In the more than a month since U.S. President Donald Trump announced his so-called "Liberation Day" tariffs on April 2, the protectionist trade policy has introduced shocks to the global economy that are only beginning to reverberate. While there are still many unknowns about how the White House will proceed, what is clear is that U.S. tariffs will prove economically and politically very disruptive to financially distressed developing economies, even if Washington decides not to follow through with its reciprocal tariff policy or lower announced trade restrictions over time. This is largely because U.S. trade policy has created significant economic and financial uncertainty, which will increase economic and financial risks, as well as introduce political instability risks, particularly in financially distressed, developing economies that are reliant on commodity exports. Those that have significant bilateral trade surpluses with the United States face even larger risks due to the higher reciprocal tariffs they will face once Trump's 90-day suspension expires in early July.
The Toll on Highly Indebted Developing Economies
There are broadly five reasons for developing economies to worry amid Trump's tariff strategy and the resulting global economic shocks.
First, across-the-board U.S. tariffs of 10% — along with potentially higher additional reciprocal tariffs — will hurt the exports of emerging and developing economies. The greater their dependence on the U.S. market, the more they will suffer by way of reduced exports and lower foreign-currency revenues. Lower export revenues will lead to growth-reducing import compressions, falling foreign-currency reserves, politically painful currency depreciation, or all of them combined. Many of the developing and emerging economies already facing financing problems — such as Angola, Kenya or Pakistan — are at particular risk of financial instability. Less highly indebted emerging economies — such as Brazil, India or South Africa — will fare better due to having greater access to international capital markets, higher foreign-currency liquidity buffers and, frequently, more flexible exchange rates, which enable them to absorb exogenous shocks through currency adjustment.
Second, higher U.S. tariffs, directly and indirectly, will also weaken U.S. and global economic growth due to higher U.S. import prices, lower exports by tariffed countries, and a general decline in consumer and investor sentiment due to heightened uncertainty. Additionally, lower global economic growth will likely weigh on commodity prices. Lower energy prices may benefit certain emerging economies that are large net oil importers (such as Turkey or Egypt); however, for other economies that generally depend on commodity exports (such as much of sub-Saharan Africa), the deterioration of terms of trade will further depress export and foreign-currency revenues.
Third, to the extent that U.S. tariffs lead to higher U.S. inflation, with some analysts forecasting a short-term increase in inflation of 100-200 basis points relative to the previous baseline, U.S. interest rates will likely remain higher for longer, even in the context of an economic slowdown. This will further slow economic growth not only in the United States, but the rest of the world. Moreover, increased global investor risk aversion due to the fallout from U.S. tariffs will make it more difficult for countries, particularly financially challenged ones, to issue debt in international capital markets. Concessional borrowing costs will also remain relatively elevated, given higher risk-free U.S. interest rates.
Fourth, if increased global economic and financial uncertainty leads to a stronger U.S. dollar, as it historically has, it will further distress developing countries by raising financing costs in local currency terms. This time, however, the dollar has weakened amid the economic shocks caused by Trump's tariffs, at least in trade-weighted terms. But while some currencies like the Brazilian real or the Indian rupee have risen against the U.S. currency, many individual developing economies are grappling with currency depreciation and hence dollar appreciation, particularly if they face financial distress. Although a weaker exchange rate can help support higher exports, assuming that slower global growth does not offset the improvement in competitiveness, a weaker currency will still lead to increased financial distress in highly indebted economies, as their debt service, measured as a share of output, will negatively impact their financial outlook and ability to fund investment.
Fifth, U.S. protectionism will lead to trade diversion, meaning that countries that can no longer afford to export to the United States due to greater trade restrictions will seek to redirect exports to other markets. For emerging economies and their domestic producers, this will increase trade competition with China and other countries. This may be less of an issue for developing economies whose domestic industries typically compete less directly with Chinese (or Indian) exports. But the goods China exports often directly compete with those exported by emerging markets (e.g., steel). That said, emerging markets may still see increased dumping of cheaper goods, which could lead to increased restrictions targeting trade diversion, thereby raising the risk of more trade wars that would further weigh the broader economic outlook of especially emerging economies.
All of this means that emerging and especially developing economies will face significant headwinds as global growth weakens, interest rates remain elevated, export revenues decline and capital inflows fall in the wake of U.S. tariffs. Many developing economies and some emerging economies — such Egypt, Ghana and Sri Lanka — are either already facing financial distress or at heightened risk of financial distress. The Trump administration's cuts to U.S. foreign aid only further dim the outlook for developing economies, as the adverse impact on economic and financial development will force them to raise interest rates and implement even more forceful, but politically controversial, macroeconomic adjustments and reforms, including spending cuts and tax increases. If balance of payments pressure forces countries to devalue their currencies and higher interest rates fail to offset the inflationary effects of higher import prices, inflation and the cost of living will increase. This sets the stage for increased domestic political tensions and potential protests in developing countries, which history has repeatedly shown can quickly devolve into violence, at times even leading to the collapse of governments.
Some Countries Will Fare Better, but Few Will Benefit
The current state of play is concerning enough, but it could worsen because it remains to be seen whether, to what extent, and on whom tariffs will be imposed if higher reciprocal tariffs snap back into effect in early July. Countries running trade deficits with the United States will be better positioned than competitors faced with higher reciprocal tariffs. To what extent they will be able to take advantage of this situation, however, will depend not just on relative tariff levels but also on their export structure. For example, a commodity-exporting country that faces lower reciprocal tariffs, such as Argentina, may find it difficult to take advantage of the decline in manufacturing exports from a country facing high U.S. tariffs, such as China. Moreover, Washington has imposed and will impose further tariffs targeting specific sectors, such as steel and aluminum, automotives, copper, lumber, critical minerals, pharmaceuticals and semiconductors. As these sectors are generally exempt from reciprocal tariffs, countries that export these goods will not be able to take advantage of differential tariffs.
Furthermore, the trade war Trump waged against China during his first term led to the emergence of so-called "connector economies" like Mexico or Vietnam that attracted trade and investment by largely Chinese companies seeking to circumvent U.S. trade restrictions. This time, only very few, if any, countries will be able to take advantage of U.S. tariffs. This is because Trump's current tariffs are much more broad-based and there is greater uncertainty as to how long they will remain in place, which will make companies less willing to set up production facilities in connector economies. Washington is also more likely to take measures, such as additional trade restrictions, targeting connector economies.
The outlook for U.S. trade policy remains uncertain. But U.S. trade restrictions will very likely remain significantly higher than they were before Trump returned to the White House. In addition to the short-term disruption to the global economy in general, and emerging and developing economies in particular, greater international economic fragmentation will also weigh on the medium- to long-term outlook for developing and emerging economies. A combination of lower global economic growth and reduced access to the U.S. market (possibly other large markets if trade tensions spill over) will make it more difficult for countries to rely on export-oriented economic development strategies. Greater global economic fragmentation will force countries to rely more on domestically oriented economic policy strategies. In this sense, the need to pursue more forceful structural economic reform, in addition to short-term macro adjustment, may further add to domestic political tensions and popular unrest. And, unfortunately for these countries, this highlights an unattractive tradeoff of its own: if they fail to pursue more forward-looking reform, they will see less economic growth and development, which is not good news, either.
