Investors have been keeping a close watch on the Chinese yuan, seen as a key indicator amid the intensifying U.S.-China trade war — and much concern has been centered on whether it will breach the 7 yuan per dollar key level.
While that's been said to be simply a psychological level, markets may react if the yuan falls below 7, leading to real economic costs for China as well as its companies, experts said.
The yuan has been testing those levels increasingly, as the trade war between the world's two largest economies deteriorated in recent weeks.
What a weak yuan does
A weaker yuan has been a key source of contention between U.S. and the China, with President Donald Trump accusing Beijing of intentionally letting its currency slide lower. A weaker yuan makes Chinese exports more attractive, giving them a competitive advantage in international markets, some experts argue.
However, a rapidly weakening currency could also lead investors to move their money out of China, analysts warned, although they said Beijing could respond by imposing tighter capital controls — or measures aimed at limiting the outflow of foreign capital.
J.P. Morgan's Chief China Economist Zhu Haibin cited a similar occurrence in 2015, where fears of a weakening yuan hit market sentiment and led to large capital outflows.
The currency slide would also hurt Chinese firms, as well as the country's push for greater use of the yuan internationally, according to Khoon Goh, head of Asia research at ANZ Bank.
While a weaker yuan would offset the costs of higher tariffs, there are also disadvantages, Goh told CNBC on Thursday.
"Don't forget, there are also economic costs in a weaker renminbi," he said, referring to another name for the Chinese currency. "A lot of Chinese firms still have large U.S dollar-denominated debt, which is not hedged. That will get them in trouble. "
Ripple effect
Other analysts have warned that a weakening yuan could also hurt other Asian economies.
Arthur Lau, co-head of emerging markets fixed income at PineBridge Investments, said a weakened yuan could hit regional currencies and lead to higher costs for those who hold dollar-denominated bonds.
"A weakening yuan could weigh on currencies in the region. Weaker local currencies imply higher debt servicing cost for US dollar bonds," he said in a note.
Lau added that some Chinese property developers, for instance, had a "relatively large" percentage of foreign currency debts as compared to other sectors.
Risks to yuan's internationalization
The drive to internationalize the yuan could also be hit.
China has "made a lot of strides to get renminbi included in the ... equity markets, in the MSCI, and this year, the bond market got included in the Bloomberg Barclays index, " said Goh from ANZ Bank.
He was referring to Chinese A shares — those traded in mainland China — getting included in index provider MSCI's global and regional indexes. The A shares, as well as Chinese bonds in the Bloomberg Barclays index, are traded in yuan.
As Chinese assets are increasingly traded in global markets, more foreigners will need to trade in the yuan, which is the intent of the internationalization drive. But a weak yuan will also reduce investor confidence.
"So from their point of view, allowing the renminbi to weaken too much could put the whole internationalization at risk," Goh said.
Analysts estimate that the full inclusion in the Bloomberg Barclays index will attract around $150 billion of foreign inflows into China's roughly $13 trillion bond market, while the MSCI inclusion will also attract billions of inflows.
On Thursday afternoon during Asia trading hours, the offshore yuan was trading at about 6.92 to the dollar, while the onshore yuan was around 6.90 to the dollar.
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