What next for the renminbi after it breaches Rmb7 per dollar?
The renminbi weakened past Rmb7 per US dollar on Monday for the first time since the 2008 global financial crisis, breaching a floor that China’s central bank has fiercely defended previously.
Here are four key questions that global markets are facing now that this longstanding mooring for China’s foreign exchange rate has been abandoned.
Why let the renminbi breach Rmb7 now?
With the People’s Bank of China having defended the Rmb7 threshold so far this year despite increasingly bellicose rhetoric on trade from the US, many analysts had expected the government to keep its powder dry until later in the year, partly in hope of not derailing trade negotiations with Washington.
But Jason Daw, emerging markets strategist at Société Générale, said US president Donald Trump’s threat late last week to hit another $300bn worth of Chinese imports with a 10 per cent tariff had forced the hand of Beijing, which had run out of US goods on which to slap import tariffs in kind.
“With China’s retaliatory options limited, they have opted to let the [renminbi] weaken sharply” against the dollar, Mr Daw said. “China has probably determined that striking a deal with the US is unlikely and it is time to allow [the currency] to fall to reflect fundamentals — weaker growth — and to dig in for a long-term stalemate,” he said.
Data last month showed growth in China’s gross domestic product slowed to 6.2 per cent in the second quarter, the lowest rate since 1992. Mr Trump’s sudden escalation of trade tensions came after he was disappointed by the outcome of talks between top US and Chinese officials in Shanghai early last week.
Hao Zhou, a senior emerging markets economist at Commerzbank, said China’s decision to let its currency breach Rmb7 was “mainly a deliberate policy action showing a hard line in the upcoming trade talks”.
Who gains and loses most from the move?
In forex markets, Mr Daw said, there were no beneficiaries except the Japanese yen, which was again getting a boost thanks to its role as a perceived haven during times of geopolitical uncertainty. The currency strengthened past ¥106 per dollar on Monday for the first time since a flash crash in January, touching a high of ¥105.08.
On the flip side, Japanese exporters — which are perceived as the driving force behind the country’s economy — do not benefit from a stronger yen, and traders said that sustained strength at these levels could mark a major turning point for the currency.
In terms of Asian emerging markets economies, Mr Daw said, “there is no winner”. The South Korean won, which dropped 0.7 per cent against the dollar, remained particularly exposed to trade war risks in addition to weak external and domestic growth.
China’s property developers would also face headwinds from the renminbi’s devaluation, said Julian Evans-Pritchard, senior China economist at Capital Economics, as would any other sectors that carried a heavy load of US dollar-denominated debt, such as construction and others heavily reliant on imports.
But he added that the boost for exports in China would be “pretty broad-based because the exchange rate applies to all of China’s export sector, not just the exports that are hit by the tariffs”.
What’s the next line in the sand for Beijing?
Seven has long been the currency floor for the PBoC, even as it has pushed investors to focus more on the renminbi’s exchange rate against a basket of peers.
But Mansoor Mohi-uddin, senior macro strategist at NatWest Markets, said that now that the renminbi had breached Rmb7, “there probably isn’t any clear line in the sand for now”.
“What markets will do instead is try and work out what is the impact of the trade war on Chinese exports and how much does the currency need to weaken to offset that.”
Mr Mohi-uddin said that in a worst-case scenario of 25 per cent tariffs across the board, the renminbi would need to weaken to levels approaching Rmb7.80 per dollar to offset the impact, though like other analysts he stressed that the central bank would allow the currency to decline gradually, to minimise the risk of capital outflows.
Mr Evans-Pritchard said Capital Economics had pencilled in a drop to Rmb7.30 by the end of 2019, and to Rmb7.50 by the end of 2020. But he added that compared with the confusion that ensued after the shock devaluation in 2015, the PBoC was better prepared to combat any pick-up in capital outflows.
“The market is much more confident in the PBoC’s ability to defend the floor,” he said. “What’s not clear is where that floor is.”
What is the upshot for global investors?
Analysts said investors could expect an uptick in volatility in the weeks, with the Rmb7 threshold having given way.
“The uncertainties from renewed trade tension and ongoing softening of global economic data have created a backdrop of risk aversion,” said Tai Hui, chief Asia-Pacific market strategist at JPMorgan Asset Management. This could persist “until we see stabilisation in either US-China trade negotiation or global growth momentum”.
For forex markets, the focus will remain on the renminbi. SocGen’s Mr Daw said Beijing’s decision to allow the Chinese currency to fall below the Rmb7 mark “has put the renminbi back in the driver’s seat: it will be a leader in the global currency cycle for the foreseeable future”.
Additional reporting by Sherry Fei Ju in Beijing and Leo Lewis in Tokyo