JAKARTA (TheInsiderStories) – Given the recent intensification of trade negotiations, the global outlook has darkened considerably. International trade and investment have been weaker than expected at the start of the year with the economic activity in major advanced economies, some large emerging market, and developing economies have been softer than previously anticipated.

Further escalation of trade disputes between the world’ largest economies renewed financial turmoil in the global economy. In early May, the United States (US) administration announced the increase of tariffs from 10 percent to 25 percent on US$200 billion of Chinese exports to President Donald Trump’ country—and threatened to do more. It also banned US companies from doing business with Chinese telecom company Huawei.

In retaliation, China announced increased tariffs on $60 billion of US exports, suspended soybean purchases, threatened to cut off exports of rare-earth metals to the US, and announced “major actions” against US high-tech firms.

Meanwhile, the White House removed tariffs on Canadian and Mexican steel and aluminum exports to expedite passage of the US-Mexico-Canada Agreement. This was immediately undermined when the president announced new tariffs on Mexico—subsequently suspended—in an attempt to force the Mexican government to better control illegal immigration into the US.

IHS Markit estimates the announced trade actions (before retaliation and escalation) will further erode near-term global growth—by at least 0.2 to 0.3 percentage point.

The United States: Tariffs ratchet up amid financial turbulence. The first-quarter real GDP growth was reported at 3.1 percent in the US Commerce Department’s second estimate, revised down 0.1 percentage point from the advance estimate.

In the IHS Markit June forecast, GDP growth slows immediately to 1.5 percent in the second quarter and averages 1.8 percent through the second half of 2019, several tenths of a percentage point below last month’s forecast.

The markdown to near-term growth reflects a soft tone to the incoming data, as well as trade tensions and less-supportive financial conditions. This forecast includes the step-up in the tariff rate on imports from China indefinitely. Following 2.5 percent annual growth in real GDP in 2019, we look for 1.8 percent growth in 2020 and 1.7 percent in 2021.

Europe: The political terrain just got a lot rougher. The recent European parliamentary elections have worsened political fragmentation. Center-left and center-right parties lost support, whereas populists gained ground in some countries (Italy) and Greens gained in others (Germany).

This change will likely complicate the task of European Union (EU) leadership in dealing with contentious issues, including the selection of the presidents of the European Commission and the European Central Bank, Brexit negotiations, the response to Italy’s flouting of the EU budgetary rules and its parallel currency threat, and trade negotiations with the US.

Meanwhile, the election results show a deeply divided United Kingdom (UK) public, which will make achieving any consensus on Brexit even more difficult, raising the likelihood of a no-deal Brexit. Against slowing global growth and simmering trade tensions with the US, this change in the political landscape warrants cautious economic outlooks for the eurozone and UK.

Japan: Growth has firmed, but signs of softness persist. Japan’s real GDP growth for the first quarter of 2019 was revised up marginally to 0.6 percent quarter on quarter (q/q), or 2.2 percent q/q annualized, reflecting higher capital expenditures.

Ongoing repercussions from the US-China tensions remain a concern. One of the drivers of real GDP growth in the first quarter was an increase in net exports, as a sharp contraction in imports outweighed a decline in exports. It points to further weakness ahead. Nevertheless, the relatively strong growth rate in the first quarter suggests the Abe government will go ahead with the sales tax increase in October.

China: Hurting, but far from helpless. The impact of the US-China trade re-escalation on China’s growth will be noticeable, but not devastating. The direct impact of a 25 percent tariff on $200 billion of Chinese goods will shave China’s economic growth about 0.3 percentage point over a year. Moreover, the tariffs’ impact on China could be more limited, as a significant share of China’s exports is in processing trade—assembling imported components and re-exporting to final markets.

IHS Markit now predicts real GDP growth to be 6.2 percent in 2019, 5.9 percent in 2020, and 5.8 percent in 2021. Our forecast is based on the tariffs currently in place, not threatened tariffs. In response to higher tariffs, the government will most likely ramp up stimulus measures more aggressively to support economic growth.

If the US imposes further tariffs, China’s growth rate could be cut as much as 0.7 percentage point, depending on the size of the additional tariffs.  While all this is going on, there are signs of further softness in China’s economy and of rising financial stress, especially among small banks.

Other large emerging markets: Collateral damage. With few exceptions, the outlook for emerging markets has deteriorated. It is evident in the recent plunge in the MSCI Emerging Market Index since its April peak and pressure on emerging-market currencies.

Even more worrisome: Argentina, Brazil, and Mexico had real GDP contractions in the first quarter of 2019. Some of these troubles have to do with weakening global growth (especially China). Some of it is also driven by shock waves from the expanding trade wars.

The US-China conflict, alone, is devastating supply chains throughout Asia—although some countries, such as Vietnam, may benefit from trade diversion away from China. The recent announcements of tariffs against Mexico and the elimination of duty-free exports from India have added fuel to the fire. In response to this direct and collateral damage, IHS Markit has lowered the forecasts for many emerging markets in the past two months.

Written by Lexy Nantu, Email: lexy@theinsiderstories.com