The U.S. raised punitive tariffs to 25%, from 10%, for $200 billion in goods leaving China on Friday and thereafter. President Trump also ordered staff to begin the paperwork to impose levies on the more than $300 billion worth of everything else China sells to the U.S.
While Beijing has met previous volleys of tariffs from the U.S. by raising duties on American goods—and the government has promised to retaliate—it held its fire. Though China has more limited tariff options, since it imports fewer products from the U.S. than the other way around, the Chinese leadership is also constrained by an economy that is in a shaky recovery from a sharp slowdown.
The tariff escalation is worrisome for Chinese officials, who are watching potential ripple effects, from weakening of the currency to crimping future foreign investment. Raising existing tariffs or imposing new ones could hit products China’s economy needs, like semiconductors, pork, oil and passenger jets.
A wider-scale trade conflict could also force Beijing to further ease credit and boost government spending to shore up growth, doubling down on the stimulus used last year at a time some analysts say it should be ratcheting back such measures.
“China doesn’t want to fan the flames,” Mark Wu, an international trade professor at Harvard University, says. “It wants to be seen as the reasonable party and open to compromise.”
China’s lead negotiator, Vice Premier Liu He, told Chinese reporters before leaving Washington that the domestic economy is in better shape than last year, with sufficient policy tools and business confidence to withstand pressure and “maintain smooth, healthy development.”
In the aftermath of Friday’s impasse, Mr. Liu stressed that negotiations haven't broken down—a message amplified by state media. Rather, according to video clips posted online by state media, Mr. Liu said negotiations “encountered unavoidable complications” and the two sides have agreed to meet in Beijing in the future.
Negotiations between the U.S. and China seemed to be heading toward an agreement earlier this month when, according to Mr. Trump and U.S. officials, Beijing backtracked on commitments made in earlier rounds. Those included listing specific laws in the agreement that China would change covering intellectual property protection, subsidies and forced technology transfers, according to people in the U.S. and China following the talks.
Mr. Liu, in remarks reported by the Hong Kong news site
Phoenix New Media
Limited, didn’t specify what caused the negotiations to founder. He disagreed that the Chinese side backtracked, saying in any negotiation changes are natural before a final agreement is reached.
How Beijing moves ahead in coming weeks is likely to depend on its reading of the economy and on the U.S.’s willingness to negotiate, the economists and analysts said.
“The most important thing is to not appear weak and cave into the U.S.,” says Arthur Krober, founding partner at research firm Gavekal Dragonomics. A likely scenario for Beijing, he says, is to “look like you’re staying the course, offer some discreet support if necessary, [and] hope they can get this thing resolved in next month.”
The higher U.S. tariffs on $200 billion of Chinese goods will slow China’s economy by 0.2 to 0.3 percentage points this year, according to Barclays Research. Fresh 25% levies on the remaining $325 billion in Chinese goods could further drag down growth by up to 0.5 percentage points in the next 12 months, after tariffs go into effect, it said.
“The moment Trump announces a date for tariffs on all Chinese goods, that’s the moment the yuan will drop,” says Bo Zhuang, an economist at research firm TS Lombard. He estimates authorities would allow the currency to swing to as weak as 7.6 yuan to the U.S. dollar, a level that would roughly offset the impact of 25% tariffs on all Chinese imports.
In the next few weeks, China watchers think the leadership will hold back from drastic moves such as reducing banks required reserves to give them more money to lend. Though the two sides haven’t set a date to resume talks, President Xi Jinping and Mr. Trump are both scheduled to attend a Group-of-20 meeting in Japan at the end of June, giving negotiators a target to work toward.
For now, Beijing has only hinted at more stimulus. The central bank on Monday announced a small cut to the amount of reserves certain banks have to keep with it, a show of policy support just after the U.S. threatened tariffs. On Friday, central bank deputy director Zou Wei said in a media briefing that financial support for the property sector would be stable this year.
Previously, Beijing had been expected to ease up on stimulus after the economy grew at a stronger-than-expected 6.4% in the first quarter. Now, “Beijing cannot afford to roll back stimulus,” said Lombard’s Mr. Zhuang. “They’ll have to continue to boost to make less concessions in the trade deal.”
—Chunying Zhang contributed to this article
Write to Chao Deng at Chao.Deng@wsj.com
