downward trendSource: RBI, Macrobond, Rabobank
Figure 3: Buckle up for this summer’s inflation figures
Figure 3: Buckle up for this summer’s inflation figuresSource: Macrobond, RBI, Rabobank

In wrestling, everybody gets hurt

After 90 years of absence, we are on the verge of reliving a situation similar to the Smoot-Hawley act back in the 1930s. The Smoot-Hawley act raised US tariffs on over 20,000 imported goods. Led by Canada, America’s trading partners retaliated, which resulted in a plunge of 61% in US exports from 1929 to 1933. There is universal agreement that no one ‘won’ that trade war, that it resulted in a sharp reduction of global trade and that it probably exacerbated the Great Depression of the 1930s.

A similar game of global wrestling nowadays would have even more serious consequences, even though the economic backdrop is more benign than in the 1930s. After all, global trade is much more prevalent and the system is strongly intertwined by supply chains. We have calculated that a global trade war would result in direct economic growth losses of 2.5ppt over five years’ time. The US would end up in a recession in 2019 and the economic damage would be substantial in the first five years: -6.3ppt of growth loss compared to a situation where trade tensions would be absent. We are talking about massive amounts here, up to USD 1,000bn of lost economic growth. What’s more, these effects do not even take into account the negative impact of disrupted global supply chains or the long-term damage on labour productivity growth.

In the end, the problem with wrestling is that everybody ends up being bruised, either be it a fat lip, a sore ankle, and potentially even a broken arm or a punctured spleen. Although India might be anxiously waiting in the locker room trying to avoid the punch-up, it most likely is not immune to these kinds of economic global shocks. So, for the sake of the global economy as well as emerging markets: let’s hope Donald Trump does know when hold back his punches.

Hugo Erken
RaboResearch RaboResearch Netherlands, Economics and Sustainability Rabobank KEO
+31 6 2223 1650

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