Light touch: China lets yuan slide run into fifth month, no floor in sight

© Reuters. FILE PHOTO: A staffer poses with 2015 edition of the 100 renminbi notes at the Bank of China Tower in Hong Kong

By Winni Zhou and Marius Zaharia

SHANGHAI/HONG KONG (Reuters) – China’s uncharacteristically laissez-faire approach to its swiftly declining currency is spawning market speculation that the yuan is part of an economic stimulus toolkit and will be allowed to weaken more over the rest of the year.

July saw an 8 percent erosion in the yuan’s value against the U.S. dollar since April, marking its worst 4-month fall on record. Losses were driven by concerns over rising U.S. interest rates, falling Chinese yields and the heated Sino-U.S. tariff row, with latest reports suggesting Washington is planning to slap even higher tariffs on billions of dollars worth of Chinese imports.

Yet, unlike in the previous bout of yuan weakness from August 2015 to late 2016, the People’s Bank of China (PBOC) has hardly done anything to contain the currency’s fall. Its daily fixings for the yuan, which determine the day’s trading band, have been strictly in line with moves in other currencies.

“I do think the trade war and escalating tension will mean China’s net exports will shrink and therefore the yuan will depreciate against the dollar,” said Iris Pang, Greater China economist at ING in Hong Kong.

Pang expects the yuan to weaken to 7 per dollar by the end of the year, another 2.5 percent depreciation from Wednesday’s spot levels around 6.82.

The tightly managed currency has fallen less against a broadly stronger dollar this year than some of its emerging market peers, including currencies of India and Indonesia, which indicates Beijing is not deliberately devaluing the yuan.

Those drawing parallels to 2015-2016, when China burnt through a trillion dollars of reserves to stem resident capital outflows and put a floor under the currency, acknowledge that stringent capital controls in place since then effectively preclude a similar crisis.

“It really boils down to the question of how much will they want and how much will they allow the renminbi to depreciate,” bond house PIMCO’s global economic advisor, Joachim Fels, told a conference last week, adding he didn’t think the authorities had any firm thresholds for the yuan.

“I think they’re looking at the currency mainly as a tool to support economic growth. Our view is that yes, we’re likely to see further depreciation but we think it will be in a very controlled and gradual fashion.”

(For a graphic on ‘China’s yuan has worst 4-month fall on record’ click


Even those market participants who suspect that Beijing is using the yuan as a weapon in its trade dispute with Trump, who has repeatedly accused China of manipulating its currency for advantages in trade, reckon it’s difficult to estimate how far the weakness will run.

China and the U.S. have already imposed tit-for-tat tariffs on about $34 billion of each other’s goods. Trump has proposed further tariffs on $16 billion of Chinese imports, and a threat of tariffs on the entire $500 billion-or-so of goods imported from China still stands.

A source familiar with the Trump administration’s plans said on Tuesday the tariffs on about $200 billion of Chinese imports could be raised to 25 percent from the 10 percent initially proposed, in order to pressure Beijing into making trade concessions.

Separately, Bloomberg reported, citing sources representatives of U.S. Treasury Secretary Steven Mnuchin and Chinese Vice Premier Liu He have been speaking privately as they seek to restart negotiations.

Chinese imports from America are only about a fourth of that amount, so a weaker yuan could well be part of Beijing’s retaliatory strategy.

A weak currency also fits well into an ongoing monetary policy loosening in the world’s second largest economy. Policymakers have allowed market yields to fall, pumped cash into the banking system and prodded banks to lend to smaller firms as part of measures to prevent a sharp slowdown in growth even as they wean the economy off its addiction to huge levels of unproductive debt.

In a somewhat surprising move, state-run banks also pushed currency swaps down sharply last week, rendering the yuan stronger in the forwards market than spot. While that made it dirt cheap for investors to borrow and short-sell the yuan, traders said the intent was merely to signal easy policy.

“They are indirectly lowering interest rates,” said ING’s Pang. “I don’t think this will directly relate to whether the yuan will appreciate or depreciate…because we are not talking about free capital outflows and inflows.”

Ken Cheung, senior Asian FX strategist at Mizuho Bank in Hong Kong, expects the yuan could rebound to around the 6.7 to 6.8 per dollar levels if trade negotiations resume.

“The overall sentiment remains bearish as the market does not seem to buy trade talks now.”