Why a Tariff Truce May Not Help China’s Economy

The 90-day truce and agreement between the U.S. and China to roll back tariffs from prohibitive levels might not do much to help China’s economy—and could further delay the more aggressive stimulus that investors have long awaited.

China’s economy has been in bad shape for years, hurt by a protracted slump in its property market, deflated consumer and business confidence and high levels of debt that make China reluctant to lean on the type of stimulus it used to get out of past slumps. China’s incremental stimulus approach, from interest-rate cuts to trade-in vouchers to consumers, created spurts of green shoots to suggest the economy could be getting its footing earlier in the year. But the damage from increased tariffs threatened exports, one of its few bright spots, and fueled expectations that Beijing would step up its stimulus measures or take a different tack.

But the truce that has brought the 145% tariffs on most Chinese imports down to roughly 30% probably means less urgency in Beijing to take on bigger stimulus, says Arthur Budaghyan, chief strategist focusing on emerging markets at BCA Research.

China’s economy is likely to continue muddling along with slow but steady growth while trying to ward off the risk of deflation—low confidence has kept both consumers and businesses from spending. And while tariffs could end up lower, they are another drag on China’s economy, especially since exports have been the primary source of growth. Companies preordering before the 90-day pause expires could boost exports in the near-term but Budaghyan predicts the sector will still show lower growth than previous years.

In a note to clients Capital Economics’ Asia economist Marc Williams thinks the hit from tariffs, if they stay at these reduced levels, can be offset almost entirely by recent currency fluctuations. But he adds that the U.S. tariffs on China are still higher than those elsewhere, and U.S. officials are trying to nudge countries to restrict their own trade with China.

That tariff uncertainty—even with the truce—isn’t going to alleviate the Chinese private sector’s skittishness about hiring or new investments. That adds to Budaghyan’s skepticism that China’s economy may be able to build momentum from Beijing’s stimulus efforts. “The key variable for a sustained cycle is consumer and private businesses, and both are still down," he says.

While stimulus can spur growth, the deflationary backdrop makes companies reluctant to spend and hire, and the uncertainty around tariffs further saps private business confidence. “No private business is going to bet Trump won’t do something different in three or six months. No one is sure about the U.S.-China relationship," says Budaghyan. “Private business confidence is weak and will stay weak—and that impacts hiring and expansion plans."That doesn’t bode well for the jobs picture. While tariffs above 60% would clearly have hurt employment acutely, Budaghyan notes that the situation is already bad—and not just in the manufacturing sector. Many employees have taken wage cuts, and some of the country’s 12 million college students are struggling to find a job.

Before the truce, the People’s Bank of China cut its seven-day reverse repurchase rate, the lever to its main benchmark interest rate, as another attempt to nudge consumers and businesses to spend. But analysts stress that monetary policy isn’t going to cut it and Beijing needs to turn on fiscal stimulus—and the truce may have just pushed the timeline out further for such moves.

Write to Reshma Kapadia at reshma.kapadia@barrons.com

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