Yuan Intervention Eases as Slowdown Curbs Inflows: China Credit

Yuan Intervention Eases as Slowdown Curbs Inflows
Chinese 100 yuan bank notes are arranged for a photo in Beijing, China. Photographer: Nelson Ching/Bloomberg

China’s central bank bought the fewest dollars in four months to stem gains in the yuan in June as slowing growth in Asia’s biggest economy damped capital inflows and reduced pressure for the currency to appreciate.

The People’s Bank of China’s purchases of foreign exchange from the nation’s lenders totaled 277.3 billion yuan ($42.8 billion), 26 percent less than in May, according to data released yesterday. Foreign reserves rose $152.8 billion in the second quarter, the least in a year, and government data today showed gross domestic product increased at the slowest pace since 2009.

Expansion is cooling after policy makers raised interest rates three times this year and lenders’ reserve-requirement ratios on six occasions, seeking to tame the fastest inflation since 2008. Forward contracts show investors are the least bullish on yuan gains since a dollar peg ended in June 2010, even after the currency trailed advances in both Brazil’s real and the Russian ruble this year. The average yield on yuan bonds in Hong Kong jumped 62 basis points, or 0.62 percentage point, since May, based on an HSBC Holdings Plc index.

“Rising hard-landing risks are dimming the allure of yuan-denominated assets, resulting in fewer hot money inflows,” said Liu Dongliang, a senior analyst in Shenzhen at China Merchants Bank Co., the nation’s sixth-largest lender. “Inflows may decline further in the second half, lessening the need for the central bank to raise reserve ratios. The PBOC is likely to raise ratios no more than once before the end of 2011.”

Yuan Policy

Major lenders’ reserve-requirement ratios were raised to a record 21.5 percent on June 20, three percentage points higher than at the start of the year. Increases help drain cash from the financial system as the PBOC issues yuan for dollars pouring into the country, a policy designed to limit currency gains.

The yuan has strengthened 2.1 percent against the dollar this year, trailing a 7.9 percent advance in Russia’s ruble and 5.1 percent appreciation for Brazil’s real, according to data compiled by Bloomberg. India’s rupee was little changed.

Twelve-month non-deliverable forwards for the yuan strengthened 0.15 percent to 6.4131 per dollar, a 1 percent premium to the spot rate, as of 10:30 a.m. in Hong Kong. The gap ended yesterday at a 13-month low of 0.9 percent. The yuan gained 0.04 percent to 6.4699 in Shanghai today, having weakened in the last two days as concern Europe’s sovereign debt crisis will worsen bolstered demand for dollars as a refuge.

‘Nice Problem’

China should keep the yuan’s exchange rate flexible to some extent, the China Securities Journal reported July 11, citing central bank adviser Xia Bin. Policy makers should continue using open-market operations and increases in reserve-requirement ratios to drain “unreasonable” additional cash from the economy, the report said.

“Slowing inflows is a nice problem to have because it will afford the central bank room and time to control the pace of tightening rates and reserve ratios,” Paul Chan, chief investment officer in Hong Kong at Invesco Asia Ltd., a unit of Atlanta-based Invesco Ltd., which manages $654 billion of assets, said in a phone interview yesterday. “I still think they are a little bit behind the curve, but which problem would you rather have: inflation or a sovereign-debt crisis?”

Consumer prices climbed 6.4 percent in June from a year earlier, the most in three years, the government reported July 9. Gross domestic product rose 9.5 percent in the second quarter following a 9.7 percent gain in the previous three months, according to data released today. Growth exceeded the median estimate of 9.3 percent in a Bloomberg survey of economists.

Swap Rate Falls

Premier Wen Jiabao pledged to curb price increases and prevent “big fluctuations” in economic growth, according to a statement on the State Council’s website yesterday.

China’s one-year swap contract, the fixed cost needed to receive the floating seven-day repurchase rate, rose three basis points to 3.77 percent in Shanghai, climbing from a two-week low, according to data compiled by Bloomberg. The repo rate, which measures interbank funding availability, fell 1.16 percentage points to a five-week low of 3.68 percent, based on a weighted average rate compiled by the National Interbank Funding Center.

The yield on 10-year government bonds was little changed at 3.89 percent yesterday, according to the Interbank Funding Center prices. It reached 4.00 percent on June 15, the highest level since February.

Yield to Decline

“The central bank may not raise interest rates or lift reserve-requirement ratios in the second half because of the slowing economy,” said Jiang Chao, a bond analyst in Shanghai at Guotai Junan Securities Co., the nation’s biggest brokerage by revenue. “This round of tightening is probably approaching its end. The yield on 10-year government bonds may decline to 3.5 percent by the end of this year.”

Growth is likely to ease to 8.4 percent and 7.8 percent in the third and fourth quarters, Jiang said.

Five-year credit-default swap contracts on the nation’s bonds were unchanged at 93 basis points yesterday, according to data provider CMA which compiles prices quoted by dealers in the privately negotiated market. The contracts insure debt against non-payment, and traders use them to speculate on credit quality. An increase suggests deteriorating perceptions of creditworthiness and a drop shows improvement.

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