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MNI INTERVIEW: Chinese Yuan To Weaken Further If US Talks Fail

     BEIJING(MNI) - The yuan is likely to weaken further if the U.S. continues
to impose tariffs on Chinese goods, counteracting some of the trade war's impact
on the country's exporters despite higher costs for companies which have
borrowed in dollars, a government advisor told MNI.
     While the People's Bank of China will probably try to buoy up the yuan
ahead of trade talks due in early October, this may change if the meeting fails,
said Xiao Lisheng, deputy director of the International Finance Department of
the Institute of World Economics and Politics at the Chinese Academy of Social
Sciences (CASS), a top government think tank.
     If the yuan depreciates to around 7.2 to the dollar, it could offset
newly-launched 15% tariffs on USD300 billion of Chinese imports, Xiao said,
adding that the yuan would have to fall to 7.5 if the U.S. raises its levies to
25%. The yuan traded near 7.11 on Tuesday.
     "According to our survey, the 7.2 level is acceptable to Chinese exporters
at present," he said.
     The People's Bank of China has taken a more hands-off approach to the yuan
since it weakened sharply to 7.05 from 6.9, breaking through the 7-level
previously seen as crucial, according to Xiao, who said that the best way of
favouring stability in markets was to allow investors the largest say in
determining key prices. This enhances the effectiveness of verbal warnings about
price levels, and of adjustments to the daily currency fixing, he said.
     "It gives the PBOC more impact and more space for policy adjustment," said
Xiao.
     Xiao was cautious about the prospects for October's trade meeting, noting
that China will not accept a disadvantageous agreement and that the U.S. will be
reluctant to surrender benefits from tariffs imposed so far. President Donald
Trump's abrupt policy pronouncements have also eroded trust, he said.
     --NO BIG REBOUND
     Even a relatively successful meeting between U.S. and Chinese negotiators
is unlikely to trigger any substantial yuan rebound, as a slowing economy will
prompt further monetary easing. The PBOC, which cut banks' reserve requirement
ratios last Friday, could lower them again, although in the near term it is more
likely to cut its prime rate, which anchors its loan rates, Xiao said.
     "There are still strict controls on property markets, so the slowdown
pressure will persist next year and rates will need to be cut."
     It has been the trade war which has triggered recent volatility in the
yuan, which would otherwise have remained at about 6.75 to the dollar as the
Federal Reserve eases policy, the advisor said, noting that China's slowing
economy has reduced imports more quickly than exports. He added that the
country's balance of payments was still balanced in the first half of the year,
and that the investment item showed net inflows. The error and omission item of
the balance of payments does indicate some outflows, but "all in all, there has
been no sign of big capital outflow like in 2015 and 2016 so far."
     A weaker yuan does not only make Chinese goods more competitive, but can
pose challenges to exporters, whose experience of using forex futures products
to hedge risks is limited, Xiao said.
     A significant depreciation would also push up many companies'
debt-servicing costs, particularly for property developers and banks.
     "About 70% of outstanding foreign debt has been hedged, so depreciation
would have limited impacts on repayment on that portion of liabilities, but it
would put pressure on new debt issuance," Xiao noted, adding that policy makers
were conscious of these risks.
     Even given the absence of large outflows, controls on capital movements
should be lifted only cautiously, particularly in the case of illegal property
transactions, he argued.
     China's shrinking current account surplus, which could turn into a deficit
as savings growth decelerates to the point where it is unable to meet the
country's investment needs, will prompt a trend of yuan depreciation over the
next five years, Xiao said.
     "When the current account goes into deficit, the currency will weaken," he
said, adding that China's relative lack of risk-free or appreciating assets
could make a deficit harder to finance.
     The internationalisation of the yuan should be a natural result of the
opening and growth of China's economy, and not be seen as a tool to challenge
the supremacy of the U.S. dollar, Xiao said, noting that Hong Kong would play a
crucial role in this process.
--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com
[TOPICS: MMQPB$,M$A$$$,M$Q$$$,MT$$$$,MX$$$$,MGQ$$$]

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