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Li Keqiang did not shirk the issue of currency wars when he spoke to the Financial Times in April.

“We don’t want to see a scenario in which major economies trip over each other to devalue their currencies. That would lead to a currency war,” said China’s premier.

Currency intervention is an issue that has chilled US-China relations for more than a decade and, while it has gone quiet of late, it is threatening to resurface.

China’s equity market shock, which from mid-June saw a wipeout of more than 30 per cent of the value of shares in Chinese companies, prompted a dramatic reaction from Beijing with regulators imposing a six-month ban on share sales by big shareholders.

As China’s economy slows, could another strident reaction be forthcoming, by depressing the value of the renminbi in order to stimulate trade, in other words a breakout of the very currency war China has pledged not to undertake?

This depends on assessing the fair value of the renminbi. The currency was pegged to the dollar until 2005, since then Beijing has allowed it to rise, except for a two-year period around the global financial crisis.

From the end of the peg to the end of 2013, it rose in value against the dollar by a third.

After the dollar hit a low of Rmb6.05, the currency pair has for the past 18 months traded in a band of Rmb6.05 to 6.27.

That, according to Aroop Chatterjee, foreign exchange strategist in Barclays, is where Beijing wants the renminbi to stay for a number of reasons.

Chief among them is Beijing’s campaign to be included in special drawing rights (SDR) the basket of currencies afforded official reserve currency status by the International Monetary Fund. A decision is expected later this year.

“Part [of the reason for the tight range] is related to the People’s Bank of China’s intention to keep the renminbi stable and a lot of that is related to the potential for destabilising capital outflows,” says Mr Chatterjee.

“But there is also the political intent on SDR. They want to project a picture of stability to the IMF and the rest of the world.”

For these reasons, several currency strategists expect the renminbi to hang around the level of Rmb6.26 by the end of the year. But Daniel Tenengauzer, emerging markets forex strategist at RBC Capital Markets, demurs. He thinks Beijing will allow the band to widen.

“Part of the internationalisation of the renminbi is a widening of the band and a more volatile exchange rate,” he says.

This opens up the debate on the renminbi’s valuation. The International Monetary Fund, in a notable statement in May, declared that it no longer believed the renminbi was undervalued.

Where the value of the renminbi goes depends on China policy. Mr Gu reckons it will rise if China accepts lower growth and opens its capital account to global investors.

But if it chooses to expand fiscal stimulus to support growth and continues to distort investment, he believes the current account surplus will shrink quickly and the renminbi will weaken.

Ying Gu, Hong Kong-based emerging markets strategist for JPMorgan, agrees, particularly as China’s current account surplus to GDP, an indicator for the currency’s valuation, has fallen to 2.3 per cent.

As the dollar strengthens through US Federal Reserve interest rate liberalisation, “I am afraid renminbi will become too expensive”, he says.

It already is, says Mr Tenengauzer. “A year ago, the currency was at fair value and now it’s 15 per cent overvalued,” he says.

Mr Chatterjee agrees. “The dollar has appreciated against the rest of the world but the dollar-renminbi pair has gone sideways. The renminbi is quite expensive,” he says.

China’s economy is showing weakness, the country faces deflationary pressures and the shock sell-off in its equity markets points to the government needing to find ways to stabilise growth and minimise risks. Cuts in interest rates are likely.

Whether that amounts to a currency war is a question of interpretation.

“In the near term, the focus is on SDR,” says Mr Chatterjee. “But further down the road, the risk to growth is to the downside. With broader dollar strength, weak growth will lead policymakers to accommodate a weaker exchange rate.

“If it was the case that the renminbi was moving because of intervention efforts, that would be different. But there are clear signs in capital outflows, in the weak economy and in weak inflation that the macroeconomic backdrop supports a weaker currency.”

Copyright The Financial Times Limited 2017. All rights reserved.
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