US-China Trade’s Diversion Divination

Amid continued speculation over a “Phase 1” US-China trade deal while mutual tariff increases are on hold, an IMF working paper points to likely distortions under a “managed “ outcome assuming agreement on higher American imports. In this way global benefits in terms of commercial efficiency and policy certainty are diluted in an effort to remedy bilateral imbalances. The research looks at the top ten products, and assumes that commodities are more substitutable than manufactured items. It finds that big economies like the EU, Japan and Korea will be hit from car, machinery, and electronics exposure, as well as small emerging markets implicated directly or in supply chains. On agriculture, China’s decision to purchase more US soybeans would affect Argentina, Brazil and Canada. Correcting the roughly $350 billion trade gap would entail 2-3% export diversion of ASEAN economies and South Africa, as well as tinier partners Angola and Oman. In a final “cascading” tally of specific categories for US and China sale the study reveals that “intensive” raw materials producers such as Mongolia and the Congo would lose the most, while Indonesia and Russia would suffer 0.5% contractions. With these risks the document urges that an eventual pact also take into consideration spillover into the multilateral trading system, where WTO and other bodies may propose safeguards.

China “A” shares still lead the MSCI index with an over 30% advance, along with Greece which was the subject of a simultaneous Article IV review predicting 2% growth through next year on “lackluster” public and private investment. Despite the Conservative party government’s economic reform agenda, demographic and productivity trends are “adverse” with structural unemployment keeping the formal rate above 15%. Bank balance sheets a decade after the crisis and a series of EU-guided rescues have near 50% bad loan ratios, as net credit provision falls. Fiscal relaxation and foreign capital inflows offer short-term impetus, but privatization and labor market changes lag and imperil long-range debt sustainability despite official breaks. Recovery is “disappointing” with income levels below the euro adoption era, although consumption and tourism are up with inflation less than 1%. The current account deficit is 3.5% of GDP under estimated 10% currency overvaluation, while the primary budget surplus exceeds the 3% target. After bilateral debt relief, sovereign bond issuance at record low 150 basis point spreads has been oversubscribed, and banks repaid emergency liquidity assistance with nonperforming assets only half provisioned. Germany and the UK are the biggest trading partners and face slowdowns and Brexit shocks reinforcing the odds for 2-3% best case medium-term growth. The new administration pledges personal and corporate tax reductions that may halve the primary balance, and pension spending must still be curbed as actuarial and solvency studies are conducted.  Worker retraining should accompany the double-digit minimum wage rise, and bank cleanup awaits new out of court restructuring options and a proposed centrally-guaranteed securitization scheme to tackle euro 80 billion in distressed assets. The legacy state lenders in turn must improve governance and profitability to be internationally-competitive. Business licensing will be streamlined further despite better World Bank rankings, and data transparency remains a serious issue with the sad saga of a prosecuted former IMF statistician lingering, the report implies.

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