MNI INTERVIEW: More Dovish Fed May Provide Yuan Reform Window

--Less Hawkish Fed Takes Pressure Off Yuan, Former SAFE Official Says

--PBOC Could Allow Wider Yuan Trading Band, Guan Tao Tells MNI

     BEIJING(MNI) - Depreciation pressure on the yuan will likely ease this

year, as U.S. rate hikes are cast into doubt, potentially giving the People's

Bank of China an opportunity to further relax controls on the currency, a former

top foreign exchange regulator told MNI.

     Possible steps for the PBOC would include allowing increased tolerance for

a wider band of yuan trading, Guan Tao, former Director General of Balance of

Payments at the State Administration of Foreign Exchange said in an interview,

in which he stressed that a flexible exchange rate is crucial for the country to

further open up its financial market.

     "Exchange rate reform should keep pace with financial market opening, or

else rapid capital flows, particularly short-term flows, will impose a big

challenge to capital management and trigger risks ... at a time when there are

still external and internal uncertainties," said Guan, who worked at SAFE until

2015 and is now a senior fellow of China Finance 40, a prominent think tank.

     But Guan admitted significant reform was unlikely with so many risks in

play, including the trade dispute with the U.S. and doubts over China's domestic

economy. The former SAFE official was optimistic regarding the trade talks,

although he expected conflicts to emerge in other areas, such as regarding

tighter U.S. controls on foreign investment and exports of high tech.

     --TAIL RISKS

     While the recent abrupt reversal of previous market expectations of

upcoming interest rate increases by the Federal Reserve should mean that

downward pressure on the yuan is relatively minor this year, a surprise Fed hike

or a burst of dollar strength could still push the currency towards the key

level of 7 to the greenback, Guan said.

     In that case, the PBOC may choose to step in to stabilise the exchange

rate, Guan said.

     "But it would have to suffer the consequence that forex reserves are spent

to boost the yuan, and market confidence would be damaged by strict rules on

capital outflows," he said, adding that otherwise he could envisage a scenario

in which the yuan depreciated until China's economy returned to vigorous growth.

     China has over the past year tried to make itself more attractive to

foreign portfolio investors, and overseas funds bought CNY82.7 billion in

onshore bonds in 2018, the second highest amount on record, to take their total

holdings to CNY1.5 trillion by the end of December, according to the China

Central Depository & Clearing Co.

     Attracting more long-term foreign funding, together with increasing the

return on overseas investments, will be key in the coming years as China's

current account trends towards deficit due to an aging population, Guan said.

     The current account fell into the red in the first three quarters of 2018,

the first time on record, but Guan predicted a moderate surplus would return

this year, particularly in the first quarter, as both imports and exports

experience weakness.

     In another novel development, China's foreign debt has increased by 36.6%

since the beginning of 2017, with short-term liabilities accounting for over

60%. Any steep depreciation in the yuan could add to concerns some debtors might

not be able to raise foreign currency to pay their debts, but Guan stressed that

serious fears would be allayed by China's over USD3 trillion in foreign

reserves.

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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