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Trade war

China returns softer yuan to arsenal as trade war intensifies

Currency seen 'cracking seven' if G-20 summit fails to produce deal

China has signaled a willingness to let the yuan "crack seven" -- soften beyond 7 to the dollar -- if the trade war drags on much longer.   © Reuters

SHANGHAI -- China appears willing to let the yuan weaken to levels previously thought unacceptable as the U.S. escalates its tariff threats ahead of this month's Group of 20 summit, raising the specter of renewed capital flight.

Yi Gang, governor of the People's Bank of China, on Friday countered widespread speculation that Beijing regards 7 yuan to the dollar as a line in the sand. "I don't think, along the mathematical scale, any number is more important than the other number," he told Bloomberg.

The central bank chief also hinted at openness to larger swings in the yuan, which is now allowed to move only 2% above or below the daily midpoint set by the PBOC. "A little bit of flexibility of renminbi is good for the Chinese economy," he said.

Yi's comments prompted the currency on Friday to soften offshore to a seven-month low of 6.96 against the greenback from around 6.93. In light of previous talk by central bank officials of keeping the yuan within a "reasonable range" -- that is, not letting it sink too far -- many investors took Yi's remarks as a sign that the PBOC has lowered its floor for the currency.

The signals that "cracking seven," or letting the yuan weaken past 7 to the dollar, is on the table come as Washington threatens to impose further tariffs covering nearly all Chinese imports that have yet to be taxed. U.S. President Donald Trump said on Monday that the duties would take effect immediately if he does not meet with Chinese counterpart Xi Jinping at the G-20 summit in Japan, putting pressure on Beijing to acquiesce to a deal there.

Should China guide the yuan lower, its exporters will have more leeway to cut prices in dollar terms, making their products more attractive to foreign buyers and mitigating the blow from the tariffs.

Trump asserted Monday that Beijing has already done so. "They devalue their currency," he said. "They have for years."

The yuan has softened about 10% since spring 2018, before the trade war got into full swing.

"This has supported exports and the economy to a degree," said Zhou Yu, head of the International Financial and Monetary Research Center at the Shanghai Academy of Social Sciences.

Many market players expect further depreciation as Beijing prepares for a protracted trade battle with the U.S. Goldman Sachs recently predicted that the yuan will weaken to 7.05 against the greenback within three months.

The U.S. Treasury Department declined to label China a currency manipulator in its semiannual report on the foreign exchange policies of trading partners, released late last month after a delay. While its status will be reevaluated in six months, Beijing may have taken this reprieve as an opportunity to test the waters and see how much room it has to let the yuan fall.

Currency markets -- along with exports of rare earths -- are among China's few remaining avenues to retaliate against U.S. tariffs. Beijing already has slapped retaliatory duties on about 70% of the American goods it imports.

But letting the yuan weaken too far risks triggering a resurgence of capital flight. Foreign investors sold 53.7 billion yuan ($7.75 billion) more than they bought in Shanghai and Shenzhen shares via Hong Kong in May, setting a monthly record. Though the currency has room to fall another 1% before it cracks 7, market watchers are nervous about the prospect of the yuan reaching a level it has not touched since 2008.

The PBOC said Tuesday it will issue bills in Hong Kong this month, an apparent effort to head off unplanned depreciation by soaking up "offshore" yuan circulating there and making short selling costlier for hedge funds. The offshore yuan rebounded to around 6.93 against the dollar on the announcement.

With the G-20 summit in Osaka just over two weeks away, Chinese currency authorities are believed to be watching the yuan's movements closely while keeping an eye out for the Trump administration's next move.

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