Coronavirus: China unlikely to defend falling yuan, despite US trade deal pressure, analysts say

China is unlikely to take forceful measures to defend a decline in the yuan’s exchange rate in response to the novel coronavirus, in the hope that that the US will refrain from labelling Beijing a currency manipulator, analysts said.

The US-China phase one trade deal, the terms of which are slated to take effect no later than February 14, included commitments by China not to engage in competitive currency devaluation. In return, the US Treasury removed the “currency manipulator” label it had imposed on China last August.

But analysts said that Beijing may now be tempted to allow the yuan’s exchange rate to gradually depreciate to support exports in the coming weeks. Extensive government efforts to contain the coronavirus are set to cause economic growth in China to slow abruptly.

The Lunar New Year holiday was extended for most of the country, while factories and other workplaces were subsequently kept shut on government orders. Widespread travel restrictions have been imposed, transport services curtailed and tourist groups banned.

“Growth is going to be very challenging because every city and every province is in lockdown. There are a lot of shops that are staying closed,” said Jimmy Zhu, chief strategist at Fullerton Markets. “[The central bank] totally understands there is going to be downward pressure on the yuan. They don’t want to kill the manufacturing sector.”

As a result, the yuan fell below the psychologically important 7 to the US dollar level this week, and is down about 2 per cent in the past month.

China had been designated a currency manipulator by the US in August after the yuan breached the 7 level for the first time since the global financial crisis more than a decade ago.

But the lack of clarity over the time horizon and scale of contagion of the coronavirus outbreak means the yuan remains loaded with risk.

Zhu predicted that the yuan would slip further to a range of between 7.05 and 7.08 per dollar by the end of the quarter, with its pace of depreciation slowed by the People’s Bank of China’s (PBOC) daily reference rate. Each day, the yuan is allowed to trade up to 2 per cent above or below the PBOC’s reference rate, which was set at 6.98 on Wednesday.

Ken Cheung Kin-tai, chief Asian currency strategist at Mizuho Bank said that the yuan’s decline may not necessarily draw criticism from US President Trump this time round, since its current depreciation was driven by domestic factors and is not being used to offset US tariff increases.

“[Also] Trump is less likely to reopen the trade war before the US election,” Cheung added, suggesting the US will be more inclined to coordinate global efforts to contain the virus.

In his State of the Union address on Tuesday night in Washington, Trump said that the United States was working with China to fight the outbreak. “We are coordinating with the Chinese government and working closely together on the coronavirus outbreak in China,” he said, without giving details.

The PBOC this week lowered the cost of funding for commercial banks by cutting money market rates on 7-day and 14-day reverse repos by 10 basis points each to 2.40 per cent and 2.55 per cent respectively. But doubts remains as to whether this will help banks extend credit to small and medium-sized private businesses.

President Xi Jinping has publicly stated that the virus is“directly affecting” China’s economic and social stability. The US Centre for Disease Control and Prevention [CDC] said it is planning for it to become a global pandemic.

“If this virus were to follow the dreadful path mapped out by the CDC, even just within China, would more central bank money really ease our pain?” said Rabobank’s Senior Strategist, Asia-Pacific Michael Every said.

The number of deaths due to the coronavirus in mainland China has already surpassed that of the severe acute respiratory syndrome (Sars) outbreak of 2003, with well over 27,000 now officially diagnosed, and more than 500 deaths in total.

Health concerns are likely to suppress domestic consumption, while the initial hit to manufacturing will be greater than it was during Sars, said OCBC Bank economist Tommy Xie Dongming. This is partly due to the fact that people are unable to get to work due to the lockdown.

“Even if workers can get into the city, they still need to go through 14 days of self quarantine and we are seeing huge declines in productivity,” Xie said, adding that if the outbreak persists beyond February and closer to the midyear point, “that would lead to a longer term slowdown”.