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May 15, 2019 | 22:15 GMT

3 mins read

China: A Worsening Economy and Hardball U.S. Tactics Don't Budge Beijing

(Stratfor)
The Big Picture

The Chinese economy has continued to slow down. With the collapse last week of a trade deal with the United States, the prospect of a protracted trade war looms large — something that could compel the Chinese government to ramp up its stimulus efforts and adjust its trade negotiating strategy.

What Happened

New Chinese economic data from April has laid bare the continuing fragility of the world's second-largest economy despite Beijing's stimulus efforts. Industrial output, retail sales and investments all slowed last month, with retail sales and manufacturing investment growing at a respective 7.2 and negative 1.2 percent, their slowest pace in nearly 15 years. The data comes on top of declines in exports and manufacturing, suggesting the deceleration is occurring across the board and dampening hopes of recovery despite positive economic indicators in March.

Why It Matters

While trade talks between China and the United States have not completely collapsed, obstacles to a deal remain large. Chief among these is Chinese resistance to U.S. demands for a codified enforcement mechanism and other legal changes. Both sides now appear to have hardened their positions ahead of the next round of negotiations set to occur in Beijing, which U.S. Secretary of Treasury Steven Mnuchin has confirmed will take place soon.

Even before the trade war, the Chinese economy was slowing.

The Office of the U.S. Trade Representative proceeded May 13 with a commenting process that is necessary to pave the way for tariffs on an additional $300 billion in Chinese goods in June. This means the next five to six weeks will be a critical window if the sides are to salvage a deal before Washington can follow through on its threats to impose additional tariffs. Beijing, however, has shown no sign it is willing to bend on U.S. demands for legal changes. In fact, it has recently sought to whip up nationalism via state media, taking a harder line on U.S. demands and emphasizing the stability of China's economy. According to the Nikkei Asia Review, Beijing has now rejected 30 percent of the most recent draft agreement with Washington.

Even so, the window for talks remains open. The Chinese and U.S. leaders are still expected to meet during the upcoming G-20 meetings on June 28-29 in Japan. But if no deal is reached and the additional tariffs go into effect, a trade agreement between the two powers will become an even more distant prospect.

Background and Outlook

Even before the trade war, the Chinese economy was slowing. Tariffs are now expected to drag down gross domestic product by another 0.3 to 0.6 percentage points as the trade war escalates. The additional tariffs are set to hit coastal China's export sector further, the majority of which is part of the private sector and is already struggling with thin margins and limited access to financing.

Worries over the worsening economy and trade war have renewed officials' focus on unemployment. On May 15, Chinese Prime Minister Li Keqiang called on the provinces to create more jobs and to prevent the social instability that could follow increased unemployment among migrant workers. Since early this year, Chinese authorities have also engaged in several rounds of rate cuts, credit stimulus and tax relief to support the economy. As the weakness and trade war persist, riskier credit stimulus packages might be required to keep the already debt-laden economy afloat.

Beijing's tougher line on trade suggests it thinks it can absorb the economic pain. It also suggests it anticipates the United States might back down as U.S. President Donald Trump heads toward his 2020 electoral campaign while contending with multiple trade negotiations, such as talks with the European Union, a crisis in Venezuela and escalating tensions in the Persian Gulf. Further economic pain could, however, force Beijing to recalculate.

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