Trump’s Trade War: A Bigger Test for Emerging Markets Than the COVID-19 Pandemic

The global trade war, reignited by US President Donald Trump’s policies, has become a major challenge for emerging markets. According to the International Monetary Fund (IMF), it now poses a greater test for central banks in developing economies than the COVID-19 pandemic did. The pandemic allowed central banks worldwide to act uniformly by slashing interest rates and offering economic stimulus. However, the trade war has created a much more fractured global economy.

Trade War A Bigger Challenge for Emerging Markets Than COVID-19 

IMF’s First Deputy Managing Director, Gita Gopinath, pointed out that while central banks moved in the same direction during the pandemic, providing a collective response to the crisis, the current environment presents an unpredictable set of challenges. Tariffs have created asymmetric shocks, making it harder for central banks in emerging markets to make policy decisions.

The Impact of Trump's Trade War on Emerging Markets

Unlike the uniform economic downturn caused by the pandemic, the consequences of the trade war are uneven across different economies. Developed nations like the US are grappling with inflationary pressures due to tariffs, while emerging markets are experiencing what Gopinath calls a “demand shock”. This situation results in slower growth and subdued inflation in developing economies.

The divergent impacts of the trade war create a dilemma for central banks in emerging markets. To support domestic demand, central banks may need to cut interest rates. However, the higher interest rates in the US, designed to tackle inflation, may force these central banks to hold rates steady or even raise them. This is necessary to protect their currencies and prevent capital flight.

Rate Cut Dilemmas for Emerging Market Central Banks

As emerging market economies navigate these challenges, the dilemma becomes more apparent. The Reserve Bank of India (RBI) is expected to cut the repo rate by 25-50 basis points during the upcoming Monetary Policy Committee (MPC) meeting. This would be the third consecutive rate cut by the RBI this year.

However, the Federal Reserve in the US, despite pressure from President Trump, has indicated it will hold off on rate cuts. This cautious approach is based on the need for assurance that tariffs will not cause further inflationary pressure. This situation creates a tightening of global financial conditions, which in turn limits the policy space for emerging economies to manoeuvre.

Read More: Trump Doubles US Steel and Aluminium Tariffs to 50% Amid Renewed Trade Tensions! 

Risks of Capital Flight and Currency Depreciation

The Organisation for Economic Co-operation and Development (OECD) has highlighted additional risks for emerging markets, including capital outflows, currency depreciation, and rising borrowing costs. If global investor sentiment weakens or economic growth prospects deteriorate, these markets could face increased capital outflows. This could lead to depreciation pressures on their currencies, further complicating the economic environment.

The OECD has warned that emerging markets are particularly vulnerable to these risks, as they rely on stable capital inflows to maintain their growth trajectory.

A Volatile Road Ahead for Emerging Markets

The outlook for emerging markets is uncertain, with Gopinath describing the situation as “steering through the fog”. The unpredictability of US trade policy, combined with the risk of capital flight and the need to stimulate domestic growth, presents a uniquely difficult environment for central banks in developing economies.

Conclusion 

While a brief truce was reached between the US and China during talks in Geneva, tensions escalated when President Trump accused China of violating the agreement and announced plans to double tariffs on steel and aluminium. This has only added to the uncertainty and challenges for emerging markets.

Emerging market economies must navigate these turbulent waters carefully, balancing the need for domestic growth with the need to protect against global financial risks.

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