Currency manipulators’ sifted sanction sequence

After a month of considering Asian emerging financial market implications of Trump Administration rhetoric against alleged unfair currency policies, investors have shifted attention from the presumed number one target China to neighbors like Korea and Taiwan that have also regularly featured in US Treasury Department reports.

The legislation to track practices and potentially brand manipulators for trade retaliation dates back decades and only recently were broad definitions of the main country universe and interference proposed based on current account surplus and deliberate depreciation formulas. The previous Obama Treasury team offered the framework in the absence of detailed guidance from the WTO, which does not handle currency disputes, and the IMF, whose research continues to work on globally-acceptable norms. President Donald Trump in a cordial February visit with Japanese Prime Minister Shinzō Abe seemed to give the issue a pass, after excoriating the quantitative easing-driven low yen during the campaign as an auto export advantage in particular.

After he also affirmed the “One China” stance as Beijing authorities in contrast to historic trade experience act to boost the renminbi, the big bilateral relationship also appeared to be outside the crosshairs for now. However, such a conclusion could be premature given the determination to negotiate new regional deals around currency concerns as a signature priority, which could also subject erstwhile TPP members and other countries to stricter monitoring and possible manipulator labeling.

The US Commerce Department reportedly has a plan to classify non-market devaluation as an “unfair subsidy” under existing anti-dumping rules, even if the WTO does not recognize the interpretation. Tariffs could then be imposed in response, and Goldman Sachs estimates that a 10% one would reduce Chinese GDP growth 1% and also result in a 25% American export fall.

This action could proceed as the central bank continues to burn through reserves, spending over $300 billion last year, to defend rather than suppress value. The consensus RMB rate is 7.2 to the dollar this year, according to a Reuters’ analyst poll. The capital outflow trend which recently brought the reserve total below $3 trillion will endure, with another $550 billion due to exit in 2017, the Washington-based Institute for International Finance calculates. The state foreign exchange body has curbed outbound “irrational” investment and now requires documentation for over $50,000 in foreign company profit repatriation.

The Trump administration may also attempt to tighten oversight of Chinese company takeovers especially in strategic industries through the Treasury Department’s CFIUS board, in part to keep exchange rate pressure on Beijing. Mainland overseas investment in the US and Europe more than doubled to $95 billion in 2016, but another $75 billion in deals were shelved on a combination of regulatory and currency restrictions, according to a tally by law firm Baker McKenzie. The Trump moves aside, foreign portfolio investors remain wary of yuan exposure, as they barely participated in $15 billion in stock exchange IPOs over the past three months, the most since early 2015, and RMB deposits in Hong Kong fell at a record pace through December.

Korea may have been closest to manipulator status after warnings in last year’s Treasury Department report expressing skepticism over “smoothing” operation claims. The won is up over 5% against the dollar since January, but the Peterson Institute for International Economics puts lingering undervaluation at the same level.

The current account surplus is 8% of GDP with one-quarter of the positive trade balance with the US, and the country recently extended a currency swap agreement with Malaysia. Although regulators have assigned top priority this year to managing runaway household debt, at the highest ratio to output among all emerging markets, a local think tank cautioned that Korea could be first in the currency firing line “to avoid extreme China confrontation,” with the 2012 bilateral free trade accord at risk, even as pacts with other partners provide a backstop.

Taiwan has no such network as a diplomatic pariah, with abundant reserves equal to 85% of GDP and estimated undervaluation of 25%, according to experts. The new government has chilly relations with the mainland, and banking and tourism flows are down. Institutional investors like insurers have long allocated their assets heavily abroad in part to divert the local dollar’s upward push, and future negotiations with Washington could insist on greater reciprocal access.

Traditionally bypassed smaller countries like Thailand, where the EU has already suspended its FTA in protest over the military coup, could also be immediate pickings for currency redress as the Trump cabinet and advisors look to establish their self-proclaimed more even field.