Opinion

Watch out for China’s currency in case of no-deal scenario

The U.S. and China’s negotiations on a phase-one deal seem to have stalled again. The market was already aware of the limited nature of the likely deal, but was still hoping for it. Against this backdrop, the investors have reacted negatively to the increased likelihood of not reaching a deal on December 15. If this is the case, the U.S. will apply additional tariffs on Chinese imports. The obvious question to address, thus, is, what can happen to China under such a scenario?

By: Date: December 11, 2019 Topic: Finance & Financial Regulation

We first need to realize that the so-called interim deal would still have left all the tough aspects, i.e. intellectual property protection, industrial policy subsidies, the role of SOEs, market access, etc., to a later stage. Given that the market has already lowered its expectations, a no-deal scenario might not be as catastrophic at it appears.

However, there is still one important aspect that one should be carefully examined, namely the RMB exchange rate. The Chinese economy has suffered from sluggish investment for a long time, and most of the government-led stimulus measures have so far failed to shore up investment confidence. And the situation has become more complicated by rising consumer prices, which further limit the PBOC’s policy room to ease. Devaluating China’s currency could turn out handy, as a more effective, and much needed, demand policy.

So far, the cost of devaluing the RMB is linked to the chances of reaching a deal with the U.S. If China realizes that all efforts on that front are futile, using the exchange rate to create external demand might become a priority. There is still a negative side effect which is the pass-through to inflation, but still, such pass-through might be low given the slack in the economy, compared to the need to gain competitiveness, which will be further hampered by additional tariffs.

All in all, whether an interim deal can be reached will have only limited consequences on the Chinese economy, but a sharp movement in China’s currency as a consequence of a no-deal scenario might be more influential.


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