In the year ahead, trade tensions between the United States and China are likely to spill over into a trade skirmish at best and trade conflict at worst.
A Chinese economy caught in a debt and deleveraging trap is likely to face the additional strain of a sharp increase in tariffs on goods sold into the U.S.
This will test the managed float of the Chinese currency just when China is seeking economic and financial stabilization rather than a reflation of its economy.
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As the trade conflict escalates, Beijing will most likely turn to currency depreciation to partially offset the impact of higher import duties on goods sold into the U.S. This depreciation will be painful for China domestically, though, because of a challenging employment environment and tepid wage growth.
In addition, as the yuan depreciates, the price of imports such as oil will rise along with the cost of servicing external dollar-denominated debt.
In the international economy, China carries the greatest amount of debt issued in U.S. dollars at $409 billion as of 2022. That is followed by Mexico with $286 billion, and India with $186.7 billion in external debt.
After that, the list is comprised of larger economies subject to greater geopolitical or economic stability risk, with Brazil ($164.4 billion), Russia ($135.3 billion) and Turkiye ($133.9 billion) the leaders of that category.
Debt and growth
For years, China has fueled its remarkable growth with debt. During this time, its provinces have used debt to build up their infrastructure and promote economic output.
China estimates that debt to be 14 trillion yuan ($2 trillion), but the International Monetary Fund puts that figure at 60 trillion yuan ($8.2 trillion).
During that time, China’s currency has gone from being pegged to the dollar to a managed appreciation (after a global outcry). But since 2014, it has lost 20% of its value despite a period of impressive growth that has now ended.
As a result, an expected rise in trade tensions with the U.S. will put additional pressure on an already strained Chinese economy that will be deleveraging for the next several years.
