The Daily Update - The Other Silk Road

The Chinese Yuan, the offshore currency known as CNH, is now trading at a spot rate of 6.9140 to the US dollar, a fall of around 2.6% this month on the back of the trade frictions with the US. The market is full of speculation as to the view of the Chinese authorities about the outlook for the currency unit with many observers speculating that they are trying to weaken the currency to offset the tariffs imposed by the Trump administration.

There are good reasons why this weakness would not be in the interest of China. The first is the fact that it would make imports much more expensive, although exporters would get the benefit. The trade surplus was much larger in the past and has been steadily falling from around 7.6% to just 2.8% of GDP over the last ten years and so a devaluation is thought to have a marginal impact. Indeed it is estimated that 20% of Chinese exports are derived from imported goods and so manufacturing would be heavily affected by further currency weakness.

Also, any further weakness would certainly cause problems for China’s other trading partners including Japan and Europe, which would certainly not be in the interest of China. There are also the lessons learnt from August 2015 when China did a small adjustment to the currency which the market took as a sign they were looking to devalue. It cost around $350bln in reserves over the following months to stabilise the currency at the initial target of just 1% weaker to permit the management of the currency against the CFETS basket of 24 currencies.

However, the biggest reason we don’t think they will devalue and use the currency as a weapon in the US trade war is that the Peoples Bank, over many years, has driven another silk road to internationalise the currency. Deregulation has taken place at a very fast but managed pace in order to make the currency widely accepted by all, by becoming market-driven rather than government controlled. To now use the currency as a weapon in any trade dispute would erode the good work of the past ten years for very little benefit in the short term and high costs in the longer term.

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