China shrugging off Fed action as yuan depreciation pressure eases

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Action to stem capital flight and stabilise the yuan have worked, helping Chinese policymakers avoid having to lock step with the US Fed, economists sa

China’s monetary authority has shrugged off the US Federal Reserve’s fourth interest rate increase in two and a half years this week, as the Chinese macroeconomic reality demands a different tool kit and a radically different approach to its previous policies, economists said.
The Fed’s two interest rate increases in December 2015 and December 2016 led to massive outflows of funds from China’s shores and a 7 per cent depreciation in the renminbi, that was only stabilised after the People’s Bank of China spent hundreds of billions of dollars from the country’s reserves to prop up the renminbi.
After the Fed’s widely telegraphed 25 basis point interest rate increase on June 14, the Chinese central bank injected 90 billion yuan of funds into the interbank market, keeping the rates of the 7-day, 14-day and 28-day bills unchanged at 2.45 per cent, 2.6 per cent and 2.75 per cent respectively.
China “has to consider its own economic condition and inflation trend,” said Morgan Stanley’s chief China economist Robin Xing, who said the Chinese authority still has another 40 to 50 basis points of manoeuvring room in the 7-day repos without having to go lock step with the US Feds.
Capital outflows and the yuan’s depreciation, two major policy concerns of Chinese leaders during a year of leadership change, are exerting much less pressure on policymakers than six months ago.
“Certain normalisation of China-US interest rate gap” and the administrative measures to stem capital flight have all helped the world’s second-largest economy shift its monetary policy focus away from currency stability to deleveraging, Xing said.
China also intervened pre-emptively to improve the market’s confidence in its currency. The central bank last month added a counter-cycle adjuster to the yuan’s daily fixing formula, a move that boosted the currency’s exchange rate by about 1 per cent against the US dollar.
That’s forced major banks to revise their exchange rate forecasts time and again, lifting the overall expectations in the market.
There’s unlikely to be any more policy rate increase for the rest of the year, said the Industrial Bank’s chief economist Lu Zhengwei, as the rate is already very high, and it has already affected the economy.
“The actual lending rate [revealed in the first quarter monetary policy report] was already much higher than a year ago, which is almost equivalent to a rate hike,” he said. “It could rise further in the second quarter.”
The PBOC on Wednesday reiterated a prudent and neutral monetary policy and vowed to strike a balance between deleveraging and liquidity stability.
While the drive has seen initial results from the single-digit growth of M2, the broad measure of money supply, and sharp contraction of shadow financing last month, it still hopes to avoid the financial and economic shocks caused by the aggressive deleveraging, especially when stability is much needed ahead of the once-every-five-year leadership reshuffle.
The Chinese economy has shown signs of slowdown from the five-quarter-high of 6.9 per cent in the first quarter. Fixed-asset investment, the major driver of the latest round recovery, has slowed by 0.3 percentage points to 8.6 per cent last month given the constraint of credit supply and higher borrowing rate, while it was only offset by the consumption and export.

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