EM Asia Struggles to Diversify from the US as China Continues to Export its Deflation

The shock of reciprocal tariff pushes Asian countries to scramble for an alternative to US markets, hoping large economies such as China will demand more goods and services. But alas, China’s long-lasting deflation and fierce domestic competition from overcapacity in manufacturing onshore have not led to a boost from Chinese demand but rather less imports and more competition. Year-to-date to September, imports from China are down –1.1%YoY while exports expanded +6.1%. The key driver of that growth is China’s shipment to EM Asia, causing widening trade deficits in India and Southeast Asia. Even South Korea which traditionally has had a surplus with China has worsening deficits.China channeling its growth to industrial sectors while leaving onshore demand sluggish have helped it grow in every segment of exports, from labor intensive to capital intensive. By stage of production, not only is it shipping more capital intensive and consumer goods, but the rise of Chinese intermediates also means that its exports are imbedded in EM Asia’s exports to other markets such as the US. As firms from Japan to South Korea and increasingly China offshore production to Southeast Asia and India, those companies still rely on Chinese components to manufacture goods destined for other markets, such as the US.But deeper regional trade integration isn’t the only reason for higher Chinese imports such as intermediates. Capital intensive exports and consumer goods are on the rise with capital intensive being the biggest Chinese exports into the region. Even in labor intensive manufacturing, Chinese exports continue to dominate the world, making up 32% of global share. As Chinese goods are cheaper and flood EM Asia, local firms struggle to compete and find it more economical to just import Chinese machines and consumer goods. India is an example where its trade deficit rise to 103bn while the manufacturing sector share of GDP declines.Across EM Asia, manufacturing share of GDP has declined over the past decade, except for Vietnam, reflecting the retreat of domestic industrial base as Chinese goods flood local markets. Vietnam is the only country in Southeast Asia where manufacturing share of GDP has increased to 24.4% in 2024 from 18.8% in 2005 thanks to a mix of manufacturing prioritization and aggressive reforms to boost competitiveness. As such, despite being dispirited by US protectionism, EM Asia finds it hard to diversify as its industrial base struggles with rising Chinese imports and weakening demand for its goods, with significant consequences.