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

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