With China-US trade war looming, will Beijing be more hands off on exchange rates?

Chinese analysts are calling on the government to give up its policy of maintaining a steady exchange rate for the yuan amid the looming threat of a trade war with the United States.

The currency in the offshore market dropped to nearly 6.53 against the US dollar in Monday, down for an eighth day and recording its longest losing streak since 2016, as US President Donald Trump escalated trade hostilities against China and China’s central bank announced policy easing on Sunday.

The central bank’s move on Sunday to release US$100 billion into the banking system, a decision that is set to add depreciation pressure on the yuan, and its setting of the daily yuan rate at he weakest level in over five months on Monday showed that Beijing is happy to let the yuan go.

“The central bank is willing to sit back and watch the yuan weakening against the dollar, or it is even intentionally driving down the exchange rate,” Xu Qiyuan, a fellow with the Chinese Academy of Social Sciences, wrote in a note.

For more than a decade, the People’s Bank of China has been committed to “keeping the yuan exchange rate basically stable at a reasonable and balanced level”, but some researchers are saying its time to change.

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In a recent article, Ma Jun, a newly appointed member of China’s monetary policy committee, and Guan Tao, a former official with the State Administration of Foreign Exchange, wrote that Beijing should stop using exchange rate levels as a monetary policy tool.

In the report published in the latest issue of the central bank’s own journal, China Finance, the pair said the yuan should be allowed to float freely to reduce the conflict between “exchange rate and interest rate policies” and ensure “independence of monetary policy”.

If the PBOC were to heed the analysts’ advice it would result in much greater volatility in the value of the yuan in the near term, and probably see it weakening against the US dollar if trade tensions with Washington escalated, observers said.

“It’s not a good time to be forecasting the exchange rate of the renminbi in the near term,” said Eddie Cheung, a foreign exchange strategist at Standard Chartered in Hong Kong, using the official name for the yuan.

Investors were rushing to sell their yuan positions, as the entire Asia-Pacific market was in the shadow of a trade war, he said.

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Teck Leng Tan, a currency analyst at UBS Global Wealth Management, said the yuan could fall to 6.70 or 6.80 to the US dollar in the coming weeks if the tariff threats made by China and the US became a reality.

The first batch of US tariffs against Chinese products are set to come into effect on July 6.

“It’s very risky for the yuan in the short term,” Tan said.

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Beijing has been very sensitive to movements in the yuan’s exchange rate since August 2015 when a misstep on a planned modest devaluation of the currency triggered a massive outflow of funds.

The incident prompted Premier Li Keqiang to say that there was “no basis for continued depreciation in the renminbi” although the central bank later introduced a “counter cyclical” factor to keep currency movements in check.

From a low of 7 yuan to the dollar at the end of 2016, Beijing successfully engineered a 10 per cent appreciation of the currency through March of this year.

While it was mission achieved in exchange rate terms, the stronger yuan hit China’s export sector and its international payment positions.

Deng Haiqing, a visiting scholar at Renmin University of China, wrote in a note that it was very likely that the currency would weaken to below 7 to the dollar.

“A depreciation of the yuan can greatly help China’s position in a trade war,” he said.

Despite Deng’s comments, central bank governor Yi Gang said earlier this year that China would not deliberately weaken the yuan in a trade war with the US.

Such a move would be “a declaration of war not only against the US but everyone”, Tan said.

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Beijing has traditionally worried about yuan depreciation because its value is often seen as a barometer for investor confidence in the Chinese economy. Another sharp fall could trigger more capital outflows.

But Yu Yongding, an economist and senior fellow at the Chinese Academy of Social Sciences, said in an article published on news website Thepaper.cn last week that Beijing did not have to worry about capital outflows as it could always implement capital account controls.

China uses a “managed floating exchange rate” to control the yuan, with the central bank announcing a daily midpoint for its value against the US dollar and other currencies, and from which it is allowed to move just 2 per cent in either direction.