MNI INTERVIEW: PBOC FX Intervention Still An Option - Guan Tao

The People’s Bank of China would have to act if an overshoot in the yuan threatened financial stability or stoked inflation, with currency intervention one of many options in the bank’s toolkit, said former senior State Administration of Foreign Exchange official Guan Tao.

“It is not impossible for the central bank to step in and spend its huge pile of forex reserves to safeguard the yuan,” said Guan, who was formerly SAFE’s director-general of its balance of payments department, adding the bank would act if a “disorderly movement” encouraged speculation of a one-way move.

Guan, who is now BOC International’s global chief economist, expects two-way volatility in the yuan despite its ongoing weakness against the rallying U.S. dollar, highlighting prospective support for the currency from policies to bolster growth and China’s record trade surplus this year.

He said the PBOC’s sharpened focus on supporting the domestic economy will help stabilize the Chinese yuan, but it needs to carefully consider what easing tools to use to minimise capital outflows.

FX RESERVES

China’s FX reserve stood at USD3.03 trillion as of September-end, declining USD 221.2 billion in the first nine months of this year, according to SAFE.

“This is mostly driven by the negative valuation effect as the Fed consecutively hiked and global financial market turmoil continues,” Guan explained, referring to the rally in the U.S. dollar against other currencies held as reserves.

A CNY32 billion increase in foreign assets on the PBOC’s balance sheet in the first half of this year suggested there was no direct interventions by the central bank in the currency market, he continued.

China’s FX reserves were “relatively abundant” when assessed against measures like the import and short-term debt coverage ratio, as well as the Assessing Reserve Adequacy metric developed by the International Monetary Fund, the former official said.

Macro-prudential tools, capital flow management measures, and official FX reserve were able to act as a “solid defense mechanism” against external shocks in FX market, he said.

Additionally, Chinese firms and households have accumulated FX assets over the years, which could act as secondary FX reserves in the private sector to help smooth out the cross-border capital flow impact, he added.

POLICY EASING

Guan viewed economic fundamentals as key to the yuan’s direction, with the PBOC expected to continue to take steps to ease policy while other major economies aggressively tighten policy to rein in inflation.

“The stability of the yuan largely depends on the economic recovery and trade surplus, so our policy making should focus on the domestic situation,” he told MNI.

Guan said the gap between China and U.S economic growth would also benefit the yuan as it is widely expected China’s GDP would expand by 3%-4% in 2022 compared to the Federal Reserve’s forecast for the U.S economy to grow 0.2%.

“The PBOC should carefully choose its easing tools and make more use of targeted facilities to limit the impact from monetary policy divergence between China and the U.S., including capital outflows.”

He said China has faced increasing capital outflows. SAFE data showed the capital account deficit surged to USD136 billion in the first half of the year, rising 3.6 times from the same period last year – the biggest half-year rise since 2017. “The volatility of the yuan has been highly related to the big outflow,” Guan said.

YUAN STABILITY

Guan defined “excess volatility” as any large move that triggered a huge supply-demand imbalance in the FX market and produced strong one-way price expectations, which could spark the PBOC to act.

The PBOC has restarted some macro-prudential management tools and it will be prepared to innovate its policies to ensure the yuan does not move too sharply. “The regulator is likely mull over new facilities for its macro-prudential moves in case the market forms immunity to current measures,” Guan said.

Guan pointed out regulators would need to monitor the impact of arbitrage in the offshore market when the spread between CNY and CNH expands to certain levels. “The arbitrage trade in the offshore market would pressure CNY,” he warned.