Why PBOC’s halt in currency intervention may be temporary
China’s foreign exchange reserves edged higher to US$3.009 trillion at the end of March, from US$3.005 trillion a month earlier
The People’s Bank of China (PBOC) , the central bank, largely suspended currency intervention last month. However, that may be temporary, according to analysts, and the yuan could start depreciating again in response to a renewed rally in the US dollar.
China’s foreign exchange (FX) reserves edged higher to US$3.009 trillion at the end of March, from US$3.005 trillion a month earlier, according to the latest official statistics, which marks the first time in almost a year they have risen for two straight months.
“At face value, then, the relative stability of the headline reserves figure suggests that after selling FX to prop up the renminbi for 16 straight months, the PBOC largely halted its intervention in March,” said Julian Evans-Pritchard, China economist for Capital Economics.
He added valuation effects should be “fairly neutral” last month, as a fall in bond prices has offset the impact of a weaker US dollar and boosted the value of the portion of the reserves held in other currencies.
Also behind the shift is a moderation in capital outflows.
“Outflows have shrunk considerably since late last year and now appear small enough to be mostly offset by the trade surplus, ” said Evans-Pritchard, a view shared by Wei Yao, an analyst with Societe Generalem who added year-on-year declines in banks’ net FX sales and net cross-border payments looked much more sizeable than seasonally usual, too, in January and February.
Most notably, monthly outward foreign direct investment data from the Ministry of Commerce showed a deep cutback in Chinese corporate overseas investment in the past few months.
When it came to inflows, the trend to re-leverage by the Chinese government seems to have gained further momentum.
“Chinese corporate issuance of foreign currency bonds has quickened meaningfully in the past two months,” Wei said.
“Increasing, external debt is likely to be the most effective means of boosting inflows in the near term.”
Larry Hu, an analyst with Maquarie Capital, said two factors had contributed to the easing of outflows.
First, the Chinese government has tightened capital controls significantly since the second half of last year, and the weak US dollar, which has helped slow outflows.
Evans-Pritchard believes the second factor is more important, suspecting the PBOC’s halt in currency intervention now heralds a longer-term policy change.
“The obvious follow-up question is whether this halt to official intervention is a temporary phenomenon or more permanent shift. Our hunch is that it will be temporary, ” he added.
But the recent stability of the yuan against the US dollar has tempered depreciation expectations, “the by-product of a pause in dollar appreciation, rather than a change in Chinese policy”.
He cautions if the US dollar strengthens again later this year, capital outflows could gather steam again, prompting the Chinese central bank to react to defend the currency.
Since the start of the year, the yuan has appreciated 0.7 per cent against the greenback, but against the China Foreign Exchange Trade System (CFETS) basket of currencies, the yuan has fallen sharply, down 2.4 per cent.
The CFETS index is a trade-weighted yuan index administered by the PBOC to measure the exchange rate against 24 currency peers.
The PBOC has been “reluctant” to allow the yuan to strengthen in trade-weighted terms, said Evans-Pritchard, meaning the yuan would likely weakening again, in response to a renewed dollar rally.
“This could trigger a shift back to more bearish views on the renminbi,” he said, “and spark a rebound in capital outflows, which would push the PBOC to resume its FX sales.”