Wary China Eyes U.S. Tax Cut as Currency Risk and Reform Chance

(Bloomberg) -- Chinese officials and commentators are greeting the news of the biggest U.S. tax overhaul in three decades with a mixture of concern over the potential market impact and a sense that opportunity to push further reforms at home has arrived.

A Senate vote early Saturday brings the U.S. close to a cut in the corporate tax rate to 20 percent from 35 percent and temporary tax reductions for most Americans. Such a sweeping change in the world’s largest economy may push up the dollar on the back of repatriating capital and faster economic growth, presenting downward pressure on the Chinese yuan, the currency of the world’s second-largest economy.

A more attractive corporate environment in the U.S. also poses challenges to China’s competitive position, at a time when its labor costs are already rising. China’s leadership hasn’t yet addressed the issue publicly, and officials are already engaged on multiple thorny issues with the U.S. from a simmering trade dispute to negotiations on North Korea.

"Tax cuts in the U.S. and their fallout will pose a challenge to China’s manufacturing and technological innovation, which China must cautiously brace for,” according to a front-page editorial in the 21st Century Business Herald on Tuesday. "We should look out for the long-term impact of the U.S. tax cuts, and be seriously prepared. This is also an important force to facilitate China’s reforms."

Strong Pull

For investors, a U.S. corporate tax rate of 20 percent may create a strong pull for American corporations to repatriate funds from in China, where companies are taxed at a standard rate of 25 percent. Chinese authorities will be "vigilant" to the effect this could have on the yuan, Raymond Yeung, chief Greater China economist at Australia & New Zealand Banking Corp. in Hong Kong, wrote in a note.

The offshore yuan fell the most since Nov. 3 on a closing basis in New York as the U.S. dollar strengthened, closing the gap with its onshore counterpart. China’s currency has been held mostly stable since a devaluation in 2015 through the use of capital controls, which are gradually being loosened.

"Among China’s five pillars of supply-side structural reforms, the focus so far has been on deleverage, capacity reduction, and property inventory cuts. Cost reduction has been lagging behind," Yeung wrote. "To boost the country’s global competitiveness, China could address the issue of an increasingly expensive operating environment domestically."

The 21st Century editorial said that China needed to implement recently announced reforms and should work to reduce corporate costs, possibly through cheaper land.

However, the impact of any U.S. tax cut could be tempered, according to Cui Li, Hong Kong-based head of macro research at CCB International Holdings Ltd., who spoke at a forum in Beijing. "Trump’s tax cut won’t have a very big impact as the current effective corporate tax is already far lower than 35 percent. The effects are likely to be less visible also because the U.S. economy is already in a recovery trend."

Own Agenda

Mei Xinyu, a researcher at the Chinese Academy of International Trade and Economic Cooperation, stated in the overseas edition of the People’s Daily on Monday that the U.S. move shouldn’t "disturb" China’s own reform agenda, though pressure on the balance of payments, currency, foreign reserves and monetary policy was possible.

The relationship between the two titans of the global economy has been complicated this year by persistent rumors of an impending trade war -- an event that has yet to materialize despite increased rhetoric. The Trump administration has most recently argued that China is backtracking on the market principles that form the norm in globalized trade. China, for its part, has mostly moderated its tone in response.

The spillover effect of the U.S. tax policy change must not be overlooked, and "we should positively deal with it by jointly raising productivity, increasing competitiveness, and benefiting workers and peoples," China’s Vice Finance Minister Zhu Guangyao was cited as saying by Ifeng.com on Sunday. "Tax policy will be an important part of global coordination on making macro-policies," he said.

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