China Cuts Tariffs for These Five Asian Countries

China has adopted conventional tariff rates on a range of imported goods originating from India, South Korea, Bangladesh, Laos, and Sri Lanka, following a recent announcement from the Customs Tariff Commission of the State Council.

Beginning July 1, 2018, tariffs on a total of 8,549 goods were reduced or cut to zero.

The tariff cuts target goods such as soybeans, precision instruments, chemicals, agricultural products, clothing, and steel & aluminum products.

Some of the significant tariff cuts include:

  • Soybeans: tariff of three percent reduced to zero percent
  • Beef: tariffs ranging from 12-20 percent reduced to zero percent
  • Liquefied petroleum gas (LPG): tariff of three percent reduced to 2.1 percent
  • Textile raw materials: tariff of 10 percent reduced to 6.5 percent
  • Medical x-ray devices: tariff ranging from two to four percent reduced to zero to 2.8 percent

The complete list of tariff reductions can be found here.

The tariff concessions are part of a larger commitment to improve trade relations between China and the other five Asia-Pacific member countries that are part of the Asia Pacific Trade Agreement (APTA).

The agreement, signed in 1975, is the oldest preferential trade agreement in the Asia-Pacific region and encompasses approximately three billion people.

Currently, all member countries, including China, have agreed to reduce tariffs by an average of a third on more than 10,000 items.

Critics, however, argue that the timing and target of these tariff cuts are not a coincidence. The announcement comes a mere two days after China stated it would impose an additional 25 percent tariff on soybeans, chemical products, and medical equipment imported from the US.

Many observers suspect that China’s decision to give effect to tariff reductions – agreed to in negotiations held over a year ago – is less about adhering to APTA commitments, but rather an attempt to diversify import channels in response to the escalating US-China trade fallout.

While it is uncertain whether imports from these five Asian countries will fill the void left by a decreased reliance on US importers, particularly in commodities such as soybeans, the tariff cuts are nevertheless a positive step to opening-up trade opportunities for countries in the Asian-Pacific region.

Many countries holding trade deficits with China have long been lobbying to expand their market access in the country. India, for example, recently pitched for increased exports of soybeans and sugar at the recent India-China strategic dialogue in April.

In addition to these tariff cuts, previously announced tariff cuts on a range of consumer goods also went into force on July 1.

Article as originally appears http://www.china-briefing.com/news/2018/07/02/china-cuts-tariffs-for-five-asian-countries.html

ASEAN’s Free Trade Agreements With The Asia-Pacific Region’s 5 Biggest Economies

Apart from the ASEAN Free Trade Area (AFTA) between ASEAN member states, the regional trade bloc has signed several FTAs with some of the major economies in the Asia-Pacific region. These include the ASEAN-Australia-New Zealand FTA (AANZFTA), the ASEAN-China FTA (ACFTA), the ASEAN-India FTA (AIFTA), the ASEAN-Korea FTA (AKFTA), and the ASEAN-Japan Comprehensive Economic Partnership (AJCEP). The aim of these FTAs is to encourage and promote businesses of all sizes in ASEAN to trade regionally as well as internationally without tariff barriers. Businesses with operations in ASEAN can use the FTAs to gain easy access to new export markets for their products at low costs, and benefit from simplified export and import procedures.

ASEAN-Australia-New Zealand Free Trade Area

The agreement establishing the ASEAN-Australia- New Zealand Free Trade Area (AANZFTA) entered into force in January 2010. The FTA is the most comprehensive agreement covering a wide range of issues including trade in goods and services, investment, intellectual property, competition as well as economic cooperation. Since its inception, the AANZFTA has encouraged trade in goods and services by removing barriers and reducing transaction costs for companies wanting to do business in member countries. According to the agreement, 99 percent of the Australia-New Zealand trade in goods with Indonesia, Malaysia, the Philippines, and Vietnam will be duty-free by 2020. Upon full implementation in 2025, almost all trade between the member countries will be free of tariff, helping businesses save millions of dollars in tariff duties each year.

ASEAN-China Free Trade Area

Over the past decade, trade and investment between ASEAN member states and China have expanded significantly under the ambit of the ASEAN China Free Trade Area (ACFTA). The Agreement on Trade in Goods was signed in 2004 and implemented in July 2005 by all the member countries. Under the agreement, the six original ASEAN members and China decided to eliminate tariffs on 90 percent of their products by 2010, while Cambodia, Lao PDR, Myanmar, and Vietnam – commonly known as CLMV countries, had until 2015 to do so. Since the signing of the agreement, China has consistently maintained its position as ASEAN’s largest trading partner. In 2015, ASEAN’s total merchandise trade with China reached US$346.5 billion, accounting for 15.2 percent of ASEAN’s total trade. Additionally, ASEAN received US$8.2 billion in foreign direct investment (FDI) from China in 2015, placing China as ASEAN’s fourth largest source of FDI. By 2020, ASEAN and China are committed to achieving a joint target of US$1 trillion in trade and US$150 billion in investment through ACFTA.

ASEAN-India Free Trade Area

The ASEAN-India Trade in Goods Agreement entered into force on January 1, 2010. The signing of the agreement paved the way for the creation of one of the world’s largest free trade area market, creating opportunities for over 1.9 billion people in ASEAN and India with a combined GDP of US$4.8 trillion. AIFTA creates a more liberal, facilitative market access, and investment regime among the member countries. The agreement set tariff liberalization of over 90 percent of products traded between the two dynamic regions. Accordingly, the tariffs on over 4,000 product lines were agreed to be eliminated by 2016, at the earliest.

ASEAN-Republic of Korea Free Trade Area

The ASEAN-Korea Trade in Goods Agreement was signed in 2006 and entered into force in 2007. It sets out the preferential trade arrangement in goods among the ASEAN Member States and South Korea, allowing 90 percent of the products being traded between ASEAN and Korea to enjoy duty-free treatment. The Agreement provides for progressive reduction and elimination of tariffs by each country on almost all products. Under the Trade in Goods Agreement, ASEAN-6 including Brunei Darussalam and Korea have eliminated more than 90 percent of tariffs by January 2010.

ASEAN-Japan Comprehensive Economic Partnership (AJCEP)

The ASEAN–Japan Comprehensive Economic Partnership (AJCEP) came into force in December 2008. The Agreement covers trade in goods, trade in services, investment, and economic cooperation. The FTA provides for the elimination of duties on 87 percent of all tariff lines and includes a dispute settlement mechanism. It also allows for back-to-back shipment of goods between member countries, third party invoicing of goods, and ASEAN cumulation. Both ASEAN and Japan have also initiated several economic cooperation projects that include capacity building and technical assistance in areas of mutual interest. These areas include intellectual property rights, trade related procedures, information and communications technology, human resources development, small and medium enterprises, tourism and hospitality, transportation and logistics, among others.

 

Dezan Shira & Associates provide business intelligence, due diligence, legal, tax and advisory services throughout the Vietnam and the Asian region.

 

This column does not necessarily reflect the opinion of the editorial board or Frontera and its owners.

A China-US Trade War: Good News For Asia

An editorial in the South China Morning Post this week has discussed the potential for a looming trade war between the China and the US. In the editorial, Scott Kennedy, a deputy director at the Freeman Chair in China Studies and director of the Project on Chinese Business and Political Economy at the Center for Strategic and International Studies, lays out how the US may be preparing itself to battle with China over what Washington DC and President Donald Trump have labelled “unfair practices”. Kennedy writes that the US is in the process of building regulatory mechanisms to support the US in the event of a major trade conflict.

This comes as China has removed Skype from the Chinese app stores, citing security and legal concerns. To be fair, given what we’ve learned over the past few years concerning US surveillance, that should hardly come as a surprise: if the US spies on its own citizens, it is sure to have infiltrated software used in global communications. Isolating American influence is a strategy increasingly being played out by both China and Russia, with Russia also about to block Facebook. LinkedIn is already restricted in both countries.

The isolation of America continues via trade, and some of it not necessarily inflicted upon it by either Beijing or Moscow. The pull back from the Trans-Pacific Partnership by the Trump administration was an ill-thought out and inaccurate reaction to a perceived loss of American jobs. Yet those jobs – unless American workers really want to be engaged at Bangladeshi wage levels making garments – are never coming back. Economies constantly need to adapt and evolve. Denying the wage differences between Asia and the United States is fool-hardy – products will simply cost the American consumer more to have them carry a “Made in the USA” label and an entire supply chain industry will be damaged.

The TPP, meanwhile, has been reinvented as the Comprehensive and Progressive Trans-Pacific Partnership (CPTPP), excluding the US, and will benefit other Asia Pacific nations, Vietnam among them. What should have secured basic, cheap imported products from Asia, which US manufacturers could have added value to in terms of design, innovation and completion, will now be the remit of high-end Japanese, South Korean and Australian businesses instead.

Washington DC’s rhetoric as regards the potential for a trade war, therefore, alarmingly fits in with the new American isolationism. But as the West is starting to learn from imposing sanctions upon Russia, a trade war between the US and China will only strengthen Chinese capabilities to secure trade and supply routes elsewhere. It will be to Asia and Eurasia’s benefit, in fact, if this does happen. China has a free trade agreement with ASEAN that has been expanding in volume by just under 20 percent per annum and is expected to reach US$1 trillion by 2020. China runs a trade surplus with ASEAN by a considerable margin; a China engaged in a trade war with the US would see that imbalance partially removed as it would seek to buy more from ASEAN members.

Other countries likely to benefit would be India, whose China trade has a long way to go to reach true potential, and would receive a large boost from a China on the hunt for new supply chains. Russia too, and especially in light of the upcoming China-EAEU Free Trade Agreement being signed can also be expected to receive a boost in bilateral trade. The China-Russian corridor has been growing at over 30 percent this year, partially because Western sanctions have motivated Russia to look east for trading partners.

Washington DC needs to think very carefully about engaging with a trade war with China. Such a move would be tantamount to a temporary burst of sanctions and tit-for-tat retaliation. Under such circumstances, China will fast track its Belt & Road infrastructure development reach to secure alternative supplies, and boost its trade with Asia.

Notably, China’s new Administrative Measures for Outbound Investment by Enterprises,  which was released on August 4 this year, already specify encouraged areas. These include:

This signals that China is also prepared for a trade war with the US should it come to pass. With alternative supply chains, free trade agreements, and nearby Asian nations keen to close their trade gap with China all in place, any resulting conflict would be a huge boost for the Asian and Eurasian regions, and potentially spell disaster for the US economy. The way out for American manufacturers? Set up alternative production facilities in Asia, and fast.

 

Dezan Shira & Associates provide business intelligence, due diligence, legal, tax and advisory services throughout the Vietnam and the Asian region.

 

This column does not necessarily reflect the opinion of the editorial board or Frontera and its owners.

Trump’s Short-Sighted Stance On Iran Leaves The Door Open For China

Earlier this month, President Trump refused to re-certify the JCPOA agreement with Iran. That same week, at the 19th Communist Party Congress in China, President Xi Jinping presented a vision of his country as a guardian of international order. Amid growing energy exports from Iran to China, this is not a battle that Trump can win.

Amid this year’s “negotiations” with a North Korean regime hellbent on achieving nuclear weapons delivery capability, the announcement that President Trump’s new Iran Strategyinvolved walking away from the Joint Comprehensive Plan of Action (JCPOA) should not have been a surprise. While Trump reluctantly re-certified the deal in April and July, he had previously labelled the JCPOA as “the worst deal ever”, and committed to dismantling the agreement if he were elected. However, despite this general negativity towards the deal, Secretary of State Rex Tillerson’s concession that Iran was in “technical compliance” with the JCPOA as late as this past September made it seem possible that the administration would preserve the deal.

Trump’s position on the Iran deal not only signals America’s exit from the international diplomatic arena in regards to Iranian nuclear development, it leaves a leadership vacuum that China’s President Xi is only too willing to fill. For all its failings, the JCPOA is a multilateral agreement born from mammoth diplomacy efforts, with the US, Russia, China, France, the UK and Germany putting aside their disparate security programmes in a bid to develop an agreement acceptable to all five permanent members of the UN Security Council and the EU. The US Congress now has less than sixty days to decide whether or not to reimpose sanctions on Iran, and Russia and China have made no secret of their desire for the deal to continue into 2018 and beyond.

The China-Iran “friendship”

The collapse of the JCPOA, and the possible return to sanctions, would inevitably lead to a deterioration of the economic and security situation on the ground in Iran – a disaster for Chinese oil imports and the future of major Chinese infrastructure investments within Iranian borders.

In recent years, China has become Iran’s leading trade partner due to its unrelenting appetite for oil and gas exports. In August, China imported 3.34 million tonnes of oil from Iran, the highest monthly transfer since 2006. Soon after the JCPOA was signed, China and Iran agreed to a 25-year plan to expand relations and boost trade tenfold to US$600 billion over the next decade, with Chinese companies financing major energy projectsthroughout the Islamic Republic, including huge oil fields in Yadavaran and North Azadegan. In July this year, state-owned China National Petroleum Corp adopted a 30 percent stake in a project to develop South Pars, the largest natural gas field globally. China has also signed a US$3 billion deal to upgrade Iranian oil refineries, including the century-old Abadan refinery.

Iran is slated to play a role in China’s “One Belt, One Road” Initiative. Beijing has provided US$1.6 billion of a total US$2.56 billion high-speed railway which is planned to run from Tehran to Mashhad in the east. The Export-Import Bank of China is said to have financed at least 26 projects in Iran to date, providing over US$8.5 billion in loans to build highways, develop mining projects and boosting steel production. According to Beijing’s vision, trains are set to run between the western Chinese region of Kashgar and Turkey’s Istanbul as early as 2020.

Shifting European alliances

Given that European trade with Iran has increased 93% since the ratification of the deal, a unanimous European resistance to a return to sanctions may open the door to a closer relationship with China in a bid to preserve the deal. The German Foreign Minister Sigmar Gabriel has expressed concern over the possibility of military confrontation with Iran over the US pull-out, with his UK counterpart Boris Johnson calling the JCPOA a “crucial agreement” in neutralising Iranian nuclear threats. The French President Emmanuel Macron has also called on Trump to revise his decision to leave the deal.

With President Xi stating his desire to see China’s rise as a “builder of world peace”, China may provide a buffer to shield Iranian energy exports from substantial disturbance in the wake of Trump’s decision. Indeed, even if the US does receive backing from European leaders – which is unlikely – Trump’s machinations to increase pressure on Iran are short-sighted at best.

 

Joanna Eva is a Political Risk Analyst at Global Risk Insights. As originally appears: http://globalriskinsights.com/2017/10/trump-jcpoa-iran-china/

This column does not necessarily reflect the opinion of the editorial board or Frontera and its owners.

New Balance Wins Landmark Trademark Case In China But International Companies Remain Skeptical

The recent ruling by a Chinese court in a trademark infringement dispute concerning New Balance’s logo marks a watershed moment in China’s intellectual property rights (IPR) regime.

The court awarded a landmark decision in favor of New Balance (NB) against Chinese competitors deemed to have infringed the company’s IPR, reflecting China’s recent efforts to improve IPR protection.

While foreign firms doing business in China may breathe a sigh of relief at this decision, they must also recognize the implications of the decision against the backdrop of the Chinese trademark regime.

What do foreign firms need to know about the case?

NB has been involved in several disputes involving trademark infringement after entering China against counterfeit Chinese shoemakers. This case involved the infringement of NB’s well-known slanting ‘N’ logo on its footwear by five Chinese shoemakers.

The court observed that by infringing the distinctive logo, the defendants had drastically damaged NB’s business reputation and market share in China. The court ordered the defendants to pay an unprecedented compensation amounting to RMB 10 million (US$1.5 million) to NB and to immediately cease producing and selling shoes that infringe NB’s logo.

Prior to the decision in favor of NB, the company had little success with IPR infringement issues in China.

In 2015, a court in the southern city of Guangzhou ordered NB to pay US$15.8 million to a man named Zhou Lelun, who had owned the trademark to NB’s Chinese name since 1994. The court ruled that NB had infringed on Zhou’s trademark ownership, as he acquired the Chinese trademark before NB under the country’s ‘first to file’ system.

Additionally, numerous Chinese copycat brands have imitated NB’s slanting ‘N’ logo for years, including brands such as New Barlun, New Bunren, and New Boom, among others.

How should foreign firms interpret the decision?

Many foreign firms have encountered IPR protection challenges in China due to the country’s ‘first to file’ system and the problem of trademark squatting. The ‘first to file’ system is not unique to China; it is used in many jurisdictions around the world, including the majority of European countries. However, the system can prove problematic for US firms and those from other countries that do not use ‘first to file’, as they are often under the impression that China recognizes trademarks registered under other jurisdictions.

Unlike common law jurisdictions such as the United States, where legal precedents have binding value, China follows the civil law system and courts are not bound to follow decisions laid down in prior cases. Therefore, it is uncertain whether this judgment will have any significant impact on future trademark infringement disputes.

Trademark and other IP infringement litigation is an expensive and lengthy process and foreign firms often incur huge expenses in legal fees in such cases. Moreover, most cases do not result in favorable awards for foreign firms as the Chinese courts are very strict about the ‘first to file’ system and often rule in favor of trademark squatters.

What strategies should foreign firms adopt to protect their trademark in China?

In order to successfully use their trademark while doing business in China and prevent trademark squatting, it is vital for foreign firms to adopt the following precautionary strategies:

  • Register trademark in China as early as possible: Registration in China may take as long as 18 months, and it is advisable to file for registration as early as possible before entering the Chinese market, or even before making concrete plans to enter China.
  • Register the trademark in Chinese character transliteration in addition to original form: In order to create the right brand image and avoid confusion, it is advisable to use Chinese characters that make a positive reference to descriptive characteristics of the brand and are also phonetically similar to the trademark. Enlisting the services of local consultants to help chose the appropriate transliteration is recommended.
  • Register trademark under all categories and sub-categories of goods and services: In order to prevent trademark squatters from registering under similar sub-categories of goods and services, it is advisable to file for registration under all categories and sub-categories. This is particularly beneficial to foreign firms who may have future plans to diversify their products or services. However, as registering can cost RMB 1,000 (US$150) or more for each category, registering in every category and sub-category may not be realistic for many small and medium enterprises.

In addition, foreign firms must also conduct careful IP related due diligence periodically and comply with applicable local laws.

How does the decision relate to the larger IP picture?

Although China has made important international commitments to promote IPR protection within its jurisdiction since the 1980s, the Chinese government had adopted a lackadaisical attitude over the years, fostering an industry thriving on IPR infringement and counterfeit goods.

Recently, amidst international criticism of China’s business environment and extensive IP theft, the government has brought about a slew of reforms aimed at improving IPR protection in China. The courts have also adopted a similar line of approach, as evidenced from recent awards passed in favor of foreign firms.

Yet, international businesses remain highly critical of IPR protection in China due to the country’s spotty track record, and although the recent reforms indicate a step towards enhanced protection, it is uncertain how far the situation will actually improve.

 

Dezan Shira & Associates provide business intelligence, due diligence, legal, tax and advisory services throughout the Vietnam and the Asian region.

 

This column does not necessarily reflect the opinion of the editorial board or Frontera and its owners.

Chinese FDI In Vietnam: Growing Economic Ties, Despite Strains

For the past 25 years, Chinese investments in Vietnam and bilateral trade between the two nations has grown steadily despite issues such as the South China Sea and increasing cooperation between Vietnam and countries such as US, India, and Japan. The Chinese mainland has emerged as the eighth largest investor in Vietnam, with the actual FDI much higher if we include their affiliates in Hong Kong and Macau. Over 60 percent of all Chinese FDI focuses on manufacturing and processing, with a majority of the investment focused on labor-intensive industries.

Trade agreements

Both countries are parties to the ASEAN China FTA, which created the largest free trade area in the world. Apart from ASEAN China FTA, both countries are currently negotiating the Regional Comprehensive Economic Partnership (RCEP), which includes the ASEAN member states, and the six states with which ASEAN has existing free trade agreements, which include Australia, China, India, Japan, South Korea, and New Zealand.

Bilateral trade

Trade volumes between the two nations have increased significantly in the last few years. Vietnamese exports to China increased at a faster pace in comparison to its imports. According to Chinese statistics, its exports to Vietnam grew by an average annual rate of 18 percent during 2010-2016, and its imports from Vietnam grew by 26 percent.

Major imports

Over 70 percent of Chinese imports into Vietnam are intermediate goods such as machinery, electrical and electronic products, textiles and fabrics, base metals and minerals, and chemicals. In the last 2-3 years, other goods such as plastic and clothing products for consumer purposes also accounted for a small part of Chinese imports in Vietnam.

In the first seven months of 2017, China has emerged as the largest exporter to Vietnam at US$ 31.59 billion, an increase of 15.3 percent compared to the same period in 2016. The below information is the percentage share of different product in total imports.

Major exports

Major Vietnamese exports to China include machinery, electrical and electronic products which account for more than half of the total exports. Other products include food items, cotton, fuel, and oil products.

Vietnam’s exports in the first seven months of 2017 stood at US$ 15.62 billion. The below information is the percentage share of different product in total exports.

Chinese FDI in Vietnam

China’s first FDI in Vietnam was in 1991 when a Guangxi enterprise (China) joint ventured with a Vietnam group to open Hoa Long restaurant in Hanoi. Since then, Chinese FDI has increased, although not consistently. For example, China’s FDI in Vietnam in 2012 was US$ 312 million, while in 2013; it rose to US$ 2.3 billion. China’s 2016 FDI in Vietnam accounted for 7.7 percent of the total FDI at US$1.88 billion.

Cumulative FDI

As of March 2017, the cumulative Chinese FDI stood at US$ $11.19 billion for 1,616 active projects. The average capital per project was US$6.9 million, much lower than the overall average. Chinese investment is mostly in the processing and manufacturing industry, accounting for 61.4 percent of total investment capital, followed by production and distribution of electricity, gas, and water, and air conditioning at 18.2 percent and real estate at 5.6 percent.

Binh Thuan province attracted the most FDI, with total registered investment capital of US$2.03 billion, for only seven projects, accounting for 18.1 percent of the total FDI from China.

Market entry strategy for FDI firms

As much as 80 percent of all engineering, procurement, and construction (EPC) contracts in Vietnam are awarded to Chinese contractors, accounting for 18.4 percent of total registered capital to be in the form of build-operate-transfer (BOT), build-transfer (BT), and build-transfer-operate (BTO) contracts. In a close second, joint ventures, business cooperation contracts, or joint stock companies account for 15 percent of the total registered capital. In terms of FDI, investments from affiliates in Macau and mostly Hong Kong have outweighed FDI from the Chinese mainland.

Commercial presence

There are numerous ways to establish a commercial presence in Vietnam.

  • Representative Office

This is the most common form of presence in Vietnam for foreign companies, particularly those in the first stage of a market entry strategy. A representative office cannot conduct commercial or revenue generating activities.

  • Limited-liability Company

It may take the form of either:

  • A 100% foreign-owned enterprise; or
  • A foreign-invested joint-venture enterprise between foreign investors and at least one domestic investor.
  • Joint-stock Company

A joint-stock company is a limited liability legal entity established through a subscription for shares. By law, this is the only type of company that can issue shares. A joint-stock company may be either 100 percent foreign-owned or a joint venture between both foreign and domestic investors.

  • Partnerships

A partnership can be established between two individual general partners.

  • Business Cooperation Contract (‘BCC’)

A BCC is a cooperation agreement between foreign investors and at least one Vietnamese partner in order to carry out specific business activities.

  • Public and Private Partnership Contracts

A Public and Private Partnership (‘PPP’) contract is an investment form carried out based on a contract between the government authorities and project companies for infrastructure projects and public services.

Major FDI projects

Overall, the Chinese mainland is the eight largest investor in Vietnam, with the US$1.76 billion Vinh Tan 1 power plant being the biggest investment. In addition, other major projects include the US$400 million Viet Lan Tire Plant in Tay Ninh province and the US$337.5 million Vietnam-China Mining and Metallurgy project in Lao Cai province.

In the textile industry, Texhong Group built a US$300 million fiber plant in Quang Ninh Province in 2013. To further their investments in 2014, they also started building the Texhong Hai Ha Industrial Zone with a total investment of US$215 million and another US$300 million for a few more textile plants in the zone.

Some of the other major projects in Vietnam include the Hung Nghiep Formosa Dong Nai Textile Limited Company project in Nhon Trach Industrial Park, Viet Luan tire project in Tay Ninh province, Tan Cao Tham rubber processing plant, the Vietnam-China Mining and Metallurgy project in Lao Cai province, the Thai Nguyen iron and steel plant extension, the Cat Linh- Ha Dong urban railway project, and the Da River water pipeline project.

Vietnam’s Competitive Advantages

Vietnam’s current competitive advantages are very similar to that of China’s around 10 to 15 years ago; low wage, low-tech, and export-focused manufacturing. As China moves up the value chain, Vietnam is taking its place and emerging as an alternative for investors.

Major advantages in Vietnam include:

  • Low minimum wages

According to Trading Economics, the average minimum wage in 2016 in Vietnam was US$136/month, while in China it was much higher at around US$300/month. Wage difference has led numerous labor-intensive industries such as textiles and footwear to shift their manufacturing hubs to Vietnam;

  • Trade agreements

Chinese investors increased their investments in the last few years in the anticipation of the Trans-Pacific Partnership, which was unfortunately canceled under the new US administration. However, while China pushes for their own China EU FTA, the EU Vietnam FTA is expected to be ratified, hopefully by next year, offers investors an alternative way to reach the EU market;

  • Infrastructure and connectivity

Vietnam has over 100 ports throughout the country, with major ports being the Hai Phong, Da Nang, and Ho Chi Minh City. In anticipation of growing exports, ports in Vietnam are currently undergoing upgrades to increase capacity.

In addition, the railway infrastructure also is a major component of the economy. In the first quarter of 2017, 166,200 tons of freight was shipped by rail on the trans-border line, which was a 66.2 percent increase from the same period last year, and a 12-year record.

Around 60 percent of the rail network in Vietnam are in the Northern provinces, with several new railway lines proposed to increase the connection between the North and South.

The need to do more

In the last two decades, Vietnam has implemented numerous investor-friendly reforms to attract investments, but going forward it needs to do more. The country needs to develop their support industries and move up the value chain.  The government has introduced incentives policies for the development of support industries and aims to meet 45 percent of local production demand by 2020, and 70 percent by 2030.

Vietnam also needs to move up the value chain and not just highlight itself as an alternative to China. The country lacks R&D investments and high-skilled labor and needs to make changes in the education sector, IP protection laws, and high-tech investor-friendly policies for a sustainable growth. As of now, manufacturers investing in Vietnam still have to rely on the Chinese mainland or other neighboring regions for high-tech production processes.

Future of bilateral relations

Going forward, China has to focus on their existing projects in Vietnam to gain consumer confidence to be successful in the Vietnamese market. Recent China-backed projects in areas such as urban railway, metals, textiles, and energy have suffered from quality concerns, delays, and cost overruns leading to public scrutiny.

In spite of numerous geopolitical differences, both countries will continue to focus on increasing economic cooperation. Vietnam is seeking more investments in high-tech industries, support industries, renewable, clean energy, and tech transfer; however, China will be pushing for a more balanced trade and Chinese companies will continue to invest in industries such as agriculture, aviation, environment, high technology, transport, tourism, and healthcare. Economic exchanges will continue to act as a stimulus for the revival of bilateral relations.

 

Dezan Shira & Associates provide business intelligence, due diligence, legal, tax and advisory services throughout the Vietnam and the Asian region.

 

This column does not necessarily reflect the opinion of the editorial board or Frontera and its owners.

 

4 Stocks To Watch If Trump Resumes Threats To Abandon South Korea Trade Pact

Withdrawal from the South Korean free trade agreement

US President Donald Trump tabled the threat of a withdrawal from the free trade pact with South Korea in early September, a move that could worsen economic tensions in the region. Since Trump came into office, the government has been pushing to renegotiate the U.S.-South Korean trade agreement known as “KORUS”. Renegotiating existing free trade agreements were a key agenda for Trump during his election campaigns. Trump has argued that the “KORUS” agreement a disastrous deal for the American economy.

Tami Overby, senior vice-president of the US Chamber of Commerce, took a public position that withdrawing from the KORUS agreement would result in negative implications for the United States. “The U.S will lose significant market share to the EU, Australia, China and others while sending a very dangerous message that America is not interested in doing business in Asia,” he said.

The U.S. goods trade deficit with South Korea rose to $27.6 billion in 2016 from $13.2 billion in 2011, the year before the deal took effect. The KORUS FTA, although signed in 2007, did not come into effect until March 2012.

The U.S. Trade Representative claims the KORUS agreement is responsible for this deficit but this is not clear. Furthermore the deficit number refers to trade of goods but not services where the U.S. has a trade surplus with South Korea. The United States had a services trade surplus of $10.7 billion with South Korea in 2016. Furthermore, exports of electronics that form the largest chunk of exports to the US were already tax-free prior to the KORUS.

Deborah Elms, executive director at the Asian Trade Centre stated, “Korus didn’t touch electronics. It didn’t touch electronics because electronics were already tariff free.” Additionally, “if we have a trade deficit in autos, it’s really hard to blame Korus for that because the timeline for Korus hasn’t done anything to autos yet,” she said.

Trade data

In 2016, South Korea was the 7th largest export market for the United States, and 6th largest supplier of goods to the United States. The United States exported $42.3 billion worth of goods to South Korea in 2016, representing ~3% of total US exports. In turn, the US imported goods worth $69.9 billion from South Korea, representing nearly 3.2% of overall imports.Last year, South Korea exported goods worth $496 billion and accounted for ~3.1% of overall global exports. The United States is South Korea’s second largest trading partner, accounting for 13.5% of South Korean exports in 2016.

Possible repercussions

Withdrawal of the trade agreement could possibly lead to a trade war between South Korea and the United States. It would result in a sharp increase in tariffs on the goods South Korea exports to the United States, in turn making them more expensive and less competitive. In turn, South Korea would also charge high tariffs on US goods and services imports. South Korea exporters would bear the brunt of a trade war and exports from the country would take a hit. As the second largest trading partner for South Korea, any trade war with the U.S. would have long-term implications on the South Korean economy as well as big exporters.

Sectors and stocks to watch

South Korea’s largest exports in 2016 were vehicles, electrical machinery, machinery, pharmaceuticals, and mineral fuels. Last year, dollar values of exports of these goods were $21 billion, $16 billion, $10 billion, $2.4 billion and $2.2 billion respectively.

In 2016, 90% of the trade deficit between the United States and South Korea came from the auto sector. South Korea was also the largest supplier of steel to the US through the first seven months of 2017, sending nearly 2.3 million net tons.

If Trump decides to withdraw from the free-trade agreement, it would adversely impact the export businesses of companies in the auto, metals and electronics sectors.

Year to date, the MSCI South Korea Index has surged 20.3% while the iShares MSCI South Korea ETF (EWY) has gained 26.4%. Comparatively, the Korean benchmark KOSPI Index has returned 15.7% in the year so far. In the last one month however, these indices have lost between 2-3% amid military tensions with North Korea and rising possibility of the US withdrawing from the KORUS trade pact.

The largest South Korean companies by revenues are Samsung Electronics, Hyundai Motors, SK Holdings, Korea Electric Power, LG Electronics and POSCO. In 2016, these companies generated revenues of $174 billion, $81 billion, $72 billion, $52 billion, $47 billion and $45 billion respectively.

Of these, Samsung Electronics, Hyundai Motors, Hanwha Corp (000880.KS), SK Holdings (034730.KS), LG Electronics, and POSCO are the biggest exporters from South Korea. In 2016, these companies exported products worth $206.5 billion, $141 billion, $124 billion, $82 billion,$31 billion and $69 billion respectively.

Now, let’s take a look at some stocks that generate significant portions of their revenues from the United States and will be most impacted in case of withdrawal of the free trade agreement.

Samsung Electronics

In 2016, Samsung Electronics generated nearly one-third of its revenues from the United States. The company’s sales to the United States increased to $60.2 billion, and constitute 34% of its global revenues of $174 billion (200.7 trillion won). The company’s 2016 Sustainability Management Report highlights the growing importance of the US for Samsung’s operations. Sales in the US as a proportion of its worldwide operations inched up to 34% in 2016, up from 33% in 2014, and 30% in 2013 due to rising demand for its smartphones in the country.

Samsung is also the largest South Korean company in terms of market cap and revenues and the Americas are the largest market for the company’s products. In 2016, the company generated revenues of $37.6 billion (42.6 trillion won) from this region. Samsung has a market cap of $264 billion and is heavily weighted in all ETFs and indices representing South Korean equities. Samsung is also currently the largest IT company in the world by revenues, just above Apple (AAPL).

Samsung is the world’s largest manufacturer of mobile phones and smartphones in terms of sales and among the largest supplier of electronic components such as lithium-ion batteries, semiconductors, chips, flash memory and hard drive devices. In July 2017, the company also surpassed Intel to become the largest semiconductor chipmaker. The company also supplies components to its competitors such as Apple, Sony, Nokia, HTC and LG. Apart from tech, the company is also among the largest home appliances manufacturer in the world and since 2006, it is the largest television maker in the world as well.

However, Samsung has witnessed two major crises over the past 12 months. Last year, Samsung faced scrutiny over the withdrawal of its Galaxy 7 smartphones after reports of its batteries catching fire. More recently, the company’s heir Jay Lee was jailed over an allegation of bribery. Neither of these scandals seem to have hurt Samsung’s share price though. The stock has soared over 30% in 2017 thus far, outperforming the South Korean stock market. However, rising tensions with North Korea and the possibility of tax hikes might hurt the company’s exports.

Shares of Samsung (005930.KS) are listed on the London (BC94.L), Frankfurt (SSUN.F), Mexican (SMSNN.MX) and Korean stock exchanges. The company is also listed on the US OTC Market with the ticker SSNLF. YTD, shares of Samsung have returned 36.2% on the Korean Stock Exchange.

Hyundai Motors

Hyundai Motors is the third largest vehicle manufacturer in the world and the largest in South Korea. The company produces more than 5 billion vehicles a year in nearly 193 countries across the world.

Last year, Hyundai Motors sold nearly 913,000 units in the United States, representing ~19% of the company’s retail unit sales. The company’s $27.6 billion (31.2 trillion won) revenues from North America account for nearly 33% of its global revenues of $82.7 billion (93.6 trillion won).

Hyundai along with its subsidiary Kia Motors operates two plants in the United States and plans to open one more. The company also plans to make additional investments of $3.1 billion in the US over the next five years. All these moves come amidst speculations that Trump might impose higher tariffs on vehicles imported from South Korea or Mexico.

Companies like Hyundai Motors or Kia Motors (KIMTF) are most at risk in case of withdrawal from the KORUS trade agreement, as their vehicles would become more expensive in the US, thus making them uncompetitive compared to domestic manufacturers.

Further, the company also faces risk in China, its largest export market backed by geopolitical tensions related to the THAAD missile. Media reports suggest that Chinese automaker BAIC motors maybe terminating its partnership with Hyundai as South Korea completes installation of the THAAD missile system. “Since the company’s sales in China have been doing quite well, investors seem to believe that the current situation will do take a toll on the company severely,” said Lee Sang-Hyun, a stock analyst at IBK Securities.

Hyundai Motors trades on the Mexico, Frankfurt and Korean Stock Exchanges with tickers HYUDN.MX, HYU.F, and 005380.KS. The company with a market cap of $27 billion is the third largest company on the Korean Stock Exchange. In 2017 till date, shares of the company have lost 6.2% value on the Korean Stock Exchange.

LG Electronics

Korean based LG Electronics and Samsung are the largest players in America’s home appliance market in terms of sales values. LG also has a 20% share in the smartphone market in the United States, and is on the third position just behind Apple and Samsung. In the first quarter of 2017, LG sold 7.6 units of smartphones in the country, it’s highest till date.

LG Electronics is the eighth largest exporter from South Korea, with exports worth $31 billion last year. Last year, the company reported sales of $48.9 billion (55.4 trillion won), of which 30% came from the North American region.

LG Electronics’ products include televisions, home theater systems, refrigerators, washing machines, computer monitors, wearable devices, smart appliances, and smartphones. LG is the second largest television manufacturer globally, just behind Samsung. The company operates through 119 subsidiaries across the globe.

Shares of LG are listed on the Korean, Stuttgart and Frankfurt Stock Exchanges with tickers 066570.KS, LGLG.SG and LGLG.F. The company’s shares are also listed on London OTC Markets. In Korea, the company has a market cap of $12 billion, and its shares have gained 2% YTD underperforming the market.

POSCO

POSCO is the largest South Korean steel producer and the fourth largest steel producer globally. The company operates two integrated steel mills in South Korea. POSCO also operates a joint venture in the United States with US Steel, known as USS-POSCO. The company’s steel plant is located in California.

China is POSCO’s largest market, accounting for nearly 20% of sales. The United States constitute ~10% of POSCO’s overseas business. In 2016, POSCO generated revenues of $47.5 billion (53.8 trillion won), and operating profits of $2.4 billion (2.8 trillion won), 18% higher compared to the previous year.

Chief executive of POSCO recently expressed his views on risks coming from the US in case of protectionist measures. “The emerging new trend is that some advanced countries are leaning towards protectionism, as the global economy is deteriorating,” POSCO CEO Kwon Oh-Joon stated in a letter to employees. “Should trade regulations spread to POSCO’s major markets such as Southeast Asia, our exports will suffer a major setback,” he said in the letter. The comments follow after the United States has imposed anti-dumping duties and fines on steelmakers from China and South Korea.

Korean steel makers such as POSCO and Hyundai Steel are at risk to export their products to the United States as the country moves to restrict steel imports by imposing trade barriers in the form of tariffs.

POSCO trades on the New York, Frankfurt and Korean Stock Exchanges with tickers PKX, PKX.F and 005490.KS. Shares of POSCO also trade on US OTC Markets. Furthermore, the company’s subsidiary POSCO Daewoo (047050.KS) is also listed on the South Korean Stock Exchange. The company with a market cap of $27 billion is the fourth largest company on the Korean Stock Exchange. In 2017 till date, shares of the company have returned 83% and have outperformed the broad based KOSPI Index.

Analysts opinion and valuations

Analysts believe South Korea’s equities have been under pressure from geopolitical tensions in the region as well as the possibility of tax hikes in case of Trump’s withdrawal from the free trade agreement. However, they believe South Korean stocks are attractively valued and investors should take advantage of the correction.

Credit Suisse analysts Keon Han and Sang Uk Kim opines, “the recent correction among the large cap Korean tech stocks provides opportunities to buy the dip,”

“Generally, investors agree that the sharp correction in Korean tech was partly driven by geo-political tensions and uncertainties from proposed tax policy changes. Capex increases by the major Korean DRAM and NAND makers also played a role. … confidence has returned as memory semi prices are tracking higher and [the] Apple (AAPL) supply chain prepares to increase component volume purchases. Interest in LGD is rising as the more comprehensive OLED strategy has been revealed.

We maintain Outperform on Samsung Electronics (005930.SK) as upward earnings revision should continue with stronger DRAM and NAND pricing outlook for the rest of 2017. Despite our Neutral rating on LG Display (LPL and 034220.SK), we note that valuations are approaching trough value and possibilities exist for a rerating if OLED execution bears fruit. LGE remains a consensus short ..” they mentioned in a release to investors.

HSBC analyst Ricky Seo thinks Samsung’s valuation still looks attractive. He expects return on equity to rise to 19% up from 13% in 2016. Seo expects Samsung’s earnings to be driving by rising prices of memory chips. The analyst has assigned a buy rating on the stock and target price of 2,600,000 won, which implies 11% upside. YTD, shares of the company have gained 37%.

Nomura Securities’ Angela Hong advises investors to stay away from South Korea’s auto sector as it most at risk to rising taxes post withdrawal of the KORUS trade agreement. In a note to investors, she highlighted Hyundai Motors’ falling margins in the US in the first quarter of 2017. She stated, “HMC’s exports fell 4% y-y, despite increased working days in Korea. While the weak export volume was partly due to the continued production line adjustment in Korea for 2H17 exports of the Creta model, we think the recent expectation of an EM demand recovery has yet to be proven. On the other hand, we remain cautious about the company’s deteriorating US margin, given it increased average incentives by 12% y-y in February but retail sales were just flat.

We stay cautious on the Korean auto sector, in light of increasing competition in the US and China as well as uncertainties on the cross-border tax.”

HSBC analyst Brian Cho is bullish on POSCO’s earnings. Cho has a buy rating on POSCO with a 360,000-won share target price, which implies 5% upside. In 2017 so far, shares of POSCO have already surged 83%.

Shares of Samsung have received 40 buy ratings, 1-sell ratings and 3 hold ratings. In comparison, Hyundai Motors has received 33 buy ratings, 5 hold ratings. and 1 sell rating.

POSCO has received 33 buy ratings, 2 sell ratings and 2 hold ratings, while LG Electronics has received 19 buy ratings, 4 hold ratings and 1 sell rating.

Valuations of South Korean equities are currently attractive with the KOSPI Index trading at one-year forward PE ratio of 15.2x and the MSCI Korea Index trading at a PE ratio of 11.4x. Analysts believe South Korean stocks have room to rally and investors should view the correction as an attractive opportunity to take fresh positions.

Currently, Samsung Electronics trades at 11.5 times forward earnings and 1.5 times book value, while LG Electronics trades at PE of 25.4x and price to book ratio of 0.9x. POSCO’s shares at 4.4 times book value and 58 times forward earnings are expensive as they have rocketed 83% already in 2017. Meanwhile, Hyundai Motors at PE of 27.7x and PBV of 4.8x is also expensive.

What’s Behind China’s Love Affair With Morocco?

From trade to tourism, Morocco is quickly becoming a media darling in China, as the country’s stability, location and culture entice Chinese investment.

Chinese involvement and investment in Africa is well documented, with Beijing a major trading partner for the continent’s resource exporters. One of the latest countries to benefit from China’s attentions is Morocco, which is witnessing an unprecedented boom in bilateral relations. Morocco is quickly becoming an important partner for China on a range of issues: one can even say that Morocco-fever is gripping the Middle Kingdom.

Despite being only the second African country to recognize the People’s Republic of China in 1958, Morocco has until recently been overshadowed by the likes of Angola, and closer to home, by Algeria. Lacking substantial oil reserves, Morocco took a backseat during China’s resource binge in the 2000s, but has since seen an outpouring of Chinese interest as Beijing seeks to diversify its investments in the region. Morocco’s rise in popularity can be traced to King Mohammed VI’s visit to China in 2016, a trip which is credited with jump-starting bilateral ties: Morocco now boasts three Confucius Institutes.

China and Morocco’s shared stances on non-intervention make them compatible partners, as does the fact that Morocco has not been overly critical of China, despite being a Major Non-NATO ally of the United States. China’s refusal to comment on the Western Sahara issue (a contested region claimed by Morocco) meshes nicely with Morocco’s silence on China’s actions towards its Muslim population in Xinjiang. While some Moroccans bemoan the plight of their co-religionists in China, Rabat has not openly voiced these concerns. Likewise, by refraining from commenting on the Western Sahara issue, China distinguishes itself from other external partners like the AU, EU and U.S which have all raised concerns about Moroccan actions in the region.

Alongside mutual non-interference, Morocco is also increasingly benefiting from Chinese efforts to diversify its foreign investment, especially regarding technology and tourism. Morocco is also becoming the default investment destination in North Africa, as the region continues to be unstable, with Morocco reaping the benefits of stability. Moreover, growing anti-Chinese sentiment in more established China-Africa relationships is also leading China to diversify its investment portfolio to hedge against anti-Chinese protests and backlashes that threaten existing investments. To this end Casablanca will be hosting the China-Morocco Trade Week in December 2017.

China on a spending spree in Morocco

Alongside traditional exports to China such as phosphates, Morocco is seeing a tidal wave of Chinese investment in a host of sectors. Between 2011 and 2015 Chinese FDI in Morocco increased 195%, with a 93% increase between 2014 and 2015 alone. Since then things have only continued to accelerate. The Chinese-built 952 metre King Mohammed VI bridge (itself part of the 42 km Rabat motorway bypass expansion) was opened in July and in November 2016, China’s Chint Group Corp was chosen to construct a 170MW solar plant. Furthermore, Moroccan authorities met with China Railway in December to discuss the construction of a multi-billion, high-speed rail link between Marrakesh and Agadir.

The Bank of China opened an office in Casablanca in March 2016 as part of Morocco’s Casablanca Finance City initiative. Similarly, Yangtse Automobile has announced a $100 million investment (expected to create 2,000 jobs) in Tangier to produce electric cars and buses for export to Europe, citing Morocco’s location as an asset in boosting exports to Europe while also shortening supply chains. Tangier is also the location of Morocco’s ambitious $10 billion Tangier technology hub project. Aided by a $1 billion investment from China’s HAITE Group, the project aims to build a smart city with 300,000 residents and provide 100,000 jobs in order to create a new technology and manufacturing hub near Tangier. The project is expected to attract investment from some 200 foreign companies, many of them Chinese.

Another growth market are citrus exports to China. As the third largest citrus exporter, Morocco has needed to seek out new markets in the wake of Russia’s agriculture import ban, with China a perfect candidate. The first batch of high-end Moroccan citrus exports set out for Shanghai in November. Copag – Morocco’s largest citrus producer – has partnered with Chengdu’s Bideng Trade Co. to sell Moroccan fruit in China. The growing demand for foreign food in China – spurred by rising incomes and health concerns regarding Chinese produce – provides an excellent opportunity. Given Morocco’s existing integration into EU food supply chains, Rabat is already beholden to high quality standards, a fact that appeal to many Chinese consumers. Indeed Chinese importers have cited Morocco’s ability to pass the EU Proficiency Test for Pesticide Residues as a seal of confidence.

Indeed China’s interest in all things Moroccan has even seen the African country begin to export donkeys to meet the demand of China’s traditional medicine market. China is importing more than 80,000 donkeys (and growing) from across Africa to supply hide and gelatin for traditional medicines, as Beijing’s annual consumption of 1.8 million animals remains insufficient.

Moroccan tourism and culture take China by storm

Alongside manufacturing and other investments, the most explosive growth has been in the tourism sector. Even before Rabat’s decision to drop visa requirements for Chinese visitors in July 2016, Ctrip as part of the 2016 National Day Travel Prediction Report predicted a 3500% increase in visa applications to Morocco. As a result by November 2016, Morocco saw a sixfold increase in Chinese arrivals – a fact all the more impressive given that no direct flights exist between the two countries. With 42,000 Chinese tourists in 2016 – a 300% year-on-year increase from 2015 – Morocco has announced a goal of 100,000 visitors from the Middle Kingdom in 2017. As a result, Chinese investors from Guangzhou met with the Moroccan Society of Tourist Engineering in late February to discuss investments in hotels, resorts, spas and amusement parks.

All this comes as China’s government-run Global Times declared Morocco the best potential destination for 2017, based on visa procedures, tourist flows, and tourist satisfaction. This has resulted in Morocco becoming a trending topic on Weibo, with photos of the North African country especially popular. This trend has been fostered by a partnership between Morocco and Chinese smartphone maker Xiaomi, whose team travelled to Morocco to snap promotional photos for its latest smartphone. Morocco has become the star model to showcase the 23 mega-pixel camera on Xiaomi’s M1 Note 2 smartphone. Photos of Morocco were prominently featured during Xiaomi’s November launch conference for the M1 Note 2. An added bonus for Morocco is that Xiaomi is providing the photos for free as pre-installed content on its phones, thus introducing Morocco to tens of millions of Chinese consumers.

Morocco was also a star attraction at the Beijing International Book Fair in August, marking Morocco’s second consecutive appearance at the event. On the other hand, The Donor by Chinese director Zang Qiwu won the top prize at the 2016 Marrakech Film Festival in December. The amount of hype surrounding China-Morocco relations and cultural exchanges has even led to the spread of fake news, with Chinese media incorrectly reporting that author Liu Zhenyun had won a popular Moroccan literary prize. This was no mere typo, as the alleged prize does not even exist, with Chinese officials having to debunk the story.

Whether this was an orchestrated effort to reinforce the trending China-Morocco narrative that backfired, or simply a viral rumour sparked by an excited netizen, it demonstrates that Morocco is clearly top of mind in China.

 

Jeremy Luedi is a Senior Analyst at Global Risk Insights.

Article as appears on Global Risk Insights: http://globalriskinsights.com/2017/03/chinas-love-affair-with-morocco/

 

Trump Wades Into The South China Sea

The new administration’s South China Sea policy is taking shape — and could send ripples through international markets.

The sea is dotted with reefs and shoals claimed by neighboring states but occupied by China. Beijing uses these reefs to make sweeping territorial claims – claims that are invalid under international law. Washington has long rankled Beijing by exercising its warships’ freedom of navigation and sailing through these Chinese-claimed waters.

The Obama administration tolerated naval harassment and illegal island-building, but the U.S will likely be far less accommodating going forward. Trump appears disinclined to keep trade and security issues separate, so the territorial dispute could send ripples through global markets.

The San Diego-based Carl Vinson carrier strike group steamed into the South China Sea on February 18th to begin a patrol mission, prompting Beijing to issue its usual complaint that “relevant countries” were “threatening and undermining” its sovereignty. This coincides with reports that top brass in the Navy and Pacific Command are nudging President Trump to approve new challenges to China’s claims there. In meetings with Japanese officials this month, Secretary of Defense James Mattis expressed a fundamental rejection of China’s maritime expansion.

Mattis is said to have specifically indicated that Washington will intensify its freedom of navigation operations in the South China Sea. Add to this Trump’s coterie of China hawks – especially Peter Navarro and Steve Bannon, who view war with China as more or less inevitable – and a more hardline approach to the South China Sea looks increasingly likely.

The timing for such a policy shift could not be more inauspicious. The Obama administration refrained from unduly provoking China in its territorial disputes, and the sea has been relatively quiet since, despite the Permanent Court of Arbitration’s rejection of China’s claims in July 2016. President Xi Jinping will want to maintain this stability in the lead up to the 19th Party Congress scheduled for October or November. However, this also means that he cannot afford to look weak in the face of what his people would see as American provocations.

Regardless of whether the Carl Vinson’s current patrol sails within China’s claimed territorial waters, a more assertive American freedom of navigation program will probably take shape. This would compel Xi to react, which could take the form of naval harassment, the declaration of an air defense identification zone, or island-building on Scarborough Shoal. The latter move would be an incendiary litmus test for the new Trump administration. A militarized island outpost there would complete the strategic triangle formed by the Paracel and Spratly islands – if Beijing stationed surface-to-air missiles there as it has in the Paracels, their range would almost reach the Philippine mainland.

Frictions across the board: linking security and trade

If the U.S countered China’s response to its patrols by conducting even more of them, tensions could escalate into a full-blown crisis. Given widespread perceptions of the Trump administration’s volatility and disorganization, serious strife in the South China Sea could rattle markets, which have hitherto remained unaffected. Past Sino-American spats over the sea did not directly impact trade – both sides kept security and economics separate. Investors cannot be entirely sure that this will continue to be the case.

“We’re going to war in the South China Sea in five to ten years…there’s no doubt about that.” – Steve Bannon, White House chief strategist. Breitbart News Daily, March 10, 2016.

With close Trump advisors already recommending a trade war, the president – who tends to take things personally – could retaliate economically. Past administrations have avoided linking security to trade because it can poison bilateral relations. 2017 could be the year that the South China Sea truly becomes a political risk issue.

The trigger for this would be an announcement by the Joint War Committee of Lloyd’s Market Association, the world’s leading authority on marine insurance. In 2010 the committee declared a piracy high risk area stretching from Somalian waters all the way to India’s western coast, causing shipping insurance costs to increase 300-fold. If the committee declared the South China Sea to be a high risk zone due to Sino-American confrontation, shipping costs would skyrocket.

Revenge of the insurance salesman

If insurance rates rose high enough, the direct route to Northeast Asia offered by the South China Sea would become unaffordable. Instead, the majority of Japan and South Korea’s oil supply would have to pass east of the Philippines, which would also be a huge expense. This would represent an annualised cost of $600 million for Japan and $270 million for South Korea. China consumes more than both countries combined, and, due to geography, its tankers cannot be rerouted and would have to bear the exorbitant insurance cost.

Beijing could instruct its largely state-owned shipping and oil firms to self-insure, which could be cost-effective because – even though the South China Sea might be labelled a high-risk area – neither Beijing nor Washington would dare to escalate to trade interdiction, so no insurance payouts would be necessary. Major shipping firms are already suffering due to oversupply and slowing global trade growth, with some teetering on the brink of bankruptcy. A political risk event in the South China Sea would likely accelerate the current upsurge in new mergers and strategic partnerships in the shipping industry.

Oil markets would also experience jitters. The rejection of China’s territorial claims in The Hague last year gave a 2% price nudge to oil futures, which previously had been unaffected by regional tensions. More serious worries would undoubtedly have a greater impact.

While a war over the South China Sea remains a remote possibility, contamination of bilateral trade relationships are not. The reverberations from this would rattle far more than just the shipping sector. If the Trump administration imposed tariffs, reduced manufacturing exports would injure China’s already slowing economy, and Beijing could target Apple, Boeing, and the American auto and agricultural sectors.

With the military’s reportedly assertive recommendations filtering up to the president, and with Beijing continuing to militarise its built-up islands, the Trump administration’s South China Sea stance may soon coagulate into a coherent policy. An amalgamation of military advice, Beijing-bashing counsellors, and Trumpian unpredictability will decide whether the South China Sea dispute will metastasise. Spillover into the $660 billion Sino-American trade relationship would harm the world economy and poison bilateral relations.

 

Roman Madaus is a Political Risk Analyst at Global Risk Insights.

As originally appears at: http://globalriskinsights.com/2017/03/trump-in-the-south-china-sea/