China will not (re)enter the currency war

Via FTAlphaville comes a very good list from Nomura on why China is not going to devalue the yuan:

Pros

1. Makes exports more competitive, helping to boost growth.

2. Raises the cost of imports, helping to reduce the risk of CPI deflation.

Cons

1. We have shown that very large net hot-money outflows, which tend to occur in tandem with market expectations of CNY/USD depreciation, can push the balance of payments into a deficit. Thus, there appears to be a significant risk of a self-fulfilling spiral forming: more hot-money outflows fuels greater expectations of CNY/USD depreciation, and so on. The result could be an unintended exchange rate depreciation overshoot, or a loss of FX reserves.

2. Hoarding of foreign currencies (FC) from local corporates. From February 2014 to August 2014, RMB depreciation fears prompted a USD112.3bn rise in corporate FC deposits. Although local corporate FC deposits fell from September to December 2014, increased depreciation fears could prompt another rise (Figure 12);

3. Increased RMB depreciation fears can prompt an increase in RMB FX volatility through lower RMB trade settlement flows (Figure 13). Examples of this were seen during the European financial crisis in both Q2 2012 and Q2 2013. This could lead to USD/CNH breaching the weak side of the band;

4. Currency depreciation could cause credit stress (Chinese corporate have significantly increased their foreign currency borrowing in recent years) and a rise in investors’ perceived risk premiums, which can lead to higher market interest rates and reduce the effectiveness of PBoC monetary easing.

5. For a country striving to internationalise its currency, a weak CNY policy sends the wrong message. This is especially important this year for the CNY to be included in the IMF’s SDR basket (5-year review expected this year). We note that, when depreciation expectations were elevated during the US financial crisis, European financial crisis and local market/growth pressures in early 2014, RMB deposits in major financial centres such as HK fell (Figure 14).

6. The boost to exports and growth from CNY depreciation is likely to be limited, as China is still a large outsourcing centre for factories of multinational corporations. CNY depreciation raises the cost of imported inputs that are assembled in China for export, thus limiting the competitive boost to exporters.

7. In any case, China already records record trade surpluses. Increasing these further could provoke a protectionist reaction from its trading partners.

8. The main reason for China’s economic growth slowdown is weakening domestic demand, especially investment. The best antidote is reforms and supportive domestic macro policies, not CNY depreciation.

9. While CNY depreciation can help ease the risk of deflation, higher CPI inflation from more costly imports is not what China needs. This could have the unintended consequence of further weakening domestic demand.

10. CNY depreciation contravenes China’s longer-run goal of economic rebalancing away from export-intensive SOEs, heavy-polluting industries and investment and towards inward focussed private enterprises, services industries and consumption.

1, 4, 8 and 10 are the key points and summarise why devaluation would run against everything that China is currently aiming to achieve.