23 May 2019
China's exports will benefit from a depreciating yuan. Photo: Xinhua
China's exports will benefit from a depreciating yuan. Photo: Xinhua

Benefits and costs for Beijing if RMB continues to fall

A weakening of the renminbi to 7.70 to the US dollar could return China’s export growth to 10 percent year on year by end-2016 and add 0.7 percentage point to GDP growth, analysis by Bloomberg Intelligence Economics suggests.

A slide to that level could also result in capital outflows of around US$670 billion, though that appears manageable given the People’s Bank of China’s large foreign exchange reserves.

The main benefit to China’s economy from a weaker yuan comes through the export channel.

Looking at the historical relationship between exports and the real effective exchange rate (REER), taking export growth back to 10 percent year on year at the end of 2016 would require a 13 percent drop in the REER, all else being equal.

That would imply the renminbi would weaken to 7.70 to the US dollar, beyond the most pessimistic forecast from the street.

A return to life for exports, which have been contracting for the last five months, would represent a significant boost to China’s growth.

Average export growth of 5 percent this year would raise gross domestic product by 0.7 percentage point.

That’s relative to a baseline scenario of zero export growth and assumes the domestic value-added share of exports is two-thirds.

With China’s growth sputtering, policymakers may reason that a period of turbulence is a price worth paying for stronger overseas sales.

The main cost to China’s economy from depreciation in the renminbi is capital outflows.

Based on the past relationship between cross-border capital flows and the exchange rate, BI Economics estimates that a weakening in the renminbi to 7.70 to the US dollar could trigger US$670 billion in capital outflows.

That calculation is subject to uncertainty given lack of good data on portfolio flows.

However, given that China’s foreign exchange reserves are above US$3.3 trillion, that suggests the problem could be manageable.

The views expressed in this article are those of Tom Orlik and Fielding Chen, economists at Bloomberg Intelligence.

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