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Economic Risks Rise As U.S.-China Disputes Heat Up

NEW YORK (S&P Global Ratings) Aug. 25, 2020--U.S.-China relations have deteriorated markedly in recent weeks across different fronts, causing the risks of an economic spillover on credit conditions in both countries to rise. With criticism of China increasingly evolving into policy in the U.S., particularly in the areas of China's access to U.S. technology and financial markets, S&P Global Ratings views the risk trend of an economic spillover as worsening.

This change indicates that we believe the strained relationship between the economic giants could place additional pressure on economic and credit conditions in these two regions, and beyond.

The Asia-Pacific Credit Conditions committee has taken the view that the multifaceted confrontation between the U.S. and China is increasing the risk of a financial market or policy reaction that results in material economic costs. Recent U.S. policies and initiatives are increasingly targeting China and the activities of Chinese entities. This could create significant business disruptions if their implementation is more severe. As such, we continue to assess the risk level that economic spillovers from U.S.-China strategic confrontation as high, but see the risk trend as worsening.

Financial market access is a particular vulnerability as any major restrictions could have extensive implications on the operations of global financial institutions and entities that rely on trade and U.S. dollar funding. Although workarounds and alternatives may be feasible, as with U.S. sanctions on other countries seen in the past, the effect could be much greater given the interconnectedness and scale of the two economies.

Likewise, another area of contention that could have substantial effect would be technology and communications, centered around the U.S.' "Clean Network" campaign (a Trump administration initiative said to guard sensitive information from untrusted parties). The direct hit on the Chinese tech sector so far is largely manageable. U.S. sanctions have only targeted a handful of entities, most notably Huawei Technologies Co. Ltd. and ZTE Corporation. However, a second-order effect up the value chain could prove to be more material for players such as semiconductor foundries and parts suppliers. Also, longer-term implications on this sector and on China's economy could get worse if restrictions reach wider and squeeze harder.

It is also noteworthy that, although any direct effect from the tension will likely be negative, some firms may find sturdier backing. China is likely to strengthen industrial policies aimed at financial, operational, and regulatory support for affected entities. This would be aligned with its "Made in China 2025" initiative, first unveiled in 2015, to make the country technologically self-sufficient in key areas. Other regions or non-Chinese firms may also stand to benefit as they capture trade and divert investment away from China.

With the unpredictability of recent and potential developments and the looming U.S. presidential elections, other areas of dispute could also flare up. Cross-border investment is undoubtedly slowing or more focused on "reshoring," which could also have a lasting effect on trade and corporate activity between the two nations and elsewhere. Retaliations from China so far have been largely limited to tariffs and diplomacy. We do not expect it to escalate or put a significant dent on U.S. businesses, unless the U.S. launches more targeted initiatives.

The North America Credit Conditions committee, too, has taken account of rising economic nationalism around the world and, specifically, the intensification of the U.S.-China dispute--and believes that the relationship between the world's two biggest economies could deteriorate in the coming months. In this light, while we continue to assess the risk that U.S.-China tension disrupts trade and supply chains and hit U.S. economic growth as high, we now see the risk trend as worsening.

With finger-pointing regarding the coronavirus pandemic and unease about China's trade and investment policies having bruised international relations broadly, the flashpoint in global trade tension remains the U.S.-China relationship. But it's important to note that the tit-for-tat tariffs the two countries have imposed on each other are just one front in a larger trade war, with the relationship strained in three areas: trade in goods and services; China's access to U.S. financial markets; and technology.

Although the "Phase One" trade deal between the U.S. and China initially alleviated some pressures, the pandemic's hit to China's economy makes it unlikely that the country will be able to meet ambitious targets for its purchases of American goods and services as the pact lays out. Moreover, the deal may not entirely appease the U.S. government's initial allegations of intellectual property and technology transfer.

This comes as the U.S. presidential campaign shifts into high gear, which will likely bring harsher criticism of China from both President Trump and Democratic presidential nominee Joe Biden. This has already played out in President Trump's executive order setting a ban on Chinese mobile apps such as TikTok and WeChat. The move could push the fragmentation of global communications networks and change the development and operating landscape of the sector in the longer term.

All told, we think the U.S.-China trade dispute, coupled with restrictions on access to U.S. advanced technologies will intensify Beijing's ongoing effort to boost self-reliance in core technologies. There's no question the technology gap between the U.S. and China is narrowing (albeit with much ground to cover), and China has made public its ambition to be a global tech leader.

While escalating tension could have a significant effect on the global tech sector, we think the likelihood of a no-holds-barred trade war is low.

From a broader credit perspective, supply-chain disruption, higher costs on Chinese goods sold in the U.S., and the possibility of non-tariff measures such as boycotts on American goods, could each potentially weigh on credit quality for certain U.S. sectors and industries. However, the effects of the recent deterioration in the U.S.-China relationship have so far been asymmetrical, with Chinese exporters to the U.S. absorbing a bigger blow than their American counterparts simply because of the different levels of trade.

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