In the near term, the renminbi exchange rate could continue to track the broader US dollar passively and the RMB index should be relatively stable as global markets react in a risk-off fashion following Donald Trump's victory in the US presidential election. However, this could be short-lived if Trump indicates that he will go through with his 45 per cent tariff proposal for imports from China. Markets will now be hypersensitive to what Trump says about China and the renminbi.
Last month, we raised our renminbi exchange rate forecasts to 6.90 against the US dollar for end-2016 (from 6.80) and 7.20 for end-2017 (from 6.90) to factor in this increased uncertainty on China's growth and foreign exchange policy posed by the new US administration. The faster pace of renminbi depreciation is also because of HSBC's revised projection of a broadly stronger US dollar across the board, notably versus the yen, Canadian dollar and Singapore dollar — which are components of the China Foreign Exchange Trading System renminbi basket.
To be sure, we still need more clarity on Trump's policies and China's potential response. In our view, it is quite possible that we could avoid a "lose-lose" situation — for example, a major trade conflict or a "currency war" — for both the US and China. Otherwise, the expected risks are substantial volatility in global markets and additional depreciation pressures on the renminbi.
Going forward, the renminbi's outlook could become more idiosyncratic. This is because Trump's victory could have a specific negative impact on the renminbi beyond the broad US dollar ramifications. During his campaign, Trump had spoken of "currency manipulation" by China and said he would impose a 45 per cent tariff on imports from China.
This tariff proposal could be implemented — and very quickly. According to the Peterson Institute of International Economics, there are at least two laws that the US president could invoke to set tariffs, quotas or regulate foreign trade in other ways.
The president would need to either claim that trade with China has resulted in a large and serious US balance of payments deficit, or that China has carried out practices that are unjustifiable and unreasonable, such as currency manipulation.
The first claim could probably be made at face value, rightly or wrongly. According to US customs statistics, China has been the single largest source of the US goods trade deficit since 2000. In 2015, the US imported US$482 billion ($698 billion) worth of goods from China (22 per cent of its total imports) and exported US$116 billion worth of goods to China (8 per cent of its total exports). The US had a US$366 billion trade deficit with China, relative to its total deficit of US$746 billion that year.
The second claim on currency manipulation would be harder to make as China has been selling foreign exchange reserves over the past year to stabilise the renminbi. Trump could nevertheless try and make a case on grounds of manipulation in the past when China's foreign exchange reserves were rising.
In the meantime, higher tariffs could very well be in place. The National Foundation for American Policy estimated that the weighted average tariff on US imports from China is currently 4.2 per cent. So his proposal is akin to a 39 per cent increase in prices of imported goods from China.
Higher tariffs would hurt the economies of both the US and China. For the US, it could be difficult to find substitutes for many of its imports from China on short notice, especially textiles and electronics, where China is a dominant global producer. Even if it could, US import costs may still rise as China is usually the lower-cost producer.
As for China, it would have to grapple with a prolonged slump in exports and manufacturing investment. Market participants could thus expect China to retaliate in the form of trade retaliation, investment disruption and currency war.
There is still a great deal of uncertainty with regard to Trump's policies and his stance on China. But we believe we have to factor in the likelihood of a broadly stronger US dollar (which could exacerbate the structural and cyclical capital outflow pressures in China) and the heightened uncertainty for China's foreign exchange policy.
In our view, there is a good chance that a "lose-lose" situation for both the US and China can be avoided. The US-China relationship is one of the most important cornerstones of the current world order and there is too much at stake. But if Trump imposes the threatened 45 per cent tariffs and Beijing retaliates, there could be substantial volatility in global markets and additional depreciation pressures on the renminbi, more so than we have pencilled in.