U.S. tariffs and trade tensions have dominated headlines over the past few months. With certain tariffs aimed squarely at China, Beijing quickly responded with tariffs of its own on U.S. goods in early July. What do the tariffs mean for investors in Chinese and other Asian technology and consumer credits?
In the short term, we would not expect a significant impact from tariffs on credit fundamentals since most U.S. dollar-denominated bond issuers in the Asian tech and consumer sectors have limited U.S.-based revenues. However, while the trade-tension headlines continue, we do expect Asian technology and consumer credits to be affected to some degree by market volatility.
In the longer term, we think size and location are likely to determine the impact. Larger companies in China should be able to withstand the impact of tariffs. Smaller Chinese companies and Asian open economies where many companies export to both the U.S. and China, such as South Korea, Taiwan and Singapore, are likely to suffer.
Small enterprises in China and open economies in Asia may be vulnerable
Under Section 301 of the Trade Act of 1974, the White House imposed a 25% import tariff on US$34 billion of Chinese goods on July 6, although it specifically excluded major consumer goods, such as cellphones and televisions. China retaliated with a similar 25% tariff on 545 U.S. goods worth $34 billion. The U.S. is expected to impose a 25% tariff on another $16 billion in Chinese goods in the next few weeks and has also threatened an additional 10% tariff on $200 billion in Chinese goods, although if that were to happen, it would be difficult to do without affecting U.S. retailers and consumers.
We expect that larger enterprises in general should be able to withstand the impact of these tariffs by negotiating with their U.S. customers, relocating capacity outside China, or leveraging the complex global supply chain to change how their internal costs are charged among subsidiaries to potentially lower their tariff bill.
However, smaller enterprises in China with concentrated revenue exposure to tariffed exports are likely to suffer, particularly given that they are already struggling with rising wages, social insurance contributions and tighter environmental protection laws. Private companies, most of which are small- and medium-sized, generated about 45% of China’s exports in January and February of this year, according to Chinese customs data. If tariffs were to have a significant adverse effect on these companies, it could lead to more onshore defaults and, possibly, social instability.
Outside China, Asian countries reliant on domestic demand to fuel growth are better positioned to weather the current trade frictions. Open economies such as South Korea, Taiwan and Singapore, which have substantial export exposure to both China and the U.S., are more likely to suffer. According to DBS Group Research, in 2017, the percentage share of total exports to the U.S. and China was 42.3% for Taiwan, 29.4% for South Korea and 23.1% for Singapore.
Consumer tech-related businesses in these countries may well be affected by the tariffs because they are involved in complex supply chains. For example, semiconductor companies in Asia have significant revenue exposure to the U.S. as part of the Apple supply chain. As the largest foundry in the world, around 70% of Taiwan Semiconductor Manufacturing Co.’s 2017 revenue was generated from North America. Looking at Apple’s supplier list for 2017, 25.8% of its suppliers were from Taiwan, 5.9% from South Korea and 3.4% from Singapore.
Given that most U.S. dollar-denominated bond issuers in the Asian tech and consumer sectors have limited U.S.-based revenues, these tariffs may not have a significant direct effect on outstanding bonds. In the short term, market volatility driven by media headlines may have some impact on pricing.
In the longer term, if the U.S. government blocks Chinese companies’ acquisitions of, or access to U.S. companies and technologies, it could damage growth prospects. Certain protectionist measures have already been taken against Asian tech companies, such as blocking proposed deals like Alibaba’s acquisition of MoneyGram, Broadcom’s acquisition of Qualcomm and barring the Pentagon from buying goods or services from ZTE and Huawei. We will be carefully observing how U.S. policy on investment restrictions and intellectual property (IP) transfer evolves.
While it might be difficult to impose tariffs on the complex global supply chain for consumer electronics, if the trade conflict between the U.S. and China escalates, foreign direct investment (FDI) and portfolio investments for Asian countries could be affected. Taken together with the consequences of the tariffs, this could have a negative impact on these countries’ GDP growth and currencies.
For more information on technology-led consumption and China’s growing digital economy, see “China’s Growth Rebalancing Provides Opportunities for Bond Investors.”
Yishan Cao is a credit research analyst in PIMCO’s Hong Kong office.