Currency devaluation: a tricky way to fight the trade war - Victor Shih

Victor Shih

Devaluating the Chinese Yuan can be an attractive, but also dangerous way for China to deal with the effect of the ongoing trade war, says financial and political analyst Victor Shih, author of Factions and Finance in China: Elite Conflict and Inflation to Reuters. " It is likely that corruption is returning, which will undermine Chinese capital control measures."

Reuters:

Victor Shih, an associate professor of political economy at the University of California, San Diego, says currency devaluation could be an attractive option for China to offset the impact of the trade war. 

But he warned the tactic had limits, as it "could create a panic on the renminbi which becomes difficult to control"... 

Shih estimates that even a modest 20 percent reduction in exports to the United States could cause the monthly trade surplus to drop by $8 billion to $10 billion, nearly a third of the average. In addition, a reduction in foreign direct investment, which brought $136 billion into China last year, would also reduce forex inflows substantially, he added. 

In China's stock and bond markets, where sentiment is far more fragile, foreign inflows could easily reverse. For example, during the first three trading days this week, foreign investors sold a net $14 billion of mainland stocks under the cross-border Connect scheme, reversing weeks of net purchases. 

The most recent data from the State Administration of Foreign Exchange (SAFE) shows that China had total foreign liabilities of $5.3 trillion at the end of the second quarter, of which $1.13 trillion was portfolio investments - equity and debt securities that foreign investors could attempt to offload in the event of market panic. 

Broader SAFE data showed China's total external debt, excluding Hong Kong and Macau, at $1.84 trillion at the end of the first quarter, an increase of $455 billion from the end of 2016. 

Although not all of those exposures are at risk of fleeing China's shores, analysts say they put the size of China's $3 trillion in foreign exchange reserves into perspective. Shih said existing capital controls were very stringent. 

"Even the billionaire class faces tight restrictions in terms of where they can invest money," he said. "However, there are still ways, and it is likely that corruption is returning, which will undermine Chinese capital control measures."

More at Reuters. 

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