China Faces Constraints in Using Yuan Devaluation Amid Intensifying U.S. Trade War

As trade tensions between the United States and China escalate, Beijing is treading carefully regarding the devaluation of its currency, the yuan. While a weaker yuan could potentially offset the impact of increased U.S. tariffs, Chinese policymakers are wary of the financial instability such a move might trigger.

Recently, the offshore yuan fell to a record low of 7.4287 against the U.S. dollar, and the onshore yuan weakened to 7.3509, its lowest since 2007. This depreciation followed the People's Bank of China's decision to set its midpoint rate at the weakest level since 2023. These developments have led to speculation that Beijing might allow further weakening of the yuan to cushion the effects of U.S. tariffs.

However, analysts caution against significant devaluation due to potential capital outflows and market volatility.

Past instances, such as the 2015 devaluation, resulted in substantial capital flight, prompting tighter capital controls.

Consequently, many experts believe that China will opt for a gradual and controlled depreciation rather than a sharp decline.

In response to the escalating trade war, China is also considering alternative measures to support its economy. These include boosting domestic demand through fiscal stimulus rather than relying solely on currency tools.

Additionally, China holds significant U.S. Treasury securities, estimated at $1.2 trillion, which could be leveraged strategically.

However, any drastic actions concerning these holdings could have global financial repercussions.

Amid these developments, financial markets remain volatile. Investors are closely monitoring China's policy decisions, as any significant moves could have far-reaching implications for global trade and economic stability.