Yuan devaluation: why the signs point to a further drop in China’s currency, whether the US likes it or not
- Neal Kimberley says debt risk and slowing growth are putting downward pressure on the yuan, and officials are hinting they won’t stand in the way of devaluation
The US Treasury may have concluded last week that China hasn’t been deliberately weakening the yuan, but it is “concerned” about its depreciation. These concerns are unlikely to abate. Markets may decide substantive arguments remain both for US dollar strength and also specifically for continuing yuan weakness.
US President Donald Trump might feel the Federal Reserve has “gone crazy” with its tightening of monetary policy, but the US central bank still seems set to continue raising interest rates. Last week’s minutes, from September’s Fed meeting, that saw a rate hike, revealed the rate-setters “generally anticipated that further gradual increases” in short-term US borrowing costs would be necessary.
Addressing possible risks to their view of US economic outlook, the Fed minutes also noted that “the divergence between domestic and foreign economic growth prospects and monetary policies was cited as presenting a downside risk because of the potential for further strengthening of the US dollar”.
Investors will have taken note of that but if, as the Fed said, there is potential for the US dollar to strengthen further, why not against the yuan?
To the extent that Washington’s imposition of wide-ranging tariffs on Chinese exports will exert something of a brake on China’s economic growth prospects, wouldn’t it be natural for the currency market to see that, and any subsequent monetary policy response by Beijing, as being consistent with a weaker yuan?
After all, the International Monetary Fund has already lowered its gross domestic product growth forecast for China in 2019 to 6.2 per cent from 6.4 per cent, and the People’s Bank of China (PBOC) has been easing monetary policy even as the Fed has been tightening.
Admittedly, when the PBOC reintroduced the counter-cyclical factor adjustment in late August, its intention was to try to contain yuan weakness. But as Simon Derrick, chief currency strategist at BNY Mellon wrote last week, while the yuan then remained relatively strong for a few days, “the story since the end of August has been a slow, steady grind lower for the [Chinese currency]”.
Containment might have slowed the yuan’s downward move, but it hasn’t reversed it and, frankly speaking, there’s no particular reason why it should, with investors perhaps mindful of a rating agency writing that China’s local governments have built up massive “hidden debts”, and amid clear evidence that the PBOC is easing monetary policy at a time when inflation in China poses no particular threat to such a stance.
A report last week from S&P Global Ratings, written by analysts Gloria Lu and Laura Li, argued that China’s local governments may have built up 40 trillion yuan (about US$6 trillion) worth of “hidden debts” that are not included in official figures, “a debt iceberg with titanic credit risks” to the Chinese economy.
Surely references such as “a debt iceberg with titanic credit risks” might seem more consistent with a weaker yuan than a stronger one.
Additionally, and bearing in mind the Fed’s intentions to carry on hiking US interest rates, China’s own monetary policy conditions are easing. “Aggressive monetary easing, including both [reserve requirement ratio] cuts and [open market operations], so far this year has injected [3.4 trillion yuan] into the banking system”, analysts at Citibank Hong Kong wrote on October 15.
The Citibank China Economics view added that Chinese authorities “may no longer view the [Chinese yuan-US dollar exchange rate] at 7 [yuan to one dollar] as an important psychological threshold to defend”, and that “in times of need, the RMB could be allowed to weaken further to beyond 7”.
Nor is PBOC monetary easing inconsistent with the level of Chinese inflation.
Commenting on China’s inflation data for September, HSBC wrote last week that “despite plenty of worries, [consumer price index] inflation prints have been quite stable over the summer”. Although it noted that producer price index inflation has been “marginally higher than expected”, the firm’s view is that “for now, stable inflation should give [China’s] policymakers plenty of policy space to further fine-tune policies”.
At this month’s IMF/World Bank Conference in Bali, PBOC governor Yi Gang said that Beijing “will not engage in competitive devaluation”, but also stated that “China will continue to let the market play a decisive role in the formation of the [renminbi] exchange rate”. The use of the word “decisive” is unlikely to have been accidental.
The US Treasury may be concerned about the depreciation of China’s currency, but there’s a persuasive narrative that argues for yet more yuan weakness. Washington might not like it, but the yuan may fall further.
Neal Kimberley is a commentator on macroeconomics and financial markets