New PBOC Governor Rules Out Currency Depreciation In US-China Trade War

While the entire world was transfixed on the speech from China's president Xi Jinping on Tuesday morning at the Bo’ao Forum, which sent futures surging due to its allegedly, if erroneously, "conciliatory" note, far fewer paid attention to the new PBOC Governor Yi Gang, who today spoke at the same forum on monetary policy and further opening up of the financial sector. Unlike Xi's speech, which was was repeat of what Xi said in Davos in January, Yi' speech was far more important as it actually unveiled Chinese strategy in the context of currency wars.

First and foremost, Governor Yi stated for the record that the Chinese currency will not be used in a trade conflict. While there had been several recent media reports about China looking into this possibility, most recently from Bloomberg, Goldman notes that factors that support a view that adoption is unlikely include:

  1. An active CNY depreciation would risk further escalation of trade tensions, and the senior leadership, including President Xi, has been generally conciliatory; it's easier to justify direct quid pro quo tariffs as a countermeasure to tariffs imposed by the US.
  2. Depreciation has debatable effects on trade; many officials do not believe exchange rate changes are that effective in supporting export growth.
  3. Given the experience of 2015-16, the risk of self-fulfilling depreciation could be on policymakers' minds.
  4. Actively managing the CNY weaker would be awkward after the government has commented extensively that it is no longer actively managing the exchange rate. We believe this is especially the case after Governor Yi’s recent promotion as he is a strong believer of a more market-based way to manage the economy.

Governor Yi's statement does not mean that the RMB will not depreciate against the dollar, but just that China will not actively intervene in the market to use currency as a tool during the conflict. Indeed, if the broad dollar strengthens, Chinese policymakers might be happy to see it as there has been a growing sense the the RMB has been moving too much in one direction against the dollar.

Separately, Governor Yi also released more details on the opening of the financial sector, both in terms of the sub-sectors involved as well as the timing (in some cases) which was helpful in supporting the broad directional statement from President Xi earlier (see details in our note here). These mainly include:

  1. Expand SH-HK stock connect daily quota (northbound to Rmb 52bn from Rmb 13bn, southbound to Rmb 42bn from Rmb 10.5bn), effective May 1; aim to implement London-HK connect before end of this year;
  2. Over the next few months, eliminate restrictions on foreign investments in banks and financial asset management companies; allow foreign banks to set up branches in China; increase the upper limit on foreign investment in brokers and funds to 51%, and eliminate this upper limit after 3 years;
  3. Before the end of this year, encourage foreign investments in trust, financial leasing, auto financing and consumer financing industries. Other ministries including MOF will likely announce more details on tariff cuts soon.

Also of note: the new Chinese central bank head mentioned that benchmark interest rate will be mainly decided by the market in future, and the two-track interest rate system (benchmark interest rate and market interest rate) will be merged to a one-market interest rate system. Governor Yi also mentioned that the interest rate spread between China and the US is “comfortable”. To be sure, analysts agree that there is no need to raise interest rate meaningfully in the near term, given: 

  1. the uncertainties related to the trade conflict,
  2. today’s downside surprise on CPI and PPI inflation data,
  3. likely downside surprise in March activity data growth, especially IP and exports.

And while Q1 GDP and activity data are likely be strong, and the fall in March IP and exports growth are likely to be mostly the result of the Chinese New Year distortions, Chinese policymakers cannot rule out the possibility that growth has already started to slow with many companies and observers voicing concerns about the impact of weak broad credit growth, tight controls on local government financing and strong exchange rate against the dollar. As we showed last night, China's Credit impulse has already cracked and is down to nearly 3 year lows, suggesting that instead of inflation, Beijing is about to start exporting deflation once again, forcing the Fed to soon cut rates and launch more QE.