The much spoken about trade war between the US and China is one component of an altogether broader confrontation in the relationship between the two largest economies in the world. The relationship has been deteriorating more quickly over the past ten years and has taken on greater intensity since US President Trump took office.
The relationship between the US and China is transforming from an essentially mutually beneficial one to an increasingly confrontational engagement. The US seems to view the rapid growth and progress in China as a threat, primarily because of their size, trading power and rapid, and often contentious, adoption of global intellectual property. China has been actively extending its influence in Emerging Market and Developing Economies (EMDEs) through infrastructural development and cooperative aid.
The rising tensions have been over the imposition of higher trade tariffs across a widening base of traded goods by the US on China and a response from China, though more muted.
Three different outcomes (probabilities) are proposed, based on a model developed by Dezan Shira and Associates, a multi-disciplinary consulting and business intelligence firm in Asia: A worst-case scenario where there is an all-out war (unlikely), a middle-ground scenario of a truce (likely) and a scenario where a trade deal is done (possible).
South African ties with China
The relationship between China and South Africa extends across diplomatic, trade and investment ties. The diplomatic relationship between China and SA has been in place for the past 21 years but in 2010, the Chinese government upgraded South Africa to the diplomatic status of strategic comprehensive partner, signalling its intention to take a more active role in its relationship with South Africa.
South Africa has been China’s largest trading partner in Africa for eight consecutive years, accounting for a quarter to a third of China-Africa overall trade. South Africa aims to promote investment-led trade.
The BRICS relationship, of which China and South Africa are part, is about liberalising trade among this bloc and pushing for a more representative global order in diplomacy and trade. At the BRICS Summit in mid-July 2018, President Jinping pledged $14.7bn of investments in South Africa. Few details of these pledges are available but Chinese banks have lent a combined $2.8bn to parastatals Eskom and Transnet, according to a Reuters report.
In 2018, SA’s exports to the China trade group accounted for 11.4% of SA’s total exports and 19.8% of its total imports. SA’s trade deficit with the China trade group is determined primarily by its net import deficit of R111.2bn in machinery, R17.1bn in textiles, R15.1bn of chemicals, R12.9bn of plastics and rubber, and R10.9bn of toys and sports apparel. These major deficit categories were partially offset by a net trade surplus of R79.5bn of mineral products, R15.4bn of precious metals and R5.9bn in vegetables.
In 2018, South Africa’s trade deficit with the Asian region (which includes the Middle East) was R165.3bn; of which China, Hong Kong and Taiwan was 58.8%, Saudi Arabia 39.9% and Thailand 18.5% and the balance by the rest of Asia and the Middle East.
Limited impact on SA China trade
China has a long-term global development strategy, which is likely to continue regardless of the outcome of the current phase of the US-China tangled relationship. China is expected to continue to invest directly and give aid to South Africa given its resource rich base and its important role in the sub-Saharan African market. If an all-out trade war was to develop, it is likely that China would reinforce its trade and investment ties with its BRICS partners and would more urgently expand its investment base in South Africa.
However, one of the key issues affecting direct investment in new production and existing businesses remains South Africa’s racial empowerment quotas regarding investment, ownership, mining rights, management, staffing and procurement. For now, the trade war has had a limited impact on SA’s trade with China, given the mix of key product categories that dominate imports and exports. In the event of a trade truce or a trade deal, SA will benefit along with the rest of the world due to the improved sentiment around global trade. In the event of an all-out trade war, base and carbon steel commodity prices are likely to come under downward pressure in the short and medium term, which would erode the value of SA’s exports.
Effect on South Africa equity investors
An escalation of the trade war should be negative for international commodity prices in the short term. Commodity base metals and carbon-based steel raw material are likely to be negatively impacted. However, the effect should mostly be offset by a rise in precious metal prices, especially gold. This means that investor positioning in the mining sectors would take on added importance.
An escalation in the China-US trade war would likely be negative for SA companies invested in Europe, given Europe’s dependence on trade with China. This could slow Eurozone GDP growth, which would affect apparel, food service and real estate companies in European markets, especially real estate. SA domestic companies are unlikely to be materially affected, other than the overall softening of market confidence due to an escalating trade war. Chinese investments in SA are in non-listed companies so SA investors can get no direct exposure.
If Chinese lenders and developers can get to a mutual arrangement with South African partners on the latter’s racial empowerment quotas, then some important infrastructural and industrial developments can get underway. Again, SA equity market investors will have very limited if any ability to participate or benefit as these businesses are likely to be non-listed.
Most likely outcome
The most likely outcome of the current US-China trade negotiations is a truce, which amounts to a trade deal that is long on form and short on substance. The global equity markets are likely to respond positively to this outcome in the short term. The deal is unlikely to be comprehensive and the policing of intellectual property and cybersecurity issues are expected to remain unresolved, which suggests further trade disagreements are likely in the medium term.
The confrontational relationship between the US and China remains far deeper than just trade; mainly due to the growing global power and influence of China, which the US sees as a threat to its global power position. In the short term, a trade deal between the two largest economies in the world should be good for global trade, market sentiment and confidence in global growth. On this basis, we still see stronger real GDP growth in advanced economies and larger emerging markets and developing economies (EMDEs) than in South Africa, in the medium term.
A trade deal would improve the global outlook, while the South African investment outlook remains structurally constrained by its empowerment policies, tighter labour legislation framework, protectionist trade unions, necessary fiscal consolidation and badly under-performing State-owned Companies, which are undermining economic stability and expansion. The SA equity market has substantial exposure to metal commodity producers, companies with international subsidiaries growing in faster economies than in SA and multinational dual-listed companies.
Mike Haworth is the Investment Strategist at Sasfin Wealth.