PBC mulling over policy options to deal with capital flows

Beijing

CHINA'S central bank views with concern the risk of volatile flows of capital into and out of the nation in the coming months, and is preparing steps to help address the danger, according to people familiar with the matter.

Two options under consideration are widening the band in which China's currency, the yuan, is allowed to fluctuate and guiding the exchange rate gradually lower by adjusting the fixing against the greenback, according to the people, who asked not to be named as the discussions are private. The yuan is now subject to a maximum 2 per cent divergence on either side of a daily reference rate set by the People's Bank of China (PBC).

While conditions under which such steps would be taken weren't specified, China took similar action in the first half of 2014, when the PBC doubled the yuan's trading limit. The monetary authority also engineered a depreciation in the exchange rate to deter speculative gains, analysts said at the time.

China "is now more concerned with outflows", said Michael Every, head of Asia-Pacific financial-market research at Rabobank International in Hong Kong. "The more prudent choice for them is to gradually weaken the fixing, and widening the trading band would be a more liberal option. Weakening the currency too far, too fast could cause panic and more outflows."

Policymakers in the world's second-largest economy are confronting the challenge of a mixture of capital outflows, slowing economic growth and yet - on a trade-weighted basis - an appreciating exchange rate.

Steps by central banks from Europe to Singapore to Australia to expand stimulus are driving their currencies down, while the PBC has limited broad-based easing out of concern over credit bubbles.

China posted the biggest deficit in its capital account since at least 1998 last quarter, adding to signs that funds are leaving as economic growth decelerates. The shortfall was US$91.2 billion in the October-to-December period, the State Administration of Foreign Exchange said on its website on Tuesday.

The yuan dropped 2.4 per cent against the greenback in 2014, which was its first annual decline in five years. Russia's rouble tumbled 46 per cent in the period, the worst performer in the 24 emerging-market currencies tracked by Bloomberg, followed by a 23 per cent slide in the Argentine peso. In trade-weighted terms, the yuan's nominal effective exchange rate reached a record high on Jan 30, according to an index compiled by Westpac Banking Corp. China last doubled the yuan's trading band from one per cent. Against the euro, the Chinese currency touched a 13-year high on Jan 26 after the European Central Bank announced a bond-buying programme. PBC deputy governor Pan Gongsheng said that the ECB stimulus was adding to depreciation pressure on the yuan.

Lowering the yuan's reference rate moderately and widening the trading band can boost exports and make it more expensive for capital to leave, Shanghai Securities News reported on Tuesday, citing former PBC adviser Yu Yongding.

"Even as exports may not be a vast driver of its growth, China is still a huge trading partner to many, how can it sit back and not get into the currency war?" said Rabobank's Mr Every. BLOOMBERG