PBOC ups ante in quest for stability as Zhou breaks long silence

FEB 15, 20168:02 AM

[HONG KONG] China's central bank has stepped up efforts to restore stability to the nation's currency and economy, with Governor Zhou Xiaochuan breaking his long silence to say there's no basis for continued yuan depreciation.

The nation's balance of payments is good, capital outflows are normal and the exchange rate is basically stable against a basket of currencies, Mr Zhou said in an interview published Saturday in Caixin magazine. That's an escalation in verbal support after such comments have been left in recent months to deputies and the central bank research department's chief economist.

Mr Zhou dismissed speculation that China plans to tighten capital controls and said there's no need to worry about a short-term decline in foreign-exchange reserves. The country has ample holdings for payments and to defend stability, he said.

"He's desperately trying to make sure that all of his work in the past few years on capital liberalization does not go to waste," said Victor Shih, a professor at the University of California at San Diego who studies China's politics and finance. "He's trying hard to instill investor confidence in the renminbi so that the Chinese government does not have to resort to the extreme measure of unwinding all of the progress on offshore renminbi in the past few years."

The comments come as Chinese financial markets prepare to reopen Monday after the week-long Lunar New Year holiday. The weakening exchange rate and declining Chinese share markets have fueled global turmoil and helped send world stocks to their lowest levels in more than two years.

AMPLE LIQUIDITY

Lost amid the angst over China's stocks, currency and sliding foreign exchange reserves is the flush liquidity situation at home. The People's Bank of China has been putting its money where its mouth is, pumping cash into the financial system to offset record capital outflows amid fears the yuan could weaken further.

Data due Monday is expected to show China's broadest measure of new credit surged in January on a seasonal uptick in lending, and as companies borrowed to pay off foreign debt. Aggregate financing likely grew 2.2 trillion yuan (S$468 billion), according to the median forecast of a Bloomberg survey of economists.

Bloomberg's China Monetary Conditions Index, a gauge that includes inflation-adjusted interest rates and the exchange rate, has been improving since June. Past episodes of improvement have presaged either an acceleration in economic growth, or a stabilisation.

Even as foreign exchange reserves have declined since mid 2014 - to a four-year low of US$3.23 trillion in January - M1 money supply has continued to rise.

CASH INJECTIONS

The central bank has turned to cash injections instead of cutting benchmark interest rates, as cuts could further exacerbate capital outflows.

Net injections have totaled more than 1 trillion yuan since mid-January, or about the same as a 1 percentage point cut to banks' required reserve ratios - the traditional way to boost liquidity. The difference is that injections are temporary and can be scaled back if policy makers don't roll over lending facilities, whereas a RRR cut is more permanent.

"The actions taken already arguably have taken away the need for an immediate 'announcement event' of a reserve ratio cut, which could have hit sentiment towards the yuan further," said David Mann, chief Asia economist at Standard Chartered Plc.

China has no incentive to depreciate the currency to boost net exports, and there's no direct link between the nation's gross domestic product and its exchange rate, Mr Zhou said in the Caixin interview.

Capital outflows need not be capital flight, and it would be hard to implement tighter controls because of the size of global trade, the movement of people and the number of Chinese living abroad, he added.

The country will not peg the yuan to a basket of currencies but rather will seek to rely more on a basket for reference and try to manage daily volatility versus the dollar, Mr Zhou said. The bank also will use a wider range of macro-economic data to determine the exchange rate, he said.

PACKED CINEMAS

Meantime, China's economy continues to give mixed signals. While areas like consumption and services show signs of holding up, the manufacturing sector remains in the doldrums. Trade numbers due Monday are expected to show that exports fell 1.8 per cent in US dollar terms in January from a year earlier, while imports dropped 3.6 per cent.

Retail sales over the Spring Festival holiday rose 11.2 per cent from the same vacation period a year earlier, with cinemas posting sharp increases in box-office sales, the country's Ministry of Commerce said in a statement Saturday.

A fuller reading on how China's economy has started 2016 won't be available until next month, when fresh readings on retail sales, investment and industrial output are due.

"The flush monetary condition is expected to help buffer the acute downside risk in the Chinese economy," said Andy Ji, a Singapore-based foreign-exchange strategist and economist at Commonwealth Bank of Australia.

BLOOMBERG