China’s Central Bank Prioritizes Strong Yuan When Managing Liquidity

Minutes of PBOC meeting highlight dilemma facing China’s central bankers

By Lingling Wei

China's national flag is seen in front of a poster explaining the design of new 100 yuan note at a bank in Beijing on Jan. 21, 2016.

China's national flag is seen in front of a poster explaining the design of new 100 yuan note at a bank in Beijing on Jan. 21, 2016. Photo: Reuters

China’s central bank faces a tough balancing act, trying to ease credit in the financial system without adding to pressures weakening the Chinese currency.

Concerns about the yuan and the annual cash crunch ahead of next month’s Lunar New Year holiday dominated a meeting held by the People’s Bank of China on Tuesday, according to minutes of the meeting reviewed by The Wall Street Journal and to accounts from banking executives close to the PBOC.

Central bank officials delayed using a traditional credit-easing tool for fear that it could add more downward pressure on the yuan, according to the minutes and the executives. Instead, to meet the rising cash needs from banks, the central bank turned to short-term and medium-term loan facilities to pump about 1.6 trillion yuan ($243 billion) of temporary liquidity into the banking system in the past week.

The decision highlights the bank’s deepening dilemma in helping to cushion the slowing Chinese economy.

Just a year ago, the PBOC addressed preholiday cash demands by resorting to a more typical method—cutting the amount banks are required to keep in reserve. Since then, the economic slowdown and volatility in the stock markets have led to a flood of capital leaving China, as Chinese investors seek better returns abroad. The yuan, also known as the renminbi, has been battered harder than the central bank would like, even as it faces calls to keep easing credit and rekindle growth.

“Currently, we need to put a high emphasis on maintaining the renminbi’s stability when managing liquidity,” Zhang Xiaohui, an assistant governor at the central bank, said at the Tuesday meeting, according to the minutes. Ms. Zhang said cutting the reserve requirement would send “too strong an easing signal,” so the bank should turn to other tools.

A reduction in so-called reserve-requirement ratio frees up funds for banks to lend on a permanent basis, while injecting liquidity through short-term and medium-term tools means the money can be taken back by the central bank when those loans expire.

Ms. Zhang told officials at the meeting that the combination of cuts to interest rates and reserve requirements made by the central bank in late October contributed to the pressure on the yuan. “Because of the double reductions, there was too much liquidity and depreciation pressure on the renminbi,” she said.

Ahead of Tuesday’s meeting, China’s big banks called on the central bank to cut the reserve requirement in the lead-up to the holiday. But the central bank balked at doing that because of worries over the stability of the yuan, the banking executives close to the PBOC said.

“They decided to put off the reserve-requirement cut until later,” one of the executives said.

The executive said the central bank would have to make the cut “at some point” because the surge in money leaving China, as well as the PBOC’s efforts to buy yuan to prop up its value, are squeezing liquidity.

The state of the Chinese economy, which Beijing says decelerated to 6.9% growth last year, and whether the yuan will collapse have become a worry for global investors, who have counted on China as a source of growth for more than a decade. That anxiety has been noticed by Beijing.

At the World Economic Forum in Switzerland last week, Chinese officials sought to allay fears of a hard economic landing, pointing to the progress made in moving the economy away from manufacturing and toward consumption. While pledging to continue that restructuring, the officials also said China needs to keep the economy growing at a reasonable rate, and has the policy tools to achieve that.

At Tuesday’s meeting at the PBOC’s headquarters in central Beijing, which was attended by senior Chinese banking officials, Ms. Zhang said: “The economic stability of China has become more relevant to the whole world.” She noted that minutes of meetings of the U.S. Federal Reserve cited uncertainty over China’s economy as a reason the Fed delayed raising interest rates in September.

Despite that, the PBOC is struggling to manage and communicate its policies. A series of surprises and reversals over the past six months—a devaluation, a new way to fix the yuan’s rate for foreign-exchange trades each day, and a move to use a basket of currencies, not just the U.S. dollar, for valuing the yuan—contributed to selloffs of the currency and left investors scratching their heads.

“They really want an orderly depreciation of the yuan,” said Raymond Nolte, chief investment officer at Skybridge Capital, a New York asset-management firm that oversees more than $13 billion in financial assets. “Question is if they can manage that.”

The uncertainties have affected Chinese who have rushed to move money offshore amid rumors that the government might tighten a $50,000 annual limit for individuals exchanging yuan and transferring it out of the country.

Speaking at the Tuesday’s PBOC gathering, Yi Gang, a deputy central bank governor, warned banks against encouraging their customers to exchange their Chinese currency for dollars at a time of growing expectation for a weaker yuan.

The $50,000 limit hasn’t changed, Mr. Yi said, according to the meeting’s minutes. “I want to remind everyone,” he said, “if anyone disseminates false information and causes any panic, such actions will be investigated.”

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