China Juggles Liquidity And Exchange Rate Without RRR Cut For Now

The People’s Bank of China (PBoC) is planning to use various methods to ensure ample liquidity during the Lunar New York and maintain stable short-term interest rates without cutting commercial banks’ required reserve ratio (RRR), says a research report by UBS.

Citing Chinese media articles detailing speeches by senior central bank officials a few days ago, UBS says that PBoC is concerned that making RRR cuts right now would send too strong an easing policy signal, which may lead to lower short-term interest rates and put further downward pressure on the RMB.

The articles underscores the conundrum faced by the Chinese central bank. The PBoC is trying to stabilize the RMB’s exchange rate, while having difficulties managing the quantity of credit extension as China’s interest rates are liberalized and regulations are relaxed, says the UBS report.

But UBS argues that even though onshore and offshore interest rate differential has been closely tied with capital flows, it is less important when compared to investors’ perceptions of the future movements of the RMB’s exchange rate.

In addition, the bank believes that short-term rates would come down further because of mounting deflationary pressure and rising debt burden in the economy, especially the corporate sector.

The PBoC estimates that holiday-related cash demand may be RMB1.6 trillion or more, and plans to use various methods outside of RRR cuts to fully cover any additional holiday cash demand during the Chinese New Year.

The central bank aims to inject RMB600 billion to RMB800 billion to fill the liquidity gap that may have been caused by capital outflows and other factors.

In addition, it plans to release RMB200 billion to RMB300 billion in standing lending facility (SLF) to meet liquidity demands of small banks during the holiday period.

It also will initiate RMB300 billion to RMB400 billion in medium-term lending facility (MLF) to replenish capital-outflow related liquidity gap, and RMB100 billion in pledged supplementary lending (PLS) to policy banks to help fund key infrastructure projects.

In the past week, the PBoC has already used multiple facilities to release ample liquidity into the system, including RMB315 billion in open-market operations and RMB863 billion in MLF.

Since these facilities are mainly used to manage liquidity demand during the Chinese New York, they would be withdrawn after the holidays.

Afterward, the central bank would need to considering two more interest rate cuts and multiple RRR cuts, forecasts UBS, as it is pressured by persistent capital outflows and the deterioration of corporate balance sheets.

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