Deutsche Bank Sees PBOC Bill Sales as Inflows Jump: China Credit

Inflows of capital into China are swelling cash supplies and increasing inflation pressure, prompting Deutsche Bank AG and GF Securities Co. to predict the central bank will resume bill sales for the first time since December 2011 next quarter.

The seven-day repurchase rate, which measures interbank funding availability, fell 195 basis points, or 1.95 percentage point last week, to 2.49 percent in Shanghai, according to a weighted average compiled by the National Interbank Funding Center. It jumped 51 basis points to 3 percent today. The London Interbank Offered Rate to borrow dollars for a week was unchanged in the period at 0.17 percent. The yuan gained 0.14 percent to 6.2147 per dollar.

A rebound in the world’s second-biggest economy and zero interest rates in developed nations drove record inflows into yuan assets in January. Premier Wen Jiabao called for “prudent” monetary policy in a speech to the parliament last week, setting 2013’s target for money supply growth at 13 percent from 14 percent last year and for inflation at 3.5 percent from 4 percent.

“Clearly there have been strong capital inflows from the start of this year,” said Linan Liu, a Hong Kong-based rates strategist at Deutsche Bank. “In case of accelerated inflows, the PBOC will have to take away excess liquidity through open-market operations and keep money supply growth stable close to the target.”

Policy makers may resume bill sales in early April, Liu said.

‘Key Consideration’

Yuan positions at local lenders accumulated from sales of foreign exchange to the central bank, an indication of cross-border capital flows into China, rose to a record 684 billion yuan ($110 billion) in January, official data showed on March 5. The yuan strengthened to a 19-year high of 6.2124 per dollar on Jan. 14.

Appreciation pressure was sustained last month. China’s exports rose 21.8 percent in February from a year ago, customs bureau data showed on March 8, beating the median estimate of 8.1 percent in a Bloomberg News survey and taking the trade surplus to $15.3 billion.

Zhang Zhiwei, chief China economist at Nomura Holdings Inc. in Hong Kong, wrote in a note that companies may be overstating exports and understating imports to move funds into China and circumvent capital controls.

“Inflows of funds are likely to be larger than 2012 and will lead to more central bank interventions in the currency market, improving the liquidity in the money market,” said Dariusz Kowalczyk, a strategist at Credit Agricole SA in Hong Kong. “The inflows will become a key consideration for China in monetary policy making. I expect larger-scale repos and bill sales to drain liquidity. There is also an outside chance of a reserve-ratio hike.”

Fund Withdrawals

The People’s Bank of China has drained a net 5 billion yuan out of the financial system in each of the last two weeks, according to data compiled by Bloomberg. Withdrawals the previous week amounted to a record 910 billion yuan, more than double the previous high in Bloomberg data going back to March 2008, as repo auctions resumed after a weeklong Chinese New Year holiday. It sold 5 billion yuan of 28-day repos on March 7.

Repurchase auctions may have been restarted because the sharp rise in foreign-exchange purchases flooded the economy with cash, according to a March 6 report by Ting Lu, Bank of America’s China economist in Hong Kong, who predicts the PBOC will keep the repo rate at around 3 to 3.5 percent.

Money Supply

PBOC Governor Zhou Xiaochuan said at the National People’s Congress meeting in Beijing on March 5 that policy makers don’t want the money supply to expand too quickly this year, as indicated by the official target. China may need to raise interest rates should gains in the consumer-price index stay at more than 3.5 percent for three months, Chen Dongqi, deputy head of the National Development and Reform Commission’s macroeconomic research institute, said on March 8 in Beijing.

Consumer-price gains accelerated to 3.2 percent in February from 2 percent the previous month, higher than the 3 percent median forecast in a Bloomberg survey. Chinese banks handed out 1.07 trillion yuan of new loans in January, compared with 738 billion yuan a year earlier, official data show. Aggregate financing, which includes non-bank lending, climbed 914 billion yuan from December to a record 2.54 trillion yuan. New loans in February totaled 620 billion yuan and aggregate financing dropped to 1.07 trillion yuan, data showed yesterday.

‘Adroit Management’

The nation is targeting economic growth of 7.5 percent this year, the same as in 2012, Premier Wen said as the National People’s Congress met on March 5. Gross domestic product rose 7.9 percent in the three months through December following 7.4 percent growth in the previous quarter.

“The PBOC is not likely to resume bill sales any time soon but will clearly consider it as one tool to drain liquidity out of the banking system as growth accelerates and credit expansion continues, fueling inflation,” said Chen Qi, a Shanghai-based strategist at UBS Securities Co.

Signs of an economic improvement have pushed up bond yields and stock prices. The benchmark yield on 10-year government bonds rose to 3.61 percent on Jan. 29, the highest since November 2011, and ended last week at 3.58 percent. The Shanghai Composite Index of shares has rallied 18 percent since Dec. 3, when it recorded the lowest close since January 2009.

“If I’m right that we’ve seen the low in A-shares, I think there will be more inflows,” said Tim Condon, chief Asian economist at ING Groep NV in Singapore. “Adroit management by the PBOC will be needed to avoid the yuan from becoming a one-way appreciation bet. It will swell the interbank liquidity and require more open-market operations.”

‘Excess Liquidity’

The cost of insuring sovereign bonds using five-year credit-default swaps fell four basis points last week to 61 in New York, after rising to as high as 146 in June, according to data provider CMA, which is owned by McGraw-Hill Cos. and compiles prices quoted by dealers in the privately negotiated market.

“The central bank may resume bill sales in the second quarter to drain liquidity because first-half inflation may be higher than expected,” said Xu Hanfei, head of fixed-income research in Shanghai at GF Securities Co., the nation’s third-biggest listed brokerage. “The PBOC will have to use bill sales to prevent a return of excess liquidity as capital inflows rise.” He predicts the inflation rate will reach as high as 3.5 percent in the second quarter.

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