The downward pressure on the renminbi since last June is a function of market sentiment rather than the trade dispute, with the slowing of China's growth last year driven entirely by domestic factors. Meanwhile, following the recent dramatic expansion of US tariffs, sentiment has taken a marked turn for the worse, which could test China's resolve to defend the exchange rate, but the base case for the renminbi remains sanguine.
These were the main takeaways from the keynote address by Guan Tao, an economics expert at Beijing-based think tank China Finance 40 Forum, at the 2019 Nomura Investment Forum Asia in Singapore.
In a sign of the relatively mild impact the trade conflict has so far had on China, Guan noted, the renminbi’s depreciation against the US dollar by about 8% since June 2018 had largely offset the impact of the initial 25% tariff on USD50 billion worth of Chinese goods imposed in two stages by US President Donald Trump from July last year, in addition to the tariffs levied in March on all imports of steel and aluminum, including those from China.
Moreover, when the dust had settled after the tariff bluster of 2018, China’s trade surplus with the US for the year reached an all-time high of USD324.4 billion, up 16.7% from the surplus in 2017. China’s balance of payments conditions actually improved last year, while demand for foreign exchange settlement was largely balanced by supply, exerting negligible downward pressure on the renminbi and obviating the need for renewed capital controls, stressed Guan.
These trends make two things clear, according to Guan. Firstly, the slowdown last year in China’s economic growth was not caused by trade frictions, but rather, a sharp drop in domestic infrastructure investment. Furthermore, it is market sentiment, not a deterioration of the trade balance – current or anticipated – that is exerting downward pressure on the renminbi since June 2018.
Trade deficits ahead?
To be sure, concerns about the future impact of tariffs have contributed to pressure on the renminbi. China's exports to the US began to decline in December, falling 10.1% year-on-year in the first four months of 2019. But imports from the US have been falling since September, and were down 30.2% in the same period. The net effect was China's trade surplus with the US from January to end-April 2019 inched up 3.8% year-on-year, while China recorded a surplus of USD6.2 billion with the rest of the world in the same period, reversing the year-ago USD9.4 billion deficit.
China's overall trade surplus actually expanded 26% in the first four months of this year to USD89.8 billion. And, as for expectations in the challenging year ahead, if history is any indicator, the last three instances of weakening external demand, in 1998, 2008 and 2015, saw China record robust trade surpluses.
Support for 7 in uncharted territory
We’ve now entered uncharted territory with the US ratcheting up tariffs from 10% to 25% on an additional USD200 billion worth of Chinese products on 10th May and the mooted imposition of tariffs on all remaining Chinese exports to the US, noted Guan, and conceded this has “created new panic in the market.”
With the renminbi hovering just below the symbolic level of 7 against the US dollar – a line it has not crossed since 2008 – there is now intense speculation among currency traders as to whether the latest tariff hike could prompt the Chinese government to allow the renminbi to “crack seven.”
In the face of these issues, the Chinese government’s commitment to support the renminbi appears genuine, Guan emphasized, noting that without its intervention through countercyclical adjustment measures since the currency began to weaken in June 2018, the renminbi would already have broken through “the psychological 7 threshold.”
Indeed, as Guan pointed out, Premier Li Keqiang's comment on the subject at the Davos Forum in September is unambiguous: “The recent fluctuations in the renminbi exchange rate have been seen by some as an intentional measure on the part of China. This is simply not true. Persistent depreciation of the RMB will only do more harm than good to our country. China is steadfast in its commitment to a market-oriented exchange rate reform.”
More recently, the current head of the State Administration of Foreign Exchange (SAFE), Pan Gongsheng, announced on 19th May that the agency has the “complete foundation, confidence and ability to keep China's foreign exchange market stable.”
Guan predicted the renminbi exchange rate would remain broadly stable this year, though there would be “two-way fluctuations” resulting from three possible scenarios.
According to the base-case scenario, the market will remain confident about the Chinese government’s determination and capacity to keep the exchange rate stable and not attack the renminbi. The best-case scenario is that the Chinese economy stabilizes while the US dollar weakens and US-China trade frictions soften, causing the renminbi to rebound “in a bumpy way amid fundamental support.”
Then there’s the worst-case outcome, whereby a slowing of the domestic economy; strengthening of the US dollar; worsening of trade conflicts; and, lack of fundamental support for the renminbi tests the government's tolerance for maintaining the exchange rate.
Considering the ground realities, it behoves China to be prepared for the worst-case outcome, said Guan, predicting that the government will implement policies to boost domestic demand to offset the external shock resulting from the escalation of the trade dispute. Yet, Guan stopped short of guaranteeing the renminbi would remain below 7 if market conditions and sentiment were to sour further, and warned that the government’s decision to continue defending the renminbi would depend on an ongoing cost-benefit analysis.