Uncertain US Tariff Policy Raises Risks for Trading Partners

The US trade and tariff vulnerability (TTV) index aims to assess the near-term vulnerability to reciprocal tariffs announced by the United States on April 2 and potential channels through which these new tariffs could affect the risk outlook.

Although tariffs are paused and subject to bilateral negotiations, significant uncertainty remains around the future trajectory of US tariff policy. There are potential repercussions for several liquidity and external income support factors in our short-term (ST) Country Default Risk (CDR) model.

Given the uncertainty surrounding near-term US trade and tariff policy toward the rest of the world, the TTV risk index creates a framework through which to measure and re-assess the impact US tariffs may have on our existing CDR (Country Default Risk) scores as tariff rates evolve, with a focus on the potential short-term CDR score impact.

Just over half of all 199 markets fall into our designated “Modest” or lowest TTV risk class. Most African, Latin American and Caribbean markets fall into this risk class. Only one G7 market appears in this class: the United Kingdom. Other medium-sized economies in this TTV risk class, indicative of moderate risk, include Brazil, Spain, Saudi Arabia, Turkey, Australia and New Zealand.

One aim of the TTV risk index is to use the results as a guide to possible scoring and outlook changes to our short-term CDR risk scores (ST-CDR). We can identify three distinct risk transmission channels from US tariffs onto our ST-CDR risk criteria, two market based (capital and credit) and one based on trade.

Capital markets channel

Global capital flows, both equity and bond related (or “portfolio”), are the most sensitive and fleet-footed to changes in the risk environment. We are already seeing some tentative consequences from the announcement of new US tariffs in early April.

The general risk environment for emerging and frontier markets is elevated; specifically, a net outflow of portfolio funds from mainland China and others in Asia becoming evident. Ordinarily, safe haven flows benefit the US where the US treasury market is the largest, deepest and most liquid. However, on this occasion there have been some outflows from US treasuries, possibly reflecting repatriation flows. Many of the higher US tariff rates imposed are concentrated in Asia where many export-dependent economies have recurring trade surpluses with the US.

Another tendency in heightened global risk environments is the return of “home biases,” where foreign portfolio capital tends to return home to their original capital sources or savings base.

The actual criteria that can be affected on the ST-CDR model are the interest rate and risk spread-based criteria. Foreign exchange reserves may also be marginally affected. Possible changes in the risk scores on these ST-CDR criteria here may reflect much weaker foreign exchange earnings if exports are squeezed by tariffs, and as denominators or debt service supports in these credit risk indicators, or higher interest or risk spreads as higher debt service burdens in their numerators.

Credit markets channel

Traditional structured credits, like trade and project finance, still form an important part of global financial flows, particularly for frontier markets. Where global banks perceive their markets as under heightened risk, many will be reviewing their entire dollar limits on the bank’s global balance sheet, not just their overall dollar value exposures, but with an initial tendency to shorten the maturities in their exposures as a possible next step to exit the market. This credit retrenchment process would involve a non-rollover of short-term debt, that is, credit liquidation, before exiting the market through the foreign exchange market door. 

In terms of impact on the ST-CDR model, this would involve downward pressure on the foreign exchange position to the extent there is credit and capital flight. The tell-tale associated signal here could also be exchange-rate depreciation.

Our “external liquidity gap” criterion in the ST-CDR model is a version of the “net short position,” involving the current account balance itself and levels of short-term debt that may rise initially as global banks “go short” on a market, and posing an increasing risk to the foreign exchange liquidity position if liquidated.

Trade channel

The clearest direct vulnerability from US tariffs on exports in the trade balance is incorporated into our external current account balance criterion. If US tariffs slow export growth or limit exports, the implication is that the market’s trade and current account surplus with the US is narrowed, or deficit deepened. This tendency may have a direct impact on our current account balance criterion in the ST-CDR model.

Furthermore, if new US tariffs restrain a market’s exports and export growth, this could directly affect its foreign exchange earnings capacity. Total foreign exchange earnings is a key support (denominator) to several solvency related credit risk indicators in our ST-CDR and MT-CDR models.

Caveats

The main caveat to the TTV score results and rankings is that there is currently a 90-day reprieve from April 10 until the new proposed tariffs. As a result, the TTV index scores and rankings should be viewed tentatively and as purely illustrative while the situation remains in flux, subject to bilateral negotiations, and are not to be seen as forecasts or probabilities, but something around which new risk conditions could crystalize in the very near term.

Secondly, the TTV index essentially reflects the intentions behind the new US tariff policy, targeting those economies with which it has a trade deficit to larger or lesser extents. The TTV index presented here aims to sharpen and deepen the uneven tariff risk impact across markets, building on the headline percentage tariff alone. There is no direct or proportional impact from the TTV index onto our ST-CDR scoring model, only indirectly through the channels described above. Economies will be variously dispositioned from their ST-CDR risk circumstance to the impact from any TTV index influence.