China should keep its exchange rate flexible if additional intensification of the trade war with the U.S. threatens further harm to the economy, according to an International Monetary Fund report completed before the recent escalation of tensions.
If the U.S. raised tariffs to 25% on remaining Chinese imports, that could trim growth by 0.8 percentage point over the following year by reducing demand and tightening financial conditions and lead to “significant negative spillovers globally,” the IMF said in its annual report on China’s economy released Friday in Washington.
“Against this shock, further easing, primarily through fiscal measures, would be warranted,” the IMF said in staff comments dated July 12. “The exchange rate should remain flexible and market-determined to help absorb the tariff shock. Greater depreciation pressures and potential capital outflows will call for clear public communication and possible FX intervention to counter disorderly market conditions.”
President Donald Trump last week threatened to impose a 10% tariff on a further $300 billion in Chinese imports starting Sept. 1 and said levies could eventually go higher.
The report comes as the world’s second-largest economy slows amid a widening trade war and the Trump administration formally labeling China a currency manipulator after the yuan broke the 7 per dollar level Monday. July data showed the industrial sector is slipping back into deflation, and the outlook is poised to dim further if additional tariffs take effect.
The IMF had said in a June release on the completion of its annual Article IV mission to China that it had trimmed forecasts for 2019 economic growth to 6.2%, as the trade war adds to risks. That matches the growth estimate from economists surveyed by Bloomberg, who project growth will decelerate to 6% next year and 5.8% in 2021.
The fund’s report Friday projected gross domestic product growth slowing to 5.5% in 2024 and said it could decelerate to 4% by 2030. “Growth is expected to remain strong in the medium term, but slow gradually as the economy shifts further from the industrial sector to lower-productivity service sectors,” it said.
IMF staff also said in updated projections that public debt as a share of GDP will rise from 72.7% last year to 80.2% this year and 101.5% in 2024. Those augmented fiscal data expand the measure of government borrowing to include local government financing vehicles and other off-budget activity.
The IMF noted that Chinese officials “continued to disagree” with the IMF’s use of augmented government debt figures and argued “local governments did not bear any responsibility for the financial obligations of local government financing vehicles” and other certain funds.
The IMF said directors on its executive board, which concluded its annual review of China on July 31, “concurred that greater exchange rate flexibility and deeper and better functioning FX markets would help the financial system prepare for greater capital flow volatility.” Some directors called for disclosure of foreign-exchange interventions.
IMF Mission Chief for China James Daniel, speaking on a conference call just after the release of the report, repeated that the fund sees the yuan as “broadly in line with fundamentals,” not significantly overvalued or undervalued. That echoed the findings of the IMF’s annual External Sector Report released in July.
Underscoring the tensions between the two largest economies, Daniel spoke around the same time as White House trade adviser Peter Navarro appeared in a CNBC interview, saying that China is clearly manipulating the currency from a trade point of view. “I don’t want them to devalue their currency, but they’re going to and we’re going to take strong action against them,” Navarro said. “This is how the Chinese are dealing with it and they’re hurting themselves.”
Under the Trump administration’s designating China a currency manipulator this week, the Treasury Department said Secretary Steven Mnuchin will engage with the IMF “to eliminate the unfair competitive advantage created by China’s latest actions.” Daniel said on the call Friday that the fund’s discussions with the Treasury continue on a range of issues, without offering additional specifics.
Friday’s IMF report also noted improvement in monetary policy and financial stability communications, citing the central bank’s English-language website, regular press conferences, expanded Q&As, and publishing stress-test results in its annual financial stability report.