According to sources, Chinese policymakers have been evaluating a number of policies including the potential risk of a renminbi devaluation; as concerns over a trade spat remain elevated. According to the article published on Bloomberg yesterday, “Senior Chinese officials are studying a two-pronged analysis of the yuan that was prepared by the government.” The one side examines the effect of using the currency as a trade negotiation tool, while the other evaluates the outcome of a RMB devaluation to counter any potential impact on exports resulting from proposed US trade tariffs. The obvious knee-jerk reactions followed the reports, which saw the RMB immediately depreciate against the dollar yesterday, but the offshore currency eventually closed 0.20% stronger.
Should the market be panicking? No, it shouldn't, and there are a number of reasons we believe it is not in China’s interest to aggressively devalue its currency. First, nothing has been agreed in regards to the current tit-for-tat tariff proposals. Second, China has learnt its lesson from its aggressive devaluation back in 2015, which destabilised the country’s asset classes. Third, Chinese policymakers have reiterated time and time again that they wish to internationalise the currency and for that to happen it needs to be more market-driven; hence limited intervention. Forth, why would China hand the words “currency manipulator” to Mr Trump on a plate? Finally, and certainly not the last reason, non-manufacturing activities make up over half of China’s GDP, so why, after all the country has done to reform its economy to more sustainable, consumer-led growth, would it wish for a weak currency?
This is not to say that the currency could not naturally depreciate if the trade spat does result in a worse case scenario. However, not only are we not there yet, but a trade war could also result in a dollar sell-off. Instead, this move appears as if there is a lot of forethought by Chinese policymakers, allowing them to decide what firepower to deploy if the US does not back down. Other firepower could include: a reduction in UST holdings, limiting US investment in China, amongst others; these are more drastic measures than a marginal depreciation of currency, however.
A public hearing due to take place on May 15, when the USTR will finalise the US’s list of tariffs, is still some way away; in the interim, both nations have stated that they are open to negotiations and do not wish to enter into a trade war. Incidentally, Trump tweeted that the trade deal will “probably” be struck with China. We could also hear more thoughts from President Xi Jinping at the Boao forum this week; following yesterday’s comment that China is in a “new phase of opening up” its financial markets and auto manufacturing sector, adding “let us dedicate ourselves to openness and win-win outcomes”. This more positive sentiment should underpin renminbi stability; at time of writing, the offshore unit is up 3.47% in spot terms so far this year and has a total return of 4.71% against the dollar.