By Saumya Vaishampayan
Escalating trade tensions have pounded the yuan, reviving questions about China's willingness to use its currency as a tool of trade policy.
The currency depreciated beyond 6.9 to the U.S. dollar this week in the offshore market, touching its weakest level since late December. Late Tuesday, it traded around 6.90 offshore -- roughly 2.5% weaker over the last seven daily sessions, as trade relations with the U.S. have soured.
The swoon puts Beijing in a tricky spot. A weaker currency makes Chinese goods cheaper for U.S. buyers, helping offset the impact of higher tariffs. But China is eager to prevent domestic concerns about currency depreciation feeding an exodus of capital and further exchange-rate weakness. A breaching of the symbolically important level of 7 to the dollar could be a trigger.
The initial scale of any further adjustment need not be that large: Deutsche Bank analysts estimate the yuan would need to weaken just beyond 7 to the dollar to counteract Friday's imposition of 25% levies on $200 billion of Chinese goods. However, President Trump has said the U.S. could also levy import taxes on an additional $325 billion of products.
Major depreciation could also trigger further flaring of tensions, especially as President Trump has long accused China of currency manipulation. In March the head of China's central bank said the country wouldn't engage in competitive devaluation to bolster its exports.
Iris Pang, an economist focused on greater China at ING in Hong Kong, said Beijing was prepared to allow some weakness in the yuan as a negotiating tactic rather than as a source of relief from tariffs. But she said it would be eager to prevent too large a move, to minimize the risk of capital flight.
"The yuan is now a political tool, it is not really an economic tool, because of this trade war," she said.
Analysts and investors say that Chinese intervention in the yuan has eased in recent years, something that the U.S. Treasury Department acknowledged in an October report.
The yuan dropped more than 5% against the dollar offshore last year, bringing it to the brink of 7 to the dollar at its trough. The decline came as the U.S. threatened and imposed levies on Chinese imports, although the yuan was also depressed by the country's economic outlook and the divergence between U.S. and Chinese monetary policy.
J.P. Morgan analysts say they don't expect a similar magnitude of depreciation this time, in part because of the Chinese economy's less precarious position and the knock-on effects from such a move, including capital outflows and U.S. retaliation.
There are signs that Beijing isn't comfortable with the latest decline. A branch of China's central bank publishes a level for the dollar-yuan exchange rate each day, around which the pair is allowed to trade in the domestic market. That level was 6.8365 yuan to the dollar Tuesday -- stronger than where the Chinese currency traded late Monday.
Write to Saumya Vaishampayan at email@example.com