Since the Trump administration announced new tariffs on Chinese imports and Beijing retaliated with its own earlier this month, China's currency has weakened to Rmb6.9 per dollar. With trade tensions elevated, the further depreciation has sparked fears that the renminbi will soon cross the all-important, psychological level of Rmb7.0 per dollar.
Given that Chinese policymakers do not allow the renminbi to trade freely and instead intervene as they see fit, whether or not the currency weakens past this level remains more or less in their hands. And right now, it is not in the country's self-interest to see the renminbi blow through this threshold.
For one, the move would bring about significant volatility for not only Chinese assets but across global capital markets more broadly. Beijing has little appetite for this outcome given it's longer-term plans of putting its slowing economy on firmer footing, according to Hans Redeker of Morgan Stanley:
Authorities have repeatedly emphasised their focus on sustainable growth, i.e. an economic expansion not funded by pushing domestic debt gearing up further. China needs foreign capital to grow and this capital will only find its way into China is investors see prospects of stability. This is why RMB volatility is not helpful and therefore not in China's interest.
The need for foreign capital only grows as China's current account surplus continues to shrink, leading authorities to tread even more carefully to prevent sizeable financial outflows. Domestic demand is growing faster than the pace of exports as China's manufacturing sector moves up the value chain. For this reason, Louis Kuijs at Oxford Economics forecasts the "virtual disappearance" of China's current account surplus by year-end. Here's his outlook beyond 2020:
It is also not in China's interest to see the renminbi slide past its own "red line", given the political ramifications that come with it. Trade tensions with the US run high, and a depreciation past this level will only encourage further escalation, rather than the motivation to find a suitable compromise.
Moreover, the timing couldn't be worse. The G20 summit in Osaka, Japan is coming up at the end of June, and much is hinging on some progress being made on the trade front between the world's two largest economies. In fact, according to Sebastien Galy at Nordea Asset Management:
Without any signs of the Chinese and US getting closer together the odds of a devaluation of the renminbi will rise significantly creating a shock in the equity market.
Relations have become dangerously frayed ever since the White House launched the latest round of tariffs just a few weeks ago. Should talks break down altogether, China may have less incentive to keep its tentative pledge to avoid a competitive devaluation. But so long as there's a chance of a deal, Beijing is unlikely to provoke the very volatility it so desperately wants and needs to avoid.
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