Above the fracas

China can ill afford to join global currency wars

China can ill afford to join a global currency war. Any preference the authorities might have for a more competitive exchange rate would quickly turn into abhorrence if a weaker yuan ends up worsening the country's large foreign-currency corporate debt.

The Chinese currency partly reversed a two-day, 0.5 per cent decline against the US dollar on December 10, prompting chatter that the People's Bank of China had intervened to prop it up. That might look like an odd stance. The yuan has weakened just two per cent against the greenback this year, compared with an 11 per cent slide in the Japanese yen, a nine per cent drop in the euro and a four per cent decline in the South Korean won.
 
China's case for joining the competitive devaluation game appears to be just as strong as it is for other major economies battling a demand slump. Inflation in November was the weakest in five years. Export growth has slumped to its slowest pace since April. A weaker currency could help boost prices of imported goods, and ward off the threat of deflation. Exporters, too, could get some relief.

But corporate debt will give China pause. The cross-border claims of global banks on Chinese residents have topped $1.1 trillion, and are growing at 47 per cent a year, according to the Bank for International Settlements. Additionally, Chinese borrowers are issuing a net $40 billion in offshore bonds every quarter. Though some of the debt is matched by foreign-currency income from trade and international operations, a sizeable chunk is probably funded by yuan cash flows. A one-way bet on depreciation could destabilise this trade, and force companies to deleverage - or default.

Political considerations, too, will shape the authorities' decision. Global censure for seeking a mercantile advantage is unlikely to be a big deterrent: the currency "manipulator" tag hasn't prevented China from accumulating close to $4 trillion in foreign reserves. Nevertheless, policymakers would be hesitant to take any action that investors will interpret as a loss of appetite for domestic economic reforms. That's one more reason why the People's Republic might for now stay away from currency skirmishes.