A Fall Into a Pit, a Gain in Your Wit – Escalation of US-China Trade Dispute Impacts Chinese Agriculture

On 15 June, the US came out with a list of 1,102 imported Chinese goods, worth USD 50bn in trade, which will be subject to a 25% punitive tariff for alleged violations of intellectual property. Most of the goods are included in the ‘Made in China 2025’ state policy and fall into the aerospace, robotics, industrial machinery, new material, and automobile categories. A number of these tariffs, amounting to USD 34bn worth of Chinese goods, will come into effect on 6 July, while another USD 16bn worth of measures still need to go through further review and public hearings.

Unsurprisingly, this move by the Trump administration further escalated US-China trade tensions and sparked immediate tit-for-tat retaliation from the Chinese government. Hours later, China announced 25% additional duties on 545 US imports, and these tariffs on imported US automobile and agriculture products are also slated to come into effect on 6 July. The implementation date of tariffs on other US goods on the list, mostly chemicals, medical equipment and energy goods, remains undefined.

On 18 June, the US administration responded to China’s retaliation by directing the US Trade Representative to impose a 10% tariff on USD 200bn worth of Chinese goods, further intensifying the trade disputes. In addition, president Trump threatened to pursue additional tariffs worth another USD 200bn, if China were to strike back again.

While the trade disputes have been making headlines in recent weeks, the strategic competition between the US and China actually goes beyond trading and is a much broader phenomenon, including, but not limited to, economics, geopolitics, ideology, the military and legal systems. No matter how hard China has been trying to avoid ‘the Thucydides trap' – when a political power becomes so big that it becomes impossible for the ruling power not to fight it – the US-China conflict has escalated over a longer period of time and will be a long-term issue. We expect to see constant, long-term trade friction between China and the US, which might last for decades, accompanied by tactical negotiations and occasional compromise.

The macroeconomic and strategic backdrop

RaboResearch has attempted to calculate the economic damage that would be done by the US and China both imposing USD 50bn of 25% tariffs on each other's exports. The results are surprisingly minor, with around 0.1 ppt to 0.2 ppt being shaved off GDP growth, largely because both economies are so large, and trade is such a small part of their total output.

However, the damage done increases with every tariff announcement. No model is needed to see that the US imposing USD 450bn of 25% and 10% tariffs on Chinese goods is highly damaging to international trade: to a large extent, this represents a break-down in trade relations between the world's two largest economies.

But what’s more worrying from a strategic perspective is that we may now be operating in a world in which short-term economic and market logic has taken a backseat. This situation increasingly looks like a struggle between the US and China over how much relative power each nation has, and who will be the leading example globally going forwards. If that is indeed the case, then further escalation beyond trade is likely, which could potentially take various forms, from measures against US firms in China, to services/tourism boycotts, to renminbi devaluation, and even to an increase in geopolitical tensions.

To say that this would be an unhelpful backdrop for global economies and markets would be an understatement.

Please see the latest report on this topic from the RaboResearch Global Economics and Markets research team.

The turbulent and unpredictable nature of US-China trade relations is likely to have a constant impact on many industries in China. Agriculture will be one of the first to feel that impact, as it is one of the few sectors for which the US registers a trade surplus with China. In 2017, China purchased over USD 20bn in agricultural products from the US, accounting for 15% of the value of US goods exported to China (USD 130bn). As recently announced, a number of US agricultural products will be subject to a 25% additional tariff, starting from 6 July, including grains & oilseeds, animal protein, and dairy products, as well as other commodities and processed foods. While the trade disputes between the two nations will have a serious impact on US farmers, they will also impact a number of Chinese agricultural sectors in the short term.

The short-term impacts on the Chinese market look straightforward. Hefty tariffs on US agricultural imports will slow down imports from the US to China, increase China’s imports from alternative origins, and cause price volatility of affected commodities in China and the rest of the world. Market risks will increase significantly.

Grains & oilseeds: soybeans

In 2017, China imported USD 12.9bn of US soybeans, making this commodity an easy target for retaliation. But soybean trade is also crucial to China, as 90% of soybean consumption is met by imports. The US is an indispensable supplier, providing 30% to 35% of total imports, second only to Brazil.

Soybean supply might not be a big issue up to August/September, the main export window of South American soybeans. In spite of the crop failure in Argentina, the bumper harvest in Brazil should be sufficient to meet China’s demand for the rest of 2017/18.

However, coming into 2018/19, China will face a supply shortage as soon as the Brazilian export window closes and North America’s opens. China will potentially have to import more soymeal or, more likely, import other oilseeds and maybe even other protein meals as alternatives. However, the small-scale availability of these commodities will not suffice to fill the gap caused by import tariffs. Rabobank expects that China’s total soybean import volume will see a YOY decline, with more shares going to Brazil, and Chinese crushers will have no choice but to purchase 10m to 15m tonnes of US soybeans, at tariff prices.

That said, prices of US soybeans are expected to weaken relative to soybeans from other origins, so the added costs of imported US soybeans are not expected to be a full 25% higher than imports from alternative origins. Still, with a 25% tariff on US soybeans in place, the soybean price is projected to increase in China. As crushers are unlikely to fully pass the inflated cost downstream, at least not in the short term, their margins are set to decline. Besides, the capacity utilisation ratio of soybean crushing will fall, further jeopardising margins.

In the longer term, if the sizeable tariffs persist, the global soybean supply should be able to adjust accordingly. US soybean acreage would drop, whereas South American acreage would increase. In the Northern Hemisphere, the Black Sea region also has potential for soybean acreage expansion. As for China, the commercialisation of GMO soybean planting could be an option for boosting domestic production and decreasing the dependence on imports. If the tariffs remain for years, China’s soybean imports could shrink, due to:

1. higher domestic soybean production

2. more imports of protein meals and other oilseeds

3. improving feed-conversion ratio, leading to lower usage of feed.

Grains & oilseeds: corn, wheat, and paddy rice

China is fairly self-sufficient in major grains, with limited trade volumes. In 2017, China imported 0.76m tonnes of corn, 1.54m tonnes of wheat, and negligible quantities of paddy rice from the US. These volumes can be easily substituted by other exporting countries.

China’s imports of corn, wheat, and paddy rice are subject to tariff-rate quotas (TRQ), with the in-quota tariff at only 1%, and the out-of-quota tariff at 65%. All applicants for quotas need to obtain prior governmental approvals, and thus, importing US grains could face non-tariff barriers. Besides, imposing an additional 25% tariff will significantly jeopardise the competitiveness of US grains compared with other countries when exporting to China.

Grains & oilseeds: sorghum

China is the largest buyer of US sorghum. The US exports about 60% of its sorghum production, with the vast majority of that going to China. In 2017, China imported 4.8m tonnes of US sorghum, which accounted for over 95% of total sorghum imports. Imported US sorghum is mostly used as a substitute for feed corn. As China produces over 200m tonnes of domestic corn per year and the state reserve still holds a massive inventory, the reduction of sorghum imports should have a limited impact on feed prices.

The Chinese government started imposing provisional anti-dumping measures on US sorghum in April, equivalent to a temporary 178.6% tariff. One month later, China decided to drop this measure, as a gesture of goodwill in the ongoing negotiations and to resolve trade tensions with the US. If a full-blown trade war occurs, the government is likely to reinitiate the anti-dumping campaign and duties again.

Animal protein

China already imposed a 25% tariff on US pork, which went into effective on 2 April, as a retaliation against US tariffs on steel and aluminium. Since then, pork trade from the US to China has gradually declined. Pork appears again in the new 15 June list, which means that another 25% tariff will likely be imposed. China’s pork market is in a downcycle at the moment, reflected by oversupply and weak prices. This means that importing pork into China has already become challenging due to competitive local supply.

US pork exports to China are expected to decline steeply if another 25% tariff is imposed. EU, Canadian, and Brazilian pork will take the place of US pork in the Chinese market. The direct impact of the latest tariffs on the Chinese pork market is manageable due to this year’s sufficient local supply. But the more significant impact will come from the higher tariff for soybeans. The expected rise in soybean and soymeal prices will lead to price volatility in feed grains and, as a result, in livestock and poultry. This will drive smaller farmers to leave the market sooner, as they have already been under loss-making pressures for months.

In addition, whey, an important ingredient in piglet feed, is among the dairy products to be given a 25% tariff. As US whey supply accounts for over half of China’s total imports, upward price pressure will make the weak performance of hog farming even weaker. In the short term, pork prices may experience more downside, as supply likely increases due to more liquidation. But it will make the recent process of industrialisation go even faster. Furthermore, the pork cycle pattern may be altered, and the current downcycle may finish earlier than expected. Leading players and specialised farmers who could sustain the market turbulence in 2018 will have more market opportunities.

US beef shipments to China have been slow since regaining market access in 2017. Therefore, a 25% tariff on US beef is not expected to have a big impact on the current trade flow, though it may somewhat benefit Australia and New Zealand, who will get to ship more premium beef to China.

The Chinese poultry sector has been on the road to recovery since the start of 2018. The expected volatile feed prices look set to weaken the margins of poultry players in China.

In seafood, the US is the second-largest supplier to China, so the extra tariffs have the potential to impact the trade flow. However, the Chinese government previously announced that they will cut import tariffs for aquaculture and wildcatch products from 15.9% to 7.1% effective as of 1 July, limiting the final impact.

Dairy

While the US accounts for only 12% of all of China's dairy imports, in liquid milk equivalent terms, it is actually the second-largest source of import by country (when each of the EU member states is measured as one country rather than as an aggregated trade bloc), be it far behind the number one, New Zealand. China’s latest retaliatory measures have now extended to dairy, under HS code 0401-0406, with an additional 25% tariff.

Of most significance is whey, for which the US is by far the largest exporter to China. In 2017, of the nearly 530,000 tonnes of whey imported by China, the US contributed 55%, followed by the EU with 35%. As China relies almost completely on imports when it comes to whey, no other region is likely able to fill the gap. As such, the tariffs would be a burden that both US whey exporters and the Chinese animal farming sector, one of the major consumers of whey, would have to bear together.

If the punitive tariffs go into effect on 6 July, the memorandum of understanding signed last year between China and the US to expand US dairy exports to China will likely be shelved. New whole milk powder (WMP) facilities that are targeting China would also face challenges in terms of ramping up utilisation, and may need to find alternative markets.

The latest package also includes an additional 25% tariff on US alfalfa. The US is by far China’s largest alfalfa supplier and US alfalfa accounted for 94% of China’s alfalfa imports last year, at over 1.3m tonnes. This is primarily consumed by China’s large-scale dairy farms. The quality of US alfalfa is seen as superior to other origins. China is currently 60% self-sufficient in high-quality alfalfa. In the short term, the tariffs could hurt Chinese large-scale dairy farms by adding about 3% to 4% to the all-in cost of production.

The US-China trade dispute is expected to push China to accelerate the economic reform needed to solve key issues and become more self-sustainable. Chinese has a well-known proverb that goes “a fall into a pit, a gain in your wit”. To achieve the long-term goal of developing Chinese agriculture, i.e. to secure food supply and fulfil China’s demand in a productive and sustainable way, we expect to see more efforts and resources going into the following activities:

Improving productivity of China’s agriculture platform through:

- Strengthening R&D and speeding up commercialisation in crop seeds (GMO and non-GMO), animal breeds, animal nutrition, and in particular alternative proteins, to increase self-sufficiency and improve quality;

- Reducing post-harvest losses through better farming practices, improved logistics, and other means;

- Developing innovative rural financing solutions tailored to the needs of Chinese farmers

Integrating better with the rest of the world

- Investing in overseas origination and logistics assets in leading agricultural countries with high potential, especially in South America and the Black Sea region;

- Access to cutting-edge technology advancements through M&A, international cooperation, or other means, under an intellectual-property right protection regime;

- Opening up to foreign investment more in order to help develop a more sustainable economy;

- Accelerating CNY internationalisation, allowing the CNY to play a more important role in global agriculture trading.