MNI INTERVIEW: China May Devalue Yuan in Trade War:Gov Advisor

--China Yuan May Centre Around 6.3-6.4 in 2018

--Economy Faces Possibility of Downturn in H2 on Weak Exports

     BEIJING (MNI) - China is likely to devaluate its currency to protect

exports if there is a full-scale trade war with the U.S., Zhang Ming, senior

fellow at the Institute of World Economics and Politics under the Chinese

Academy of Social Sciences, told MNI in an exclusive interview.

     While the yuan has generally strengthened against the dollar since last

year, China's policymakers have largely tolerated the gain, signalling a

willingness to address the Trump administration's criticism of its trade

practices, Zhang said. If the U.S doesn't "reciprocate" this olive branch, China

will be forced to protect its own interests, said the researcher, who is a

member of the prominent Chinese state think tank.

     "We cannot rule out the possibility that China takes a drastic course of

action to defend its exports," Zhang said on Thursday, before Trump ratcheted up

pressure on China by levying about $60 billion of tariffs on unspecified imports

and imposed restrictions on Chinese investments. 

     The yuan has gained 2.76% against the U.S dollar this year, extending the

6.3% surge last year. The Central Parity Rate, set by the People's Bank of China

(PBOC), has advanced 3.17% this year after a 5.81% jump in 2017.

--TRADE SURPLUS

     China's stronger-than-expected 6.9% GDP growth in 2017 resulted largely

from a positive trade surplus. Foreign trade contributed 0.6 percentage point

(pp) to GDP growth last year, compared with a negative 0.4 pp in 2016, according

to Zhang's analysis. Meanwhile, domestic demand contributed to 6.3 pp, or 91%,

of the total growth in 2017, sharply down from 7.1 pp in 2016. 

     China's economy may face a significant downturn in the second half, Zhang

said. Domestic demand is expected to soften, while the ongoing deleveraging

campaign limits investment, he said. Given that the impact of the exchange rate

on exports usually takes up to two quarters to surface, the concurrent weakening

of all three pillars of the Chinese economy -- consumption, trade and investment

-- can be disastrous, Zhang said.

     "The rapid appreciation of the yuan has made policymakers uncomfortable,

particularly when the yuan is also rising against the basket currencies," Zhang

said. If the trade surplus drops sharply, the PBOC would step in to pull back

the strong momentum of the yuan, he said. 

     The yuan may trade in a band of 6.2 to 6.7 against the dollar this year,

centred mostly around 6.3 to 6.4, Zhang forecast.

--CAPITAL OUTFLOW

     The PBOC could reintroduce the counter-cyclical factor and relax the

restriction on capital outflow, such as stepping up both the Qualified Domestic

Institutional Investor and Qualified Domestic Limited Partner, two programs

designed to channel investment overseas, to dampen the strong momentum of the

yuan, Zhang said.

     China is also unlikely to take on the dollar by sharply reducing its

holding of U.S. Treasuries, Zhang said. In terms of liquidity, risks and

benefits, no other assets can compare with U.S. government debt as the right

venue to park China's enormous forex reserves, he said. A sharp reduction in

Treasury holdings may also be a signal of escalation, which China wants to

avoid, Zhang noted.

     As this is the first year for China's new government, top leaders have

emphasized stability, so they will want to avoid sharp fluctuations in all

financial markets, including forex, bond and stocks, Zhang noted. 

     And that same drive to maintain stability may also further slow the reform

of the yuan formation mechanism and the yuan internationalization, Zhang said.

--MNI Beijing Bureau; +86 (10) 8532 5998; email: marissa.wang@marketnews.com

--MNI Beijing Bureau; +86 10 8532 5998; email: william.bi@mni-news.com

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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