The escalation of the US-China trade dispute has weighed on China’s renminbi in recent days, stoking broader fears among emerging market investors. While we expect some continued short-term volatility in currency markets, we believe Chinese policymakers will refrain from allowing significant weakness in the renminbi, given the country’s long-term goals. Furthermore, China’s bold ambitions make the renminbi a strategic growth story, in our view.
There’s too much at stake for China’s long-term goals for it to allow significant currency weakness
The implementation of tariffs by the US on goods imported from China creates an immediate competitive disadvantage for Chinese exporters. This naturally sparks the fear among investors that the Chinese authorities may look to mitigate the effect by allowing the renminbi to weaken significantly. Such a move would ignite risk aversion across emerging markets. While theoretically plausible, we believe this is an overly simplistic conclusion as there are various factors to consider, which we list below.
1. The stakes of provoking the US are too high
Right now there is a general sense of despondency over the likelihood of a comprehensive trade deal between the US and China. However, we believe a deal remains first prize from the perspective of everyone involved; weakening the currency meaningfully would damage the prospects of this.
2. China knows better than to succumb to short-term temptation
As we wrote earlier this year, China has made huge strides towards more prudent policy-making. And in recent weeks, the People’s Bank of China reiterated its commitment to maintaining currency stability. We think China is likely to resist the short-term allure of a ‘weak FX’ sugar fix.
3. China’s economy doesn’t need the stimulus of a weak currency
We think the market is overestimating China’s need for the stimulus that a weak currency brings. Its economy is performing better now relative to much of 2018, thanks to targeted and well-managed stimulus measures. Furthermore, a mercantilist approach flies in the face of the broader economic reform momentum, which is seeing China shift its economy away from a reliance on exports and investment and towards a more consumer and services driven model.
4. China needs a solid currency for its global ambitions
With their inclusion in major investment indices, Chinese bonds are moving firmly to the mainstream, as we wrote recently. This should incentivise China to support the renminbi (or risk deterring foreign investors) while also boosting inflows into the currency.
5. China won’t risk fuelling capital outflow pressure from residents
As previous years have shown, a weaker renminbi policy incentivises Chinese citizens to diversify their savings out of China to the rest of the world, which creates further downward pressure on the domestic currency. This has significantly complicated the policymaking framework in the past by limiting the ability of authorities to adopt effective counter-cyclical measures. In the event of a weak renminbi, further capital controls would likely be necessary which again takes China further away from its global ambitions.
6. Pride and saving face play a significant role in China
Allowing the renminbi to weaken significantly would risk making China’s authorities appear weak and dent sentiment, offsetting any economic benefit of a weaker currency.
Longer term, the renminbi is a growth story, in our view
While we don’t expect much further weakening of the renminbi over the short term, we do expect some of the currency’s regional peers to depreciate against the US dollar and we have short exposure to a number of these across our local currency debt strategies.
Longer term we are bullish on the renminbi, not least because of the shifting sands we talk about in our series on dedollarisation.
Now is a pivotal moment for the future of the renminbi and Chinese bonds. Looking beyond the short-term noise, we believe China’s pragmatic policy-making, driven by long-term and bold ambition, will support the renminbi over the short term and that the long-term horizon remains bright.
Emerging market: These markets carry a higher risk of financial loss than more developed markets as they may have less developed legal, political, economic or other systems.