Despite expressing grievances with Canada, Mexico, and the European Union, Asia is likely to emerge as the top target of the Trump trade war. Indeed, on the “Liberation Day” list, 6 out of the 10 highest tariffs would be imposed on Asian nations. To a degree, this is understandable. Nine of 15 of America’s largest bilateral trade deficits are with Asian partners — accounting for 60% of the global US external imbalance. And, while China’s surplus has declined since the imposition of tariffs in 2018, the imbalance with the other eight nations has more than doubled.

To be sure, the region’s economies are vulnerable to the anticipated slump in global trade, especially the smaller, export-oriented countries. Fortunately, however, Asian nations have options to mitigate against these risks. Therefore, while GDP growth will decelerate in 2025, Asia will avoid recession, and output gains will exceed the USA by a considerable margin. However, while there’s plenty of scope to negotiate trade deals to appease the Trump team, there is no quick fix to America’s trade imbalance with the region. Therefore, trade tensions will continue to cloud Asia’s medium-term outlook.

China, rightly, will remain the key focus of American trade policy. To be sure, the escalating trade war between the world’s two largest economies is unsustainable and undesirable. However, China may be less vulnerable in the near term than is widely assumed. Quite possibly, the trade war may prove more damaging to the USA. Nevertheless, slumping global trade will add to the ongoing problems in China’s domestic economy. Therefore, Chinese GDP growth will slow towards 3%-3.5%, despite the more flattering government data.

Asian financial markets often benefit from a weaker dollar and lower US interest rates — both of which I expect. However, slumping global trade and weak world-wide GDP growth is likely to lead to an underperformance of the region’s equity markets until trade tensions ease. The smaller, export-focused countries (and Vietnam) will be most vulnerable. India, Indonesia, and China — with larger domestic markets — less so. Asian FX could weaken substantially if the trade war escalates. On the other hand, Japan will be pressured to allow the very undervalued JPY to appreciate.

Asia Trade Imbalance: No Quick Fix

The US administration believes the large and growing bilateral imbalances reflect unfair Asian trading practices. Indeed, the Chart above illustrates that while Canada, Mexico, and the European Union enjoy large surpluses with the USA, their export/import ratios are near the US world-wide average. On the other hand, all Asian economies have very low readings.

But, does this suggest Asia is “ripping off” the USA? The Chart above indicates that in most cases Asian non-agricultural tariffs are not that much higher than America’s. Indeed, Japan’s are lower. Of course, there are exceptions. WTO rules provide for preferential treatment for poorer countries, e.g. India, et al. Likewise, meaningful sectoral variations exist. For example, transportation equipment taxes can be as high as 50% in China and Indonesia and 125% in India, Korean chemical charges are as much as 30%, and Japan’s footwear fees are up to 185%. The gap, moreover, is even more evident on agricultural products (next Chart).

If tariffs are not to blame, what about currency manipulation? Rather than being systematically undervalued, most Asian FX rates are in line with long-term fundamentals (next Chart). Indeed, some are overvalued (THB, PHP, INR). The very undervalued Japanese yen, however, is a noteable exception, reflecting the government’s past efforts to end the long period of deflation.

To be sure, the existence of non-tariff trade barriers contribute to Asia’s bilateral trade surpluses. However, the persistence of large imbalances is more structural. In particular, America’s trade deficit — both worldwide and with Asia — stems from its much lower savings ratio than elsewhere (next Chart).

To be sure, higher US tariffs may cut America’s trade deficit with the region, but only as weaker US consumption (and GDP) growth reduces import demand. Indeed, Asia may well reduce further their already low tariffs. However, as the ongoing trade negotiations will not address this fundamental issue, I don’t anticipate a meaningful reduction in America’s trade imbalance with the region. In addition to focusing on reducing non-tariff barriers to trade in manufacturing products, negotiations should aim to pry open Asian markets to US services. America enjoys a comparative advantage in this sector, and Asian protectionism is substantial (next Chart). I would not expect progress on agricultural trade.

Asia’s Vulnerability: Mitigating the Risk

To be sure, Mexico and Canada are most vulnerable to full-blown trade hostilities with the USA. However, Asia is also especially at risk, as trade with the USA accounts for a big portion of GDP (Chart above). The smaller, export-oriented countries (and Vietnam) are of greatest concern. On the other hand, countries with large domestic markets are less vulnerable, e.g. Indonesia, India, and China (I will deal with China in the next section). Importantly, as its economy is less reliant on trade, the USA enjoys considerable negotiating leverage (which Mr. Trump is not shy about exploiting).

In addition to skillful negotiating diplomacy, how can Asia mitigate against the risk posed by Trump 2.0? To be sure, the Asian post-Covid economic recovery has relied heavily on exports ( Chart below). But, Asia has several macroeconomic policy options. For example, much of the region has considerable leeway to expand fiscal policy. To be sure, government debt ratios are higher than before Covid. However, Asia is in a far better position to deal with downside economic risks than the USA (Chart above). Of course, Japan and China are important exceptions.

In addition, while Asian domestic demand is stronger than elsewhere in the world, spending remains well below the pre-pandemic trend (Chart above). With inflation low, Asian central banks will be able to lower interest rates to boost private spending. Likewise, as mentioned earlier, most Asian currencies are in line with long-term fundamentals. Therefore, I would expect Asian central banks to allow exchange rates to depreciate considerably to offset the impact of higher US tariffs, if necessary. Japan would be an exception.

Even though the majority of Asian trade is with its regional neighbours, the export-led post-Covid recovery has relied heavily on sales to the USA. Indeed, most Asian nations successfully gained US market share; displacing China after the 2018 imposition of tariffs (Chart above). Potentially, therefore, higher US trade impediments could choke off this source of growth. In response, I suspect Asian nations will revert back to their earlier reliance on local trade; deepening regional trade ties as both China and Indonesia have done in recent years.

China: America’s #1 Target

Despite some reduction in the bilateral imbalance since 2018, China remains the #1 target of the Trump trade war — the one thing US politicians can agree on. But clearly, the escalating tensions will hurt both countries.

What can China do to offset the external economic risks? The answer seems obvious — stimulate domestic spending. Indeed, China has a huge local economy, and one of its key strategic objectives has been to rebalance GDP from exports/industry to consumption/services. Unfortunately, however, after years of sucess in expanding the tertiary sector, progress has stalled since Covid, as the government has supported SOEs and tech expansion (Chart above).

Resolving problems in the housing market and cutting corporate debt have proceeded slowly and inconsistently (Chart above). Consequently, consumer confidence remains at rock bottom (next Chart).

Despite repeated calls for additional fiscal stimulus, the government has continued to make only incremental adjustments. This reflects the lack of fiscal space following the huge explosion in public sector debt during the past decade (next Chart). Furthermore, support of SOEs has taken priority over efforts to boost household spending. Until the government returns its focus to boosting consumption (which I expect…eventually), downside economic risks will remain substantial. The burden for boosting domestic spending will remain with the PBOC. And, I expect interest rates to decline another 100-150bp.

Since 2018, meanwhile, China has succeeded in offfsetting weaker exports to the USA by boosting sales elsewhere (next Chart). Indeed, sales to Russia and Latin American have soared. Perhaps most importantly, China has deepened its regional trade ties and supply chains with other Asian nations. I suspect that will remain a key strategic goal.

If trade negotiations with the USA stall, I expect the PBOC will allow the Yuan to depreciate further (in real terms), as it did following the 2018 tariff hike. Indeed, inflation-adjusted CNY could decline well below its long-term average in an effort to regain lost competitiveness (Chart below). However, given the deepening regional trade ties, CNY weakness could produce competitive devaluations throughout the region.

Recent volatility in the US bond market has led to speculation China may be selling its holdings of US Treasury securites, perhaps as a warning to the Trump Administration ahead of negotiations. While China has been reducing its US bond investments in recent years, there is little indication China has been a factor in the recent rise in American bond yields. This could become a risk, if trade negotiations break down (next Chart).