Now that the PBoC has created a situation where it’s forced to prop up the yuan via open FX ops just about as often as it’s forced to prop up the SHCOMP via China Securities Finance,concerns are growing about liquidity and a severe tightening of money markets.
With each successive intervention, China is draining liquidity from the market, a decisively unwelcome outcome as it effectively works at cross purposes with the multiple policy rate cuts the PBoC has resorted to this year in a desperate attempt to buoy the flagging economy.
In short, RRR cuts were meant to free up cash for lending and speed up economic activity. Unfortunately, demand for credit is weak (unless one counts “demand” from the plunge protection team) and ultimately, rate cuts have proven ineffective.
As such, China resorted to devaluation (just as we said they would) but because the market expects the yuan to ultimately weaken by around 10% (which would presumably give exports a boost of around 10 percentage points with a three-month delay), the PBoC has been forced manage expectations by supporting the yuan and that, in turn, offsets the effect of the RRR cuts.
Cue the frantic liquidity injections.
As we noted yesterday, the PBoC injected CNY120 billion via 7-day reverse repos on Tuesday – that was triple the CNY40 billion injected late last week. “As the PBOC tries to stabilize markets, keeping liquidity ample to ensure proper functioning in the domestic financial system is essential,” a fixed-income strategist at DBS Group Holdings Ltd. in Singapore told Bloomberg.
The PBoC also injected $48 billion into China Development Bank and another $45 billion into the Export Import Bank via the Wutongshu Investment Platform last month. As The South China Morning Post notes, the injections occurred “from July 15 to July 20 through the central bank’s investment unit in a bid to allocate abundant capital for the country’s ongoing reforms.” That seems to suggest that either the PBoC was attempting to bolster the banks for the coming yuan tsunami or the central bank was simply trying to force the issue amid sluggish credit demand.
Finally, on Wednesday, the PBoC injected CNY110 billion yuan in 14 banks via its medium term lending facility (another policy tool). “Reverse repos help in the short-term and the MLF works for the medium-term. Now, all we need is another cut in the bank deposit reserve ratio for long term funding, given there’s continued outflow pressure and a U.S. rate hike is coming,” one trader told MNI. Here’s a bit more from Reuters:
The MLF is one of several lending tools the central bank has developed to supplement its usual bi-weekly open market operations at longer maturities.
Sources speculated that the loans were intended to offset tightened liquidity conditions following a more than three percent devaluation in the yuan’s value since Aug. 10.
Besides demonstrating how difficult it is to micromanage markets on a daily basis, the above also underscores the extent to which manipulating anything and everything sometimes requires the implementation of policies that trip over each other at nearly every turn, rendering the entire effort futile. Only China isn’t likely to acknowledge the futility, especially since it still has ample room to slash the RRR rate another couple of times by year end, freeing up liquidity that will be immediately sucked out by daily FX interventions. As one analystobserved, “if the PBOC injects too much, the market will worry about further devaluation pressure. It’s a balancing act.”
In the meantime, for its trouble, China gets to watch its FX reserves deplete at a rate of at least CNY50 billion per quarter, and that will only increase should the market get nervous about further yuan depreciation (prompting still more reserve-depleting “expectation management”) as China’s export-driven economy remains stuck in global growth-sapping low gear.
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