China to tolerate weaker yuan, wary of trade partners’ reaction – Reuters

China’s central bank is willing to let the yuan drop to 6.8 per dollar in 2016 to support the economy, which would mean the currency matching last year’s record decline of 4.5 percent, policy sources told Reuters.

The yuan is already trading at its lowest level in more than five years, so the central bank will aim to ensure a gradual decline for fear of triggering the sort of capital outflows that shook the economy earlier this year and criticism from trading partners such as the United States, said government economists and advisers involved in regular policy discussions.

Presumptive U.S. Republican Presidential nominee Donald Trump already has China in his sights, saying on Wednesday he would direct his treasury secretary to label China a currency manipulator if elected in November.

A surprise devaluation of the yuan last August sent global markets into a spin on worries the world’s second-biggest economy was in worst shape than Beijing had let on, prompting massive capital outflows as investors sought safe havens overseas.

“The central bank is willing to see yuan depreciation, as long as depreciation expectations are under control,” said a government economist, who requested anonymity due to the sensitivity of the matter.

“The Brexit vote was a big shock. The market volatility may last for some time.”

The yuan has dropped to the new lows following Britain’s vote to leave the European Union and so far the central bank has stood aside from intervening, suggesting it is happy with the currency’s depreciation.

Other emerging market currencies have also fallen, but the yuan is the weakest major Asian currency against the dollar this year.

The yuan CNY=CFXS hovered near 6.64 per dollar on Thursday, just off the 5-1/2-year intraday lows and bringing its fall so far this year to about 2.3 percent.

The PBOC did not respond to a request for comment.

TRADE RELATIONS

Currency dealers said the strength of the dollar and the weakness in economic growth, which hit a 25-year low in 2015, justified a decline in the yuan.

But investors and trading partners will be wary of any significant decline after August’s devaluation and a sharp decline in the currency over a matter of days in January that analysts said was engineered by the central bank.

In the past decade, China has also faced criticism from Western lawmakers who say it held back the appreciation of the yuan.

Earlier this month, U.S. Treasury Secretary Jack Lew said it would be “problematic” if the yuan only went down over time and Trump has said he would take a hard line on trade disputes with China if elected.

Labelling China a currency manipulator “should’ve been done a long time ago,” he said on Wednesday.

China’s premier, Li Keqiang, has repeatedly said China has no intention to stimulate exports via a competitive currency devaluation. The Foreign Ministry said on Wednesday the exchange rate was not the reason for unbalanced trade with the United States, which runs a goods and services trade deficit with China.

However, the sources acknowledged the diplomatic risks of a steep fall in the yuan.

“The pressure from the United States could rise if China allows sharp depreciation,” said a government source.

China has the biggest global exports market share of any country since the United States in 1968, so the yuan’s exchange rate acts as a bellwether for other exporting countries and is a cause of concern for some.

“We are concerned at how quickly the yuan is falling and in turn how the won seems to be tracking its movements,” said a finance ministry official in South Korea, a major exporter that competes with China in textiles, electronics and petrochemicals among other sectors.

However, a person familiar with Japan’s currency diplomacy, was less concerned, saying the yuan’s decline didn’t seem out of line considering the dollar’s strength.

“I don’t think Japan has much to complain about,” this official said. Although Japan rivals China in exports including electronics and heavy machinery Tokyo is struggling with its own currency dilemma of how to contain a sharp rise in the yen following the Brexit vote last week.

MARKET FORCES

“We should gradually let market forces play a bigger role. The market believes that the yuan is under pressure, so our foreign exchange policy should follow this trend,” said a researcher with the Commerce Ministry.

“China needs to safeguard its economic growth and trade but also make sure we don’t create competitive devaluation.”

Julian Evans-Pritchard, China economist at Capital Economics, said in a note that a sharp fall “could set off a renewed bout of fears over renminbi depreciation and a pick-up in capital outflows.” The yuan is also known as the renminbi.

But he said the central bank would want to avoid “panic” so was likely to intervene to stabilize the currency if need be.

The PBOC has been trying to reform the way it manages the yuan by making it more market-driven and transparent, apparently having leant lessons from policy missteps in the past, including the criticism of its August devaluation.

The PBOC sets the yuan’s daily mid-point versus the dollar based on the previous day’s closing price, taking into account changes in major currencies, analysts and officials said.

This year, the PBOC has been guiding the yuan lower by pegging the yuan to the dollar when the U.S. currency weakens and pegging the yuan to a basket of currencies when the dollar rises, they said.

The currency regime gives the central bank more room to allow two-way swings in the yuan versus the dollar, deterring one-way bets on the currency.

The CFETS RMB Index, a trade-weighted exchange rate index that was unveiled by the central bank in December, fell 5.6 pct between the end of 2015 and June 24 of this year, although the central bank has pledged to keep the yuan basically stable against the basket.

Source: Reuters