Markets were rattled again this week by the outspoken president elect’s comment that US companies ‘can’t compete with them [Chinese firms] because our currency is too strong and it’s killing us.’
Those words left the dollar reeling, weakening against both the CNY and CNH by 0.8% to close Tuesday at 6.845 and 6.8023, respectively. The dollar had recovered some of the lost ground by Wednesday afternoon with the USD/CNY trading at 6.8601 and the USD/CNH at 6.82.
Still, Bank of America Merrill Lynch head of China equity strategy David Cui said in a teleconference on Wednesday that the prospectof a weaker dollar cannot be ignored as it would be a huge boost to China.
A weaker dollar could help reduce RMB depreciation expectations as well as capital outflows, Cui explained. That is because even though Beijing has been actively promoting the idea of calculating the renminbi’s value in the context of a basket of foreign currencies since late 2015, most in the country are still fixated on the dollar — the result of a prolonged peg to the USD.
As a result, dollar strength means higher renminbi devaluation expectations, which leads to a stronger urge by local households and corporates to move money offshore.
For example, even if just the richest 3% people in China decide to diversify 5% of their financial assets into foreign currencies or foreign currency denominated assets, Cui estimates that this would lead to a $1tr drain on the country’s FX reserves.
Such a scenario would severely jeopardise Beijing’s attempts to maintain a stable exchange rate policy given that its FX reserve was barely above $3tr in December 2016 and having already lost a quarter of its total in the last two and a half years.
But if the Trump administration is able to engineer a weaker dollar, this would remove most of the pressure on the renminbi, which would then lead to a reduction in capital outflows —China’s most important and imminent problem.
“Overall we’re very cautious of China this year with the market, in general, expecting a stronger dollar,” Cui said. “But if that changes [because of Trump’s recent comments] then the pressure China faces will be much less.”
Still, he maintained that how things will actually pen out is heavily dependent on the actions of the upcoming Trump administration as the possibilities of China-US trade conflicts should not be overlooked. Trump is scheduled to be sworn in as US president on Friday.