By V Shunmugam & Ravi Bhushan
At the start of year 2018, commodities held out much promise building up on the strong gains that had set in during second half of 2017. Metal and energy prices touched multi-year highs and so were most global equity markets. But then the markets were hit by the abrupt assault of 'sanction & tariff bombs' amidst domestic protectionism ruling the day. In late March 2018, the US President signed a memorandum imposing tariffs of 25% on steel and 10% on aluminium imports. China retaliated by imposing tariffs on 128 US products (worth $3 billion). The development sowed a seed of endless imposition of tariffs and retaliation that spread to other countries.
On the sanctions front, in early April, the US imposed sanctions on Russian company Rusal, the biggest aluminium producer outside of China, and one of the biggest suppliers to US, from accessing the global markets for its aluminium, firing up aluminium market. Volatility was abrupt during April-May last year; aluminium prices sky-rocketed by 30% in two weeks while these fell by around 14% in the next week as the market came to the grips of its impact. In another measure of protectionism, by end of May 2018, the US said there will be a 10% tariff on imports of aluminium from Canada, Mexico and the EU.
The trade war with multiple goalposts between the US and China remained the mother of all disputes that declined to die down, causing episodes of volatility in financial markets, including commodity markets. In July 2018, the US imposed tariffs on $250 billion worth of goods imported from China, with Beijing retaliating with duties on $110 billion worth of US products. The tug of war between the top two economies left global commodity and equity markets bleeding. Chinese markets tumbled near three-year lows bringing down commodities along with it.
A simple way to put the effect of tariff-based trade war is that tariffs between economies can precipitate a fall in global trade, disrupting the global supply chain through higher costs, lower investment and confidence, while farmers and producers of producing countries also get hit hard by retaliatory measures. Many developing countries have a resource-intensive economy, which tends to improve and worsen with commodity prices.
The current fall in commodity prices arising out of growth concerns as fallout of trade disputes has hit the economies of commodity-intensive countries hard. Australia stands clearly impacted. Particularly so as China is the biggest export market for Australia and it accounts for roughly one dollar for three export dollars earned. Minerals make up 60% of exports with the country being one of the biggest exporters of iron ore, coal and liquefied natural gas. Declining commodity prices and softening raw material demand from China had a cascading effect on the Australian economy. Its quarterly growth dipped to a decade low of 0.5%, the slowest since the Global Financial Crisis.
In a few cases, to deter the impact of the escalating trade dispute, commodity-based economies have actively managed their currencies to make them depreciate to remain competitive in the export markets-the reported action of China in depreciating its currency is a clear case in point that countries may attempt to gain the lost trade competitiveness through active currency management.
India is a net import-based economy wherein commodities comprise more than 80% of total imports. India should gain from the fall in prices of commodities including that of crude oil. Alas, India was also dragged in the bilateral trade dispute early this year after the US withdrew favourable treatment to India under the Generalized System of Preferences (GSP), as India runs a surplus in its trade with the US. In retaliation, India imposed tariffs on select products that the US exports to India, including apples and walnuts. The irony is that the top two global economies engaged in fierce trade dispute have an Indian connection-while the US is the largest export destination for India with 16% of total exports, China is the largest source of imports accounting for 14% spread over a diverse basket of goods. India can benefit in terms of low commodity prices but for the weak rupee that will potentially offset some gains, apart from weak sentiments in the economy.
Additionally, the global economic slowdown may, in turn, hit India's exports very hard, of which services contribute about 40%.
Commodity-based economies are vulnerable to price shocks and price volatility. The current trade disputes clearly have an uneven but negative impact in the global economies fuelled largely by the economic slowdown. The longer the trade war continues, the more profound its effect will be; new trade relationships will be formed and global commodity flows will be rerouted to other nations, unsettling the equilibrium of commodity-based economies and, at times, challenging the economic efficiency that the commodity supply chains would have built into.
Unlike other trade wars, the current one is fortified with geopolitical tensions, falling economic growth of nations, rising risks to economic stakeholders, and risks to investment. Unless this rift is resolved in an efficient manner by the stakeholders, measures by central banks and nations towards economic upliftment will prove to be futile.