Currency war
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China’s Vice-Premier Liu He is expected to sign the phase one trade deal with the US President Donald Trump in Washington next week. Photo: Bloomberg

China seen to be complying with US trade war deal by allowing market forces to dictate yuan exchange rate

  • The phase one trade deal between China and the United States, set to be signed next week, is expected to include clauses prohibiting currency manipulation of the yuan
  • The yuan has started the year strongly due in part to seasonal needs by Chinese exporters for cash ahead of the Lunar New Year holiday
Currency war

China’s central bank has stood back from intervention so far this year and let market forces push up the yuan’s exchange rate ahead of the anticipated signing of the phase one trade agreement with the United States next week that is expected to include a clause prohibiting currency manipulation.

The yuan started the year with a 0.26 per cent gain against the US dollar, becoming the second best performer among Asia’s 11 most traded currencies, according to Bloomberg data.

On Wednesday, the partially-convertible yuan was trading near a five-month high at 6.94 per US dollar after Tuesday’s rally because of market demand and supply forces rather than policy guidance from authorities.

American officials have said the trade deal includes a clause prohibiting currency manipulation after having previously demanded China limit the yuan’s depreciation that would offset the impact of US tariffs on Chinese goods.
In August, the US Treasury Department declared China a currency manipulator for the first time in 25 years after the yuan fell below the psychologically important level of 7 to the US dollar in response to US tariffs. It is unclear if China’s manipulator designation will be addressed by the US as part of the interim trade agreement.
The strength of the yuan so far this year is likely to be welcomed by Washington, although Beijing will not want it to appreciate so much that it would hurt its exporters, especially since US tariffs remain on US$360 billion of Chinese imports.
The People’s Bank of China (PBOC) has repeatedly pledged to keep the yuan “basically stable” at a reasonable and equilibrium level.

Traders and fund managers are optimistically buying the yuan amid the trade truce in the costly conflict between the world’s two largest economies, said Khoon Goh, head of Asia research at Australia & New Zealand Banking Group.

Chinese authorities have not really been intervening, or definitely not disallowing market forces to dictate where the yuan is going. A part of that has to do with the phase one deal
Khoon Goh
Yuan demand is also strong because Chinese exporters are converting their US dollar receipts into the local currency ahead of the Lunar New Year so they can pay for additional expenses and bonus payments to workers ahead of the week-long public holiday that begins on January 24.

“Chinese authorities have not really been intervening, or definitely not disallowing market forces to dictate where the yuan is going,” Goh added. “A part of that has to do with the phase one deal that they have with the US, which includes a currency clause in there.”

China’s Vice-Premier Liu He is set to lead a trade delegation to Washington from Monday for talks ahead of the expected signing of the trade deal on Wednesday. Among other things, provisions of the deal would require China to nearly double its purchases of US exports over the next two years, including buying an additional US$80 billion in US agricultural goods.

But China has not confirmed the amount of its US import purchases or other details in the pending trade deal. An agriculture ministry official said Tuesday that China would not increase its annual grain import quotas to accommodate more US agriculture purchases, making it more difficult to meet import demands from the US.

US trade representative Robert Lighthizer has said that as part of the deal China also agreed to open up its financial services market to US firms, to better protect US intellectual property and to curb the coerced transfer of American technology to Chinese firms.

The contents of the currency section are likely to be similar to a clause in the United States-Mexico-Canada Agreement that will replace the North American Free Trade Agreement once it is ratified.

China likely agreed not to engineer a weaker yuan to gain a competitive advantage for its exports, Gao Qi, currency strategist at Scotiabank said.

The devil will be in the details in the phase one deal. And there is still a lot of uncertainty if there will be a phase two deal
Jimmy Zhu
A key condition, according to Gao, would be China’s willingness to agree to more transparency in its currency market operations, and notify the US of any intervention in the spot and forward currency markets.

The differences in the US and China statements about the details of the deal continue to raise questions about exactly what was agreed.

“Things are likely to calm down on both sides at least in the coming months,” said Jimmy Zhu, chief strategist at Fullerton Markets. “But the devil will be in the details in the phase one deal. And there is still a lot of uncertainty if there will be a phase two deal.”

US President Donald Trump has said the phase two deal negotiations would begin immediately, suggesting discussions could start next week when the Chinese trade delegation is in Washington. Those negotiations will tackle the most difficult bilateral trade issues, including Chinese subsidies for domestic industries.

In any case, China’s central bank has continued to refrain from direct intervention in the currency market, as reflected in the latest official foreign exchange reserves figures, Julian Evans-Pritchard, senior China economist at Capital Economics, said.

China’s total stockpile of reserves, the largest in the world, amounted to US$3.108 trillion at the end of December, up US$12 billion from a month earlier due largely to the strong yuan exchange rate. It has remained relatively stable around US$3.1 trillion in recent years due to draconian capital controls on Chinese individuals and corporations that prevent large capital outflows.

ICBC International said in a research note that the more stable yuan and weaker US dollar outlook this year has given China the opportunity to accelerate the pace of the yuan internationalisation and so support the country’s move to shift to higher quality industrial output.

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