We expect Beijing’s initial response to Trump’s 10% tariff announcement to be modest, both in terms retaliatory moves and off-setting stimulus.
Impact of tariffs on China’s economy:
The Peterson Institute for International Economics projected last month that the direct effect of Trump’s tariff hikes on Mexico (25%), Canada (25%) and China (10%) would lower China’s GDP by less than 0.20 percentage points relative to baseline in 2025. This underestimates the full hit to China for several reasons:
- There will be a knock-on effect on China’s domestic investment and consumption activity
- The 25% tariff rate on Mexico hits Chinese firms that have been exporting to the US through Mexico, a channel that has been growing quickly in recent years
- The Peterson Institute may assume that depreciation of the CNY will offset some of the impact of tariffs, but we expect very modest depreciation in coming months (see further below)
- Trump’s executive order includes a pledge to remove the $800 de minimis exemption on customs duties, a major avenue for Temu, Shein and other Chinese e-commerce firms to target the US market through parcel shipments. (Temu and Shein have been adjusting their supply chains in advance, but smaller firms face stiffer challenges).
All-in, the full hit to China’s GDP is probably closer to 0.5 percentage points of GDP on an annual basis, but of course this depends on the duration of tariffs, China’s retaliation (if any), the impact of currency depreciation, and the ability of Chinese firms to find additional workarounds.
Retaliation and negotiation:
China’s Ministry of Commerce (Mofcom) released a brief initial statement on Sunday, pledging to a file suit against the US in the WTO and take “corresponding countermeasures to firmly safeguard [China’s] own rights and interests.”
This is relatively mild in tone – certainly relative to threats from Canada – and in keeping with our view on Beijing’s calculus on the tariffs:
- Avoid stability risks: China’s economy is in worse shape than the last trade war, and Beijing wishes to avoid climbing an escalatory ladder with Trump on tariffs unless necessary.
- Keep up good will: To a surprising extent, Trump has thus far been far tougher on Mexico and Canada than China, both in terms of tariff rates and rhetoric. The president continues to speak positively about Xi Jinping and seems interested in a potential trade deal. This is a strong incentive for Beijing to keep calm for now – and to let Canada and Mexico lead the way on retaliatory measures.
- See if Trump backs down: Beijing will watch to see if the economic and political reaction in coming days forces Trump to moderate his actions. In theory, the fentanyl issue is politically easier for Trump to climb down from – say, in response to strong pledges of cooperation from counterparts – than a dispute over structural trade issues. However, Trump’s statements in recent days suggest that fentanyl is just one of his reasons for implementing tariffs, and may not even be the most important.
For the near term, we expect Beijing to impose only symbolic tariff increases (if any) on China’s imports from the US. We also expect China’s informal retaliation (such as directing commodity purchases away from the US) to be light as Beijing continues to explore a broader deal with Trump.
Could Beijing mollify Trump with actions on fentanyl? The biggest US complaint with Beijing is that Chinese chemical companies are the main source of precursors for fentanyl products, which are then produced in Mexico and third countries. US-China cooperation on fentanyl has improved since the November 2023 Biden-Xi summit, though Beijing could do more to satisfy US concerns with a tougher crackdown on firms exporting to Mexico. Beijing will likely take some specific actions in this regard in coming months, while promising to take stronger measures as a part of a potential US-China deal.
What about the broader outlook on US-China trade tensions? We continue to hold a base case that Trump will end up imposing additional tariffs on China imports beyond this initial 10%. These may wait for the outcome of trade policy reviews due on April 1, but of course could come sooner (if Trump becomes impatient) or later (if he explores a US-China trade deal). Trump’s fondness for tariffs, the optics of a very large deficit with China, and the domestic politics of targeting China all make it unlikely that he stops here. We do not dismiss the possibility of a US-China trade deal, though see the political bar as fairly high, especially in this first year of Trump 2.0.
Stimulus plans:
In our 2025 outlook report (link HERE), we emphasized that Beijing’s response to US-China trade risks will be incremental and reactive. China’s leadership will try to maintain disciplined fiscal stimulus – its most powerful tool – to save policy space for contingencies, including the prospect that trade tensions could worsen significantly over the next four years.
On monetary policy, we expect Beijing to prioritize exchange rate stability, given the risk that a depreciating currency could lead to capital outflows and a loss of confidence that feeds on itself. Significant currency depreciation could also antagonize Trump. This limits the scope for monetary easing. We expect PBOC to hold back on a cut to its loan prime rate (LPR) cut for the time being. PBOC will likely cut RRR ratio in the coming weeks, as an RRR cut has a more modest impact on exchange rate.
We have been expecting the National People’s Congress (starts March 5) to announce a policy package that includes a GDP growth target of “around 5%” this year, an increase in the official budget deficit from 3% to 4% of GDP, and special bond issuance of CNY 3 trillion (including 1 trillion for bank recapitalization). While events are fluid, we still expect this to be the case despite Trump’s 10% tariff announcement. Beijing has off-balance sheet tools (such as lending to local governments through the PBOC) that can add a bit more cushion to growth in addition to the more explicit policies above. This overall approach will still require additional stimulus in the second half to avoid a growth slowdown and achieve Beijing’s target. But only clear signs of a more aggressive tariff push from Trump will lead Beijing to announce a much stronger stimulus package at the NPC.
