China Poised to Boost Banks’ Liquidity to Counter Weaker Yuan
People’s Bank of China officials say another reduction in banks’ reserve-requirement ratio is imminent
BEIJING—The People’s Bank of China is preparing to flood the country’s banking system with new liquidity to boost lending, according to officials and advisers to the central bank, as a weaker currency could spur more funds leaving Chinese shores.
The step—which involves cutting the deposits banks are required to hold in reserve—would signal that the Chinese central bank’s exchange-rate maneuvering in the past two weeks is backfiring, forcing it to resort to the same easing measures that so far have failed to help spur economic activity.
The move, which the people say could come before the end of this month or early next month, would involve a half-percentage-point reduction in the reserve-requirement ratio, they say, potentially releasing 678 billion yuan ($106.2 billion) in funds for banks to make loans.
It would be the third comprehensive reduction in the reserve requirement this year. Another option being considered at the PBOC is to only target the cut to banks that lend large amounts to small and private businesses—the ones deemed key to China’s future growth—though that strategy hasn’t proven effective in the past in channeling credit to those borrowers.
On Aug. 11, the PBOC engineered a nearly 2% decline in the yuan’s official rate set by the central bank against the dollar, which has resulted in a decline of 4% in the currency’s market rate—the yuan’s steepest slide in two decades. The central bank tied the devaluation to its effort to make the exchange rate more market-driven, as investors have shifted in the past year to now expect the currency to weaken rather than strengthen.
But the devaluation came at a time when a faltering stock market had already severely battered investors’ faith in the government’s ability to manage the economy. And as fears grow of a deepening slowdown, the yuan has kept falling, and the PBOC has resorted to a strategy it has said it would use less: direct intervention to control the yuan’s value.
The latest interference has involved selling dollars and buying yuan to keep the Chinese currency from plummeting. Analysts at Orient Securities Co., a Shanghai brokerage, estimate the central bank has spent more than $40 billion of China’s roughly $3.6 trillion foreign exchange on the currency intervention. As the actions have effectively drained yuan funds from the market, the PBOC last week pumped 260 billion short- to medium-term funds into the financial system to offset the liquidity squeeze.
However, that may not be enough as the slowing economy and weaker currency would trigger greater capital outflows. Yuan positions at Chinese banks accumulated from foreign-exchange purchases fell by a record 249.1 billion yuan in July, a sign that more money is leaving China.
“A new round of reserve-requirement reductions is inevitable,” said Zhang Ming, a senior economist at the Chinese Academy of Social Sciences, a government think tank. Mr. Zhang projects as many as four such cuts in the rest of the year.
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Still, within the central bank, doubts remain about the effectiveness of such measures, according to the officials and advisers. The latest PBOC data show the government’s efforts to prop up share prices since early July have resulted in a surge in lending to financial institutions, but loans to the real economy have slumped. In addition, a further significant increase in China’s broad money supply of $21 trillion, nearly twice the size of the U.S.’s, could push up inflation and cause asset bubbles.
“The central bank would have preferred not to flood the market again with liquidity, if only it had a choice,” said one of the officials close to the central bank.
The dilemma shows that China’s monetary policy largely remains at the mercy of its still-rigid exchange-rate system. Beijing’s desire to control the yuan’s value, as evidenced by the recent currency intervention, means that unlike the U.S. Federal Reserve and other central banks, the PBOC still lacks the ability to conduct an independent monetary policy. That is because buying or selling the yuan to influence its exchange rate would affect domestic liquidity, causing the central bank to have to adjust its monetary policy as a result.
“We call it Zhou Xiaochuan’s dilemma,” said Wang Jian, an analyst at Orient Securities, referring to the PBOC’s long-serving governor.
For most of the past decade, the PBOC had sold yuan and bought dollars to keep the Chinese currency from rising too fast, which resulted in a massive foreign-exchange reserve and led the central bank to soak up the liquidity by raising the reserve-requirement ratio for banks. Since last year, as market expectations for the yuan’s direction changed to depreciation from appreciation, China has experienced some unnerving capital outflows and the central bank has had to instead cut the reserve-requirement ratios to keep capital from leaving the country as well as to boost market liquidity.
The PBOC has debated whether to devalue the yuan for a long time, according to the officials and advisers. It had resisted the action largely because of its desire to turn the yuan into a global currency, as a weaker yuan could hurt its appeal to international businesses and investors. But in recent weeks, as China’s economy continued to sputter, the central bank found itself having to bow to the depreciation pressure from within the Chinese government.
‘A new round of reserve-requirement reductions is inevitable. ’
—Zhang Ming, a senior economist at the Chinese Academy of Social Sciences
In the months before its surprise move on Aug. 11, the central bank had kept the yuan largely unchanged against the dollar, effectively pushing it higher against currencies in other emerging markets and hurting China’s exporters. In fact, until the depreciation action, the yuan had strengthened by 55.7% against the currencies of its trading partners, after adjusting for inflation, since the Chinese currency was allowed to float somewhat in mid-2005. The yuan had appreciated roughly 33% against the U.S. dollar over the same period.
At a news conference on Aug. 13 explaining its devaluation decision, Zhang Xiaohui, an assistant PBOC governor, said that to keep the value of the yuan—also known as renminbi, or People’s currency—more in line with those of its peers, “there’s a certain need to devalue renminbi against the dollar.” PBOC officials also hinted in recent days that the central bank is largely done guiding the yuan lower and will now focus on holding the line at around 6.4 yuan a dollar.
Some within the Chinese government viewed the PBOC’s strategy of combining the yuan depreciation with market reforms as a smart move that could fend off criticism from China’s critics. Others, however, think the central bank’s timing is questionable and that better communication by the central bank could have avoided some of the subsequent volatility and what some call a market overreaction to the yuan-devaluation move.
Press officials at the central bank didn’t respond to requests for comment.