A slowing PMI manufacturing reading raises some concerning issues while the PBOC governor sends mixed messages about yuan appreciation…..
CHINA WEEKLY
It has been a busy week in China with several important developments to take note of, we start by looking at the comments by the central bank governor Zhou Xiaochuan, who said that China has no plans to change the rate of appreciation of its currency in spite of calls to accelerate the process. The comments, made on the sidelines of the G20 meeting over the weekend, articulated that China will stick to its plan for a gradual internationalization of its currency saying there has been no change to its strategy. Zhou was cited as saying “the topic is quite complicated and we have no new announcements so far” offering no hints of changes to the pace of appreciation. The comments by the central bank governor are certainly not a surprise to us and Zhou certainly towed the line, but in light of other recent actions by the central bank and China’s general push in the direction of internationalizing the yuan we had been hopeful for a little more from the governor.
China’s push for international acceptance of the yuan has expanded in recent weeks to embrace three, synchronized steps: currency outflow to overseas investments, offsure yuan market in Hong Kong and backflows of yuan to China as foreign investment. The central bank, which is leading the governments’ go-global campaign, expanded a pilot program for yuan-based settlement for cross-border trade in January with the release of a related measure covering foreign direct investments by Chinese companies. And, in anticipation of the third go-global step, which is still said to be in the planning stage, a source close to the development said research is being conducted for a program that would allow yuan-denominated investment in China by foreign firms to facilitate currency back-flow. The source also said that research has involved various government ministries ranging from the Ministry of Finance to the State Administration for Industry and Commerce, noting that in the best case scenario the government’s back-flow policy could be ready in six months. Overseas investors are sure to be pleased by the direction that the central bank is moving in as it would simplify what’s now a complex currency exchange process. Also, further availability of the yuan is likely to please many since the yuan now is in short supply and there are few channels for foreign investors to access yuan funds. The central bank’s decision to expand the trade settlement project while adding the anti-speculator step and studying back-flow policy came after China’s annual quota for yuan conversions for cross-border trade settlements assigned to the Bank of China-Hong Kong was suddenly exhausted last October. Immediately after that incident, officials from the Hong Kong Monetary Authority (HKMA) met with counterparts at the central bank and China Securities Regulatory Commission and decided to step up activities encouraging overseas markets for the yuan and further promote the offsure yuan market in Hong Kong. Considering these developments in recent weeks the PBoC governor’s comments (above) on the sidelines of the G20 sent mixed messages about the central bank’s policy regarding the internationalization of the yuan, we will therefore follow the age old phrase; actions speak louder than words and trust the actions taken by the central bank rather than a regurgitated party line.
Moving on, China’s manufacturing sector slipped to a seven-month low in February , though activity remains expansionary, according to a flash reading of manufacturing PMI, which stood at 51.5 down from 54.5 in January (any reading about 50 is expansionary). In a statement released by HSBC and Markit, who conducted the survey, they said “flash PMI data points to a meaningful slowdown in the industrial sector in February, the Chinese New Year may be a factor but not the only reason. It also implies that quantative tightening is starting to filter through yet more still needs to be done to check inflation”. The implications of this statement could be rather dire, we have mentioned in this report repeatedly that Beijing has a very difficult task of tamping down inflationary pressure without overstepping their bounds and affecting growth too much. While it has been made known that Beijing is no longer focused exclusively on maintaining white-hot growth and dealing with inflation has become a priority there is a fear that measures enacted to tackle inflation will be draconian in nature and will slow growth too sharply creating a ripple effect across the global economy. The other option, of not tackling inflation effectively enough, has rather severe implications for the Chinese economy too. Therefore, we will continue to watch the actions of the administration carefully and hope that they manage to walk the fine line between rampant inflation and a hard landing for the economy. Growth is already forecast to be lower than the average of 9.5% over the last decade moderating to 8.1% annually. While the probability of growth in China slowing to below 5% a year, often cited as a doomsday scenario, is still relatively remote, Morgan Stanley said in a report last week that “overly aggressive tightening of monetary policy” could be a potential factor to derail China’s growth.
Finally, talking of aggressive tightening, the central late last Friday hiked the reserve ratio requirement (RRR) for banks by 0.5% bringing the officials RRR to a record 19.5% for bid banks. This was the second RRR hike of 2011 and comes just a week after the central bank raised the key interest rate by 0.25%. The hike will drain about 350 billion yuan ($53.24 billon) from the banking system, according to estimates by Bank of America-Merrill Lynch.