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China’s currency devaluation could be double-edged sword

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US President accuses Beijing of currency manipulation as trade war escalates

BEIJING: China's move to devalue its currency could prove to be a double-edged sword in its escalating trade war with the US, offsetting tariffs but potentially hurting Beijing's efforts to shore up its weakening economy, analysts say.

Although China's central bank governor Yi Gang insisted on Monday that the country would "not engage in competitive devaluation", US President Donald Trump wasted no time in labelling the yuan's plunge below the symbolic level of 7 per US dollar "currency manipulation" in a tweet.

China fired back yesterday, with the bank saying it is "resolutely opposed" to the US designation.

The yuan, also known as the renminbi, is not freely convertible, and Beijing limits its movement against the US dollar to a 2 per cent range on either side of a central parity rate, which is set each day.

Mr Trump has long accused Beijing of manipulating the currency as a weaker yuan makes Chinese exports - which lie at the heart of the trade war - cheaper.

Mr Yi said Beijing would not use depreciation "as a tool to deal with external disturbances such as trade disputes" and insisted the central bank would maintain "a stable and balanced RMB exchange rate".

But some analysts have suggested that Beijing will allow the yuan to fall further.

Mr Bo Zhuang, chief China economist at TS Lombard, said the yuan's fall was the obvious result of "active monetary policy intervention" in response to Mr Trump's most recent tariffs threat.

It is now clear that China "is willing to tolerate further currency weakness in the face of the renewed escalation of trade tensions," Mr Bo said.

The two sides characterised last week's resurrected trade talks in Shanghai as constructive, but tensions have mounted rapidly since then, as Mr Trump vowed to impose fresh tariffs on US$300 billion (S$413 billion) in Chinese goods from Sept 1.

This would subject virtually all of the US$660 billion in annual merchandise trade between the world's two top economies to punitive duties.

Mr Bo predicted the yuan could weaken another 3 per cent to 7.25, and possibly breach 7.5 in 2020 if the US retaliates by imposing 25 per cent tariffs on all Chinese exports.

But depreciation also poses risks to China - a fact that has not escaped Beijing's policymakers.

"We don't think... (the central bank) will let the yuan want only weaken as a significant depreciation could have severe and destabilising effects on the domestic economy," said Mr Stephen Innes, managing partner at VM Markets.

Other analysts agree that Beijing's dislike of instability - and fears of a large capital outflow - will prevent the central bank from allowing too much dramatic movement.

"In my view, it will probably seek to prevent any rapid, volatile or major renminbi decline through the continued implementation of tight capital controls... and use other tools at its disposal," said Mr Mark Sobel, former official for international and monetary policy at the US Treasury department.

However, the trade war could also serve Beijing's broader ideological needs.

China's economy is already slowing - growth slipped to its weakest pace in almost three decades in the second quarter - and the trade spat throws up an easy scapegoat if the situation fails to improve. - AFP