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July 21, 2014

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PBOC cuts back on currency market intervention, but not totally hands off

Source: Agencies | July 21, 2014, Monday | Print Edition

CHINA’S central bank has reduced heavy intervention in the currency market, removing a thorny issue in relations among the world’s top two economies, but traders say the People’s Bank of China (PBOC) isn’t about to take its hands off the wheel.

Chinese firms, including banks, have increasingly held on to dollars as capital inflows into China slow as a result of slowing economic growth and particularly after the PBOC let the yuan surprisingly fall in the first four months of 2014.

The rough balance of dollar supply and demand in the market as a result of these developments will enable the central bank to reduce the frequency of its operations to control the yuan’s exchange rate in future. But the PBOC — with a trading room of its own in the China Foreign Exchange Trade System and often acting via state banks — is likely to keep quoting the yuan every day and conducting routine trading through which it can guide its movements and prevent its value from running out of control, traders said.

“All data points to evidence that the central bank has indeed reduced its intervention into trading to influence the value of the yuan in recent months,” said Liu Dongliang, a currency strategist at China Merchants Bank in Shanghai.

“Market anticipation of the yuan’s future value has changed a lot after the yuan’s unexpected depreciation earlier this year, with firms more reluctant to sell dollars they earn. Still, the PBOC’s daily activity will last at least for another couple of years as the market learns to operate without the central bank’s guidance, among other reasons.”

PBOC Governor Zhou Xiaochuan said this month during the annual US-China Strategic and Economic Dialogue that China would “significantly” reduce its yuan intervention when some prerequisites are met. US officials say China deliberately holds down the yuan to boost its exports, an accusation China denies.

The PBOC engineered a fall in the yuan earlier this year, guiding it down by as much as 3.4 percent by the end of April, to dampen speculative bets on one-way yuan appreciation.

Since May, however, the central bank has shifted to holding the currency steady, suggesting that its drive to guide the yuan lower was largely over, although the yuan is still down 2.5 percent so far this year.

China’s trade surplus widened sharply to a five-year high of US$35.9 billion in May from April’s US$18.5 billion, but Chinese banks posted a surplus of only US$6.8 billion in their foreign exchange settlements for their clients in May — the smallest in 10 months and the fourth straight month of falls. That indicates that Chinese corporates are retaining much of their foreign currency earnings, partly reflecting changed market views of the yuan’s future value, traders said.

“Reflecting the new trend, the market has now shifted its attention more toward real dollar demand from corporate orders and away from policy factors,” said a dealer at a European bank in Shanghai.

As a result, the PBOC and commercial banks together bought just 38.7 billion yuan (US$6.22 billion) of foreign exchange on a net basis in May, down from 116.9 billion yuan in April, the lowest level since last September. The dip reflects less capital inflows into China, traders said.

More surprisingly, the PBOC’s foreign exchange assets only edged up 361 million yuan in May, down from an already thin 84.6 billion yuan rise seen in April, the lowest growth since July last year. The increase and decrease in its forex assets reflect its dollar purchases and sales in the yuan market. Compared with overall banks’ dollar purchases, the virtually flat PBOC forex assets show that commercial banks have also tended to keep more dollars on hand.

“These data points are supported by others,” said a trader. “Banks’ forex deposits and loans have also showed corporates increasingly retaining dollars as assets while denominating liabilities in yuan.”

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