Reduced currency market intervention by China’s central bank is fueling speculation it plans to cut lenders’ reserve requirements for the first time in two years to boost its supply of yuan.
The nation’s foreign exchange reserves slid by a record US$105.5 billion in the third quarter to US$3.89 trillion as the People’s Bank of China (PBOC) scaled back US dollar purchases that add yuan to the financial system.
Major lenders need to set aside 19.5 percent of deposits in reserve by June 30 and 19 percent by the end of next year, down from 20 percent now, based on the median forecast in a Bloomberg survey published on Wednesday last week.
The world’s largest currency pool is shrinking as the yuan heads for its first annual loss in five years and economists forecast the slowest economic expansion in 24 years. The PBOC has already cut its reserve requirement ratio (RRR) for some lenders and is pumping cash into money markets to lower borrowing costs.
“The very high RRR is no longer necessary,” Nomura Holdings Inc economist Changchun Hua (花長春) said in an interview on Thursday last week. “If growth is weak, in order to give the market a moderately strong signal, an RRR cut is appropriate.”
Nomura estimated the central bank bought a net US$21 billion in the currency market in the six months through September to limit yuan gains, down from US$106 billion in the first quarter when it was seeking to encourage two-way moves in the currency. The central bank often takes steps to mop the yuan sold in so-called sterilization.
The yuan is close to a reasonable equilibrium level, Guan Tao (管濤), head of the balance of payments department at the State Administration of Foreign Exchange, wrote in an article in the Shanghai Securities News on Thursday last week.
As China promotes a market-oriented exchange rate mechanism and the central bank refrains from regular intervention, the yuan’s exchange rate is set to swing and “we need to stay composed,” he wrote.
“A reserve requirement ratio cut may be inevitable,” CICC economists led by Beijing-based Liang Hong (梁紅) wrote in an Oct. 27 report. “A 20 percent requirement was to sterilize quick growth in forex positions. When the trend reverses, it may be lowered accordingly.”
The central bank provided about 200 billion yuan (US$32.7 billion) of funds to some national and regional lenders last month, after injecting 500 billion yuan into China’s five biggest banks in September, according to people familiar with the matter. The monetary authority also lowered the reserve ratio twice for selected banks in the second quarter. The PBOC last announced a system-wide cut in 2012.
The net foreign exchange rise on the PBOC’s balance sheet was 774.8 billion yuan in the first nine months of this year, according to Bloomberg calculations based on central bank data. That is almost 1 trillion yuan less than that of a year earlier.
“The liquidity provided only matched the drop in foreign exchange positions, the traditional way for base money supply,” said Shi Lei (石磊), Ping An Securities Co Ltd’s Beijing-based head of fixed income research, a unit of the nation’s second-largest insurance company, in a phone interview on Friday last week. “The PBOC will need to continue pumping cash into the system.”
The seven-day repo rate, a gauge of interbank funding availability, declined 235 basis points in the first three quarters of this year, the biggest nine-month slide since the 2008 world financial crisis. The rate was 3.31 percent yesterday, data showed.
The 10-year sovereign bond yield fell to 3.72 percent on Wednesday last week, the lowest level since August last year, according to ChinaBond, before rising to 3.76 percent on Friday last week.
“We expect the PBOC to halt repos within the next three months,” CICC fixed income analysts led by Beijing-based Chen Jianheng wrote in a note on Monday last week. “The PBOC may also use open-market operations to boost money supply in the system. When the yuan’s forex positions declined in 2012 and 2013, the PBOC suspended repos and started reverse repos.”
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