Commentary: Widening tail risks

Two major sources of dread loomed over the recently concluded IMF Spring meetings in Washington DC. One was about the US policy-led friction on trade, immigration, and functioning of the government. The other was about the future of rules-based multilateral approach to trade and commerce. The latter, while admittedly in need of reform and improvement, has served the interest of the international community, especially small economies, over many decades. With the US keen to pursue unilateralism, the concern expressed repeatedly was the inexorable move toward multiple spheres of influence, a rise in complexity and distortions, and an increase in instability in trade, finance, and commerce.

Global economic outlook was revised down by the IMF, but given the noise of late, the magnitude of revisions was modest. Widespread recession fears notwithstanding, the IMF sees global growth softening by 50bps this year. The US forecast was lowered, but it is still expected to grow by nearly 2% this year. The underlying factors driving this somewhat sanguine view on the US are as follows:

The US economy stepped into 2025 with a great deal of momentum, with strong consumption and investment offsetting some slowing of public spending. This momentum has fed into sustained strength in the labour market, notwithstanding the job cuts announced under the aegis of the Department of Government Efficiency, which have proven to be of marginal consequence. Latest data on unemployment, job creation, and wage growth continue to attest to this strength. Current uncertainties will dampen consumption and investment, but it does not yet appear that that would lead to a major decline in activity. The US, a large, domestic demand-driven economy, benefitting from lower energy prices and a likely large tax cut later this year, could well absorb a chunk of the tariff shock. A period of empty shelves and inflation jump could materialise if some goods from China stop coming, but that could well force a de-escalation of trade frictions. What policy can wrest, it can alleviate.   

We think this central scenario is subject to long tail risks. As seen in various surveys, consumer and business sentiment markers have deteriorated sharply in recent months. Markets still have confidence in trade negotiations progressing, but the room for disappointment is ample. Persistently large US fiscal and current account deficits warrant continued goodwill of investors, locals and foreigners. Positioning can unwind dramatically if the White House overplays its hands on trade and finance.

What about China? The IMF expects growth to slow there by 100bps this year to 4%, as exporters scramble to find alternative sources of demand, both at home and in non-US markets. Fears of dumping could cause Chinese exporters to face trade restrictions outside US markets. If some countries do deals with the US at the expense of China, that could unleash additional layers of friction as well.

Domestic demand support measures would be rolled out by Chinese authorities, negotiations with the US will eventually take place, and local innovators and entrepreneurs will keep capturing the imagination of the rest of the world, but the ride will be bumpy. Most critically, the erosion of US-led global order will require China to pursue an open and stable set of policies with the rest of the world. Just as it sees the world’s largest consumer market become increasingly closed, it would need to show the world that its market will be progressively more open.

The Trump administration asserted repeatedly during the week that many countries have reached out for trade deals. We are sure that most government would rather work amicably with the US, but we are worried about the terms they will have to face.

As the 90-day tariff pause moves on, US demands may turn out to be characterised by inconsistencies and escalations. Nations like Mexico, given their dependence on trade with the US, may do whatever is demanded of them, from boosting spending on immigration measures to mirroring US tariffs on China.

In contrast, the likes of Vietnam may find no amount of adjustment would get them tariff relief. For the likes of Japan, South Korea, and Singapore, their close relationship with the US may not be sufficient to revert to the pre-April trade regime.

A 10% tariff on every country outside of USMCA seems like the base case to us. Some exceptions for pharmaceuticals and electronics would be made, and but that could come and go. Nothing can be taken as sacrosanct.

As uncertainties related to trade and investment persist beyond the tariff pause, companies and countries will be seen carrying out short-term strategy vis-à-vis the US such as tariff arbitrage, friend-shoring, and on-shoring. Then there would be long-term strategy for the rest of the world, including multiple supply chains and regional trade deals. Shocks to exporters would have to be offset by boosting domestic demand through supportive policies.

The US authorities made sure that the DC meetings were not overwhelmed by questions on the weaponisation of the USD and USD assets. US fiscal outlook is mired with downside risks, given Trump’s multitrillion-dollar tax plans and a rigid spending envelop marked by ballooning defence, interest, and social security payments. Treasury Secretary Scott Bessent expressed support for a strong dollar policy, but there was an important caveat. The US does not want an appreciating currency, rather it just wants to assure investors that US asset markets would remain open and attractive for investment. This was done, in our view, to distance the administration from the thoughts expressed by the Stephen Miran, head of Council of Economic Advisers, which include charging a user fee on US bond holders.

The week was not marked by a charm offensive by US officials, but there was some push to reduce the temperature. The US is not walking away from multilateralism, but it would demand forcefully that the system serves its purpose. The world would have to take such demands as a given. There is no going back; the genie is out of the bottle.    



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