MNI INTERVIEW: Chinese Firms Should Hedge Dollar Risk-Guan Tao

Chinese exporters should reduce dollar holdings and diversify trade settlement currencies to mitigate the risk that the U.S. dollar will be tipped into an extended weakening trend by America’s aggressive tariff policies, a prominent Chinese economist and former State Administration of Foreign Exchange official told MNI.

A potential U.S. recession, prompting Federal Reserve rate cuts, could combine with a broad loss of confidence in the U.S. currency to accelerate an exit by investors from dollar-denominated assets, said Guan Tao, a foreign exchange expert and global chief economist at BOCI China.

The yuan, which looks like ending a cycle of weakness begun in 2022, could now strengthen, said Guan, adding that this could provide an opportunity to enhance the flexibility of China’s exchange rate. (See MNI: PBOC Persists With Yuan Support For Now-Advisors)

The yuan also appreciated against the dollar during the sharp unwinding of the “Trump trade” in 2017, gaining more than 6% as the dollar index dropped almost 10% and restoring the credibility of the People’s Bank of China’s exchange rate policy, according to Guan in an interview.

FOUNDATIONS FOR STRONGER YUAN

This time round, the rally in China’s currency has stronger foundations, as domestic enterprises and households have increased dollar holdings during the years of yuan weakness, explaining why a large trade surplus has not translated into an increase in foreign exchange reserves, he added. These holdings could now be exchanged into yuan, he continued. 

Chinese exporters, which settle about 90% of their sales in dollars, need to use tools like forwards, swaps, and options against the risk of an appreciation of the yuan, Guan said. They should also be encouraged to settle in yuan or in alternative currencies such as the euro, he added. (See MNI: China To Leverage U.S Tariffs, Target Deals With EU, Asia)

A stronger yuan against the dollar would have only a moderate effect on the competitiveness of China’s exports, given that it should remain relatively stable against the currencies of other trading partners, while low Chinese inflation should also help keep the  yuan’s real effective exchange rate low, Guan said.

On the other hand, if the yuan were to depreciate along with a sharply-falling dollar, its value would fall versus other currencies, potentially heightening concerns in Asia and Europe about cheap Chinese exports, he said.

Guan expects talks on trade to resume between China and the U.S., adding that a shift from confrontation to dialogue would calm markets and boost the yuan. 

China is willing and capable of increasing imports from the U.S. and to expand investments in that country, Guan said, but he stressed that key issues include whether Washington will relax restrictions on China’s imports and outward investments, as well as on allowing Chinese students to study in the U.S.