A dramatic slide in the renminbi has fuelled speculation that China is engineering a currency devaluation in its trade fight with the US. But memories of crises past are fresh with the bureaucracy, and the chances of more forceful intervention increase should the renminbi near a key level at 7 to the US dollar.
The onshore renminbi exchange rate has fallen nearly 5 per cent against the dollar this year, to Rmb6.81 per greenback. This is not a significant move by global standards — sterling has fallen more than 9 per cent in the past three months while the Turkish lira has dropped 28 per cent this year — but is surprising for the speed with which gains in this closely managed currency have given way to losses.
The authorities maintain that renminbi weakness is largely the flipside of dollar strength. It has been exacerbated by China’s move to loosen monetary conditions to offset the impact of its deleveraging campaign, even as the Federal Reserve stays on its relatively aggressive path of raising US interest rates.
More striking is the fall of the trade-weighted index that the People’s Bank of China uses to manage the renminbi’s value. This index is now down year on year, belying expectations that the authorities would keep it stable as the dollar-renminbi cross weakened.
The authorities have made halfhearted interventions to slow the pace of the renminbi’s slide against the dollar but may step in more decisively as the currency approaches 7. This was the line in the sand at the end of 2016, when the PBoC stepped up its defence of the exchange rate in the face of massive capital outflows.
Every little helps
While the authorities insist they will not resort to competitive devaluations, currency weakness cushions economic growth by making Chinese exports cheaper. Our latest monthly survey of exporters found another small increase in the number of respondents estimating their profit margins were over 10 per cent in July, while the proportion of respondents citing appreciation as a problem for their business began falling with the renminbi.
Demands that a weaker renminbi be used to support exporters have been a constant of the Chinese bureaucracy going back to at least the Asian financial crisis of the late 1990s. These advocates for devaluation have been emboldened by the aggressive tone struck by the administration of US president Donald Trump.
But there are limits to how far the government will allow the renminbi to slide. Although the PBoC manages the currency with reference to the basket, it is the dollar-renminbi exchange rate that makes headlines — and this is what Mr Trump was referring to when he recently revived his accusations that China is manipulating its currency. Despite the lobbying of mercantilists and economic nationalists, the leadership understands that allowing the renminbi to continue to weaken risks inflaming an already tense situation with the US.
More immediately, a weakening currency fuels expectations of further depreciation, spooking investors — both foreign and domestic — and risks a resurgence of large capital outflows. This would mean a replay of 2015 and 2016, with liquidity draining from an already-jittery domestic financial system and the authorities scrambling to restore calm.
Sanguine, for now
The State Administration of Foreign Exchange, the agency that manages China’s capital account, says it is vigilant on outflows, but also that flows are more balanced now than at any other period since the turmoil of 2015.
However, money is bleeding out. The travel services deficit, which some analysts believe masks capital flight, hit a new record in the first quarter (a widening shortfall in services trade, rather than manufactured goods trade, is what is eroding China’s current account surplus). Net errors and omissions, which captures items that cannot be reconciled elsewhere in the balance of payments and are also thought to reflect capital flight, were also firmly in the red.
Despite tight restrictions on foreign exchange, Chinese investors have spent $30.4bn on US residential real estate in the past year, according to the US National Association of Realtors, while our monthly consumer survey shows that household demand for foreign exchange has only increased since the turmoil of early 2016.
Outflows have been balanced by record inflows from foreign investors, particularly into the onshore bond market. June data suggested these investors took the depreciation at the end of that month in their stride, but growing signs of currency risk could convince them to sell.
If the authorities allow the renminbi to weaken past 7 to the dollar and, particularly if the basket continues to fall, this would signal a significant change in the Chinese leadership’s calculations.
Memories of 2015 are fresh, and we do expect the threat posed by capital outflows to prompt intervention before long. However, this is uncharted geoeconomic territory and, as Mr Trump strikes an ever more aggressive tone, so pressure mounts internally for Chinese leadership to dig in its heels.
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