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Foreign exchange market

Yuan value reflects need for protection in uncertain times

China’s currency is showing the strain as a trade war with the United States looms, and Beijing is right to enact safety measures for the economy

PUBLISHED : Wednesday, 04 July, 2018, 4:56am
UPDATED : Wednesday, 04 July, 2018, 4:59am

The United States has periodically accused China of being a currency manipulator. This is despite a multi-year strengthening of the yuan.

Among the accusers has been Donald Trump, both as president and when he was running as a candidate. Whatever the truth of the matter, the intention, seemingly bipartisan, has been to warn Beijing not to provoke Washington’s anger by incurring too many trade advantages with a weak currency and worsening the trade imbalance in China’s favour.

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But with a looming trade war, the incentive not to anger Washington is being removed. A clear sign of that has been the fall in the value of the yuan for 14 straight days. The currency has never been allowed to float freely, though more leeway has been introduced in recent years to allow a greater role for market forces to determine its value.

Every morning, the People’s Bank of China sets a daily fixing rate around which the yuan can be traded within a range of 2 per cent up or down. The daily fixing is therefore a good indication of the central bank’s intentions and outlook.

The bank declined to follow the latest interest rate rise by the US Federal Reserve last month. The offshore yuan trade has convincingly breached the 6.7000 per US dollar level for the first time since August last year.

With a trade war on the horizon, China’s central bank tactic seems to be allowing the official rate fixing to be lower in an effort to cushion the effects of trade tariffs imposed by Washington. Generally speaking, a weaker currency helps boost a country’s exports by making their prices more competitive overseas.

If this school of thought is correct, then the threats emanating from the Trump White House will continue to weigh heavily on the yuan until there are signs of trade tensions easing.

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Meanwhile, the value of the yuan is also being affected by recent official data showing slower economic growth on the back of Beijing’s sustained efforts at deleveraging to tighten credit and curb risky borrowing. There are indications of a slowdown in the property sector, credit growth, exports and consumption.

It is unlikely that devaluation will be used as a retaliatory tool as Beijing will have to consider the perception in Washington if the yuan continues its plunge and risks opening another front in an economic war.

So far, Beijing has shown restraint in the face of American hostility, having focused on in-kind tariffs without resorting to other retaliatory measures. But the central government must enact safety measures for the economy, such as providing liquidity support to financial institutions and lowering the tax burden for small businesses and households. A weaker yuan should be seen in this light, as both a natural outcome of an uncertain outlook and a protective tool.