Trade war deal could allow China to loosen monetary policy and exchange rate flexibility, analysts say

Frank Tang

A phase one trade deal between China and the United States could make the central bank in Beijing more willing to ease monetary policy at home and let the yuan exchange rate fluctuate, according to analysts.

The People’s Bank of China said in its 2020 work plan published on Sunday that it would let the market play “a decisive role” in determining exchange rates this year, although the central bank reiterated its long-standing position that it would keep the yuan exchange rate “basically stable”.

The central bank did not mention the proposed trade deal with the US, which US President Donald Trump has said will be signed later this month, but allowing the yuan to move more freely would be in line with a fact sheet published by the Office of the US Trade Representative about the deal last month.

It said the agreement would require Beijing to increase transparency over the yuan’s exchange rate and to avoid using currency devaluation as a way to boost exports.

The central bank also said its monetary policy would be “flexible” in 2020 and it would keep “growth in money supply, credit and aggregate social financing in line with economic development” – a more dovish stance on borrowing than previous years.

On New Year’s Day, the central bank announced that it would cut the required reserve ratio (RRR) on commercial banks – the percentage of deposits they must place in the central bank – by 50 basis points from Monday.

The move will pump 800 billion yuan (US$115 billion) into the banking system to lend to factories, investment projects and households.

The move came a day after Trump said he would sign “a very large and comprehensive” phase one trade deal with senior representatives from the Chinese government on January 15, although the central bank made no link between the two.

The cut in the required reserve ratio was made “mainly because the trade tension has not been reversed and the technology war has intensified,” said Iris Pang, chief Greater China economist of ING Bank, who predicted there would be a further RRR cut in the second quarter.

China’s monetary policy at home is mainly determined by domestic concerns, but Beijing’s relations with the outside world can sometimes influence the central bank’s policy.

Concerns about a deep fall in the yuan’s value, which could trigger an exodus of funds from China, have dogged domestic monetary policy for years.

The fear has forced Beijing to adopt a prudent monetary policy at home, while maintaining draconian controls over capital outflows and managing the yuan’s exchange rate rigidly.

Ding Zhijie, vice-president of the University of International Business and Economics who is set to head a research institute under the State Administration of Foreign Exchange, told a forum in Beijing last month that the yuan had appreciated for much of this century thanks to China’s economic growth and financial stability.

He said the conclusion to be drawn was to get the economy in shape so that there is “a basis for yuan stability and for the yuan to become a strong currency”.

Liu Qiao, dean of Peking University’s Guanghua School of Management, noted in a co-authored report published last Thursday that China would focus on stabilising growth at home.

The improvement in China-US relations will help form a relatively stable market expectation and shore up manufacturing investment

Liu Qiao

“The improvement in China-US relations will help form a relatively stable market expectation and shore up manufacturing investment,” Liu wrote.

But while China can buy some time with an interim deal with the US, some observers fear this will only provide it with a short window of opportunity.

Raymond Yeung, chief Greater China economist at ANZ Bank, said that the bilateral rivalry is set to continue after the interim deal is signed this month. “The phase two negotiations will be much harder. We shouldn’t be over optimistic,” he said.

Additional reporting by Zhou Xin

More from South China Morning Post:

This article Trade war deal could allow China to loosen monetary policy and exchange rate flexibility, analysts say first appeared on South China Morning Post

For the latest news from the South China Morning Post download our mobile app. Copyright 2020.