Question 21M.2.HL.TZ0.2b

Trade war with the United States puts pressure on China’s currency

1. As a trade war between the United States (US) and China worsens, a central bank official has said that China will not use its currency to deal with trade conflicts and will continue with the market-based reforms of its exchange rate system. In the past, the US has accused China of being a currency manipulator that has maintained a fixed exchange rate to keep the renminbi (RMB, China’s currency) undervalued. According to a US trade official, “a depreciating currency is good for the Chinese economy”.
   
   
2. The value of the renminbi has fallen 9 % against the US dollar (US$) in the past six months. Expansionary domestic monetary policy, concerns about economic growth and an escalating trade war continue to put downward pressure on the renminbi. Allowing the value of the renminbi to fall suggests that the central bank is currently maintaining a managed exchange rate rather than a fixed peg to the US dollar.
   
   
3. The cause of the lower value of the renminbi—aside from a slowdown in Chinese economic growth—is a shrinking current account surplus. The US has imposed tariffs on US$250 billion worth of Chinese imports. The US president has also threatened to impose tariffs on the remaining imports from China. This, along with a widening trade deficit in services, caused mainly by the rise in Chinese tourists travelling abroad, would further reduce China’s current account surplus. In 2017, China’s current account surplus was 1.6 % of gross domestic product (GDP). By the first quarter of 2018, the surplus became a small deficit.
   
   
4. There is international concern about the potential damage that a prolonged trade war with the US could cause to the Chinese economy. Central bank officials in China are concerned about the depreciating currency but are trying to avoid central bank intervention. To support the export sector, the Chinese government is considering measures such as subsidies and exemptions from some indirect taxes. These measures, along with a falling renminbi will allow Chinese exporters to avoid passing on some of the tariff costs to US consumers.
   
   
5. To complicate matters for China, economic growth in the US is causing US interest rates to rise and the US dollar to strengthen. This, along with China’s first current account deficit in 20 years, is negatively affecting China’s financial account. Responding to the rising US interest rates with increases of its own is not a good option for China’s central bank, because Chinese companies have a heavy debt burden that is slowing economic growth. Recently, a government official advised against increasing China’s interest rate because of its impact on borrowing costs in China.

[Source: Michael Smith, The Australian Financial Review, 2018. China risks further US fire as currency hits 10-year low. [online] Available at: https://www.afr.com/markets/currencies/china-risks-further-us-fire-as-currency-hits-10year-low20181030-h17agp [accessed 30 October 2018]. Source adapted.

Financial Times: Tom Mitchell, 2018. US rate rises compound trade pressure on China. Available at: https://www.ft.com/content/27a73392-c534-11e8-bc21-54264d1c4647 2 October. Used under license from the Financial Times. All Rights Reserved. [Accessed 1 October 2018]. Source adapted.

Trading Economics, 2018. China Current Account. Available at: https://tradingeconomics.com/china/current-account [accessed 31 October 2018]. Source adapted.]