Goldman Says China Tariff Pain Will Be Eliminated by Yuan Slump

(Bloomberg) -- The yuan’s recent tumble on a trade-weighted basis will offset the drag on Chinese growth from the first two rounds of U.S. tariffs, according to Goldman Sachs Group Inc.

A Bloomberg replica of the CFETS RMB Index, tracking the yuan against 24 currencies, has fallen more than 5 percent from this year’s peak in June. By helping China’s export competitiveness, the slump should boost the country’s gross domestic product by 40 to 50 basis points, which is enough to blunt the impact of U.S. levies on $250 billion of Chinese goods, Goldman economists led by MK Tang wrote in a note dated July 25.

Goldman Says China Tariff Pain Will Be Eliminated by Yuan Slump

“Yuan depreciation is a relatively effective tool to cushion downward pressures on growth,” the analysts wrote, though they don’t expect Chinese policy makers to proactively weaken the currency. “Potential policy considerations to avoid additional complications in the U.S.-China trade relationship and to mitigate domestic residents’ currency worries may restrain the scope for much further depreciation.”

Here are some other points Goldman made in the report:

  • The boost a weaker yuan gives to the economy will probably be realized in a few months
    • A 10 percent drop in the yuan against the basket may boost export growth by about 6 basis points after a lag, adding around 80 basis points to GDP
  • Headline Consumer Price Index inflation would only increase by 20 to 30 basis points with a 10 percent decline in the yuan
    • “The notion that exchange rate depreciation can boost growth significantly without causing a large increase in inflation represents a favorable trade-off, given that the risk of high prices constraining policy easing is more important than the risk of overly low inflation”
  • Chinese companies’ foreign-exchange debt was about $2 trillion at the end of 2017, which is fairly modest relative to the size of the economy and seems unlikely to be a key stress point if the yuan’s weakness extends
  • Yuan depreciation is particularly appealing given the backdrop of deleveraging, as exports are a much less credit-intensive growth driver than fixed investment and to some extent household consumption
  • The yuan faces medium-term pressures as mainland investors diversify their portfolios and the current account surplus diminishes
  • Policy makers may act if depreciation hurts the stock market and triggers large capital outflows. Sharp declines are unwanted as that hurts foreign interests in onshore bonds and equities
  • Goldman expects the yuan to rise to 6.7 per dollar in three months -- up from 6.7818 Thursday -- amid broad dollar weakness. Risks are tilted to a weaker yuan given possible further downward pressure from trade friction and softer domestic macro conditions

©2018 Bloomberg L.P.