Why devaluing the yuan is a no-no for China amid US trade war fears
It is neither reasonable nor logical to expect Beijing to devalue the yuan to handle trade frictions with the US as it goes against China’s priority of curbing financial risks and its strategic goal of creating a global currency, economists said.
Beijing got its fingers burned on August 11, 2015, when it shocked the world by devaluing its currency against the US dollar by 1.9 per cent.
The People’s Bank of China tried to explain the move as a by-product of it tweaking the yuan exchange rate mechanism, but the move caused confusion about Beijing’s true intentions and fanned speculation that a bigger depreciation was down the road.
Yi Gang, then a deputy governor at the central bank, had to convene a special press conference on August 13 to talk up the yuan, denying gossip of a potential 10 per cent fall in the currency as “completely groundless”.
When Yi, who was promoted as the central bank governor last month, faced a similar question at a forum on Wednesday over whether China would depreciate its currency if Trump levied import duties on Chinese goods, he said Beijing had no intention of manipulating its exchange rate to try to boost trade.
“Our exchange rate system is demand and supply determined … basically, the central bank has not had an intervention for a long time and this serves the Chinese people well,” Yi said.
Guan Tao, a former Chinese foreign exchange regulator who still advises the government, was quoted by the official Shanghai Securities News as saying that reports of a deliberate depreciation from Beijing were sourced from “a small group of speculators who tried to cause confusion and to profiteering in the process”.
While the central bank has the power to reset the yuan exchange rate, Beijing has been quite restrained in wielding that power. Apart from the “unintended” devaluation three years ago, the central bank has revalued the currency only once.
That was in July 2005 when it announced a 2.1 per cent appreciation of the yuan against the dollar, the first such move since the country introduced a unified exchange rate in 1994.
A weaker yuan is likely to trigger a massive exodus of funds from China reminiscent of that seen during 2014 to 2017 when the currency weakened 13 per cent from 6.05 to 6.94 against the dollar. This is the last thing Beijing wants to see now as it has made financial risk control its top of priority, according to economists.
“Financial stability is China’s top priority now,” said Raymond Yeung, chief economist for Greater China at ANZ. “There is no chance that China would consider devaluation as an option.”
Although the yuan has strengthened more than nine per cent against the dollar since December 2017 and foreign exchanges reserves have since bucked a downward trend, pressure of capital flowing out the country is still present should a devaluation misstep occur, said Yeung.
Devaluing the yuan is also against China’s long-term goal of building it into a global currency, according to Hong Hao, managing director at Bocom International Holdings.
“Depreciation would harm the credibility of China and the yuan, and other countries would be more unlikely to include it into their forex reserve stockpile,” Hong said.
While the International Monetary Fund in 2016 officially granted the Chinese currency nominal international currency status by including it in the Special Drawing Rights basket, the use of the yuan in the world market has not picked up partly due to Beijing’s missteps in August 2015.
According to data compiled by the SWIFT international financial transactions network, the yuan’s share of global payments fell to 1.56 per cent in February, from 1.66 per cent a month earlier, ranking it below not only the world’s big four currencies, but also the Swiss franc and the Canadian dollar.
The yuan’s high point in terms of global payments came in August 2015 when it ranked fourth most popular for the month, with 2.79 per cent.
At the same time, a weaker yuan also comes with risks of offending countries other than just the US as it will put pressure on economies such as South Korea, Taiwan and Japan that compete with China for export markets, Hong at Bocom International Holdings added.
“[Devaluation] is a massive weapon that affects every country, not just China and the US,” said Hong.
Following the yuan’s accumulative fall of three per cent on August 11 and August 12 in 2015, all Asian currencies faced downward pressure due to the countries’ economic interdependency with China.
Devaluation would also create “clear political risks” for China as it has been accused of currency manipulation in the past and such a move would provide evidence for US President Donald Trump to take fresh moves against Beijing, according to Christopher Balding, an economist at Peking University HSBC Business School.
“If they did decide to push it lower, that would clearly indicate that yes, they are manipulating the currency by changing the value,” Balding said.
Iris Pang, chief Greater China economist at ING in Hong Kong, agreed that a devaluation would only “make things worse” as it feeds into US criticism of China’s unfair trade practises.
A weaker yuan also does not necessarily lead to more exports. As China’s currency appreciated against the dollar 27 per cent from 2005 to 2014, its trade surplus with the US in goods still managed to soar from US$202 billion to US$344 billion, according to statistics from the US Census Bureau.
The trend continued from 2014 onward, despite the fluctuation of the yuan’s exchange rate against the dollar. “The exchange rate and the trade surplus are both results of China’s productivity gain and economic improvement over the years,” Hong said.
In short, China cannot turn the clock back by relying on cheap exports when the country is quickly moving up the value chain in global production and is now producing more advanced goods than low-cost ones, according to economists.
“China is not competing with Vietnam or Cambodia on exporting shoes or clothes,” Yeung at ANZ said. “It is trying to boost its competitiveness through technology instead of lower costs.”
Additional reporting by Sarah Zheng