MNI Interview: PBOC May Hike Rates To Bolster Yuan: Researcher

--PBOC May Hike Rates At Moderate Pace Following Fed

--200-300 bps Across-the-board RRR Cut This Year Possible

--More Targeted RRR Cuts and Credit Policies To Be Seen

     BEIJING (MNI) - The People's Bank of China (PBOC) may further raise policy

rates following rate hikes by the U.S. Federal Reserve in order to stabilize its

currency and support financial deleveraging, A senior state researcher said in

interview with MNI.

     "The yuan exchange rate is the main reason that the PBOC had been following

the Fed's rate increases in the past year," said Peng Xingyun, director of

Monetary Theory and Policy Department at Chinese Academy of Social Sciences

(CASS), who is also the chief economist of First Capital Securities.

     Should the expectation on the yuan's depreciation grow further, the central

bank may very likely counteract by raising rates of open market operation tools,

said the economist at the think tank, which provides advices to policymakers.

     The world's second-largest economy needs a stable and strong currency as it

pushes for greater international acceptance and usage, Peng said. That process

pitches China against the U.S. as the yuan's widening sphere of influence may

erode the dollar's dominance and fuel bilateral friction, he warned.

     --HELPS DELEVERAGING

     Meanwhile, raising policy rates is in line with the financial deleveraging

goal, because currently there is still a wide spread between money market rates

and the yield on sovereign bonds, which encourages speculators to conduct

arbitrage, said Peng. 

     On Tuesday, the 10-year China Government Bond closed at 3.6700%, against

the 7-day reverse-repo average of 2.7283%. 

     However, Peng said the PBOC is likely to keep the pace of the rate hikes

modest given the cost of funding in the real economy is already quite high.

     "The central bank would continue its small step, for example, raising 5

basis points each time, particularly given currently debt defaults are on the

rise," Peng said.

     Since March, the PBOC has followed the Fed rate hikes by nudging up the

7-day, 14-day and 28-day reverse repos by 5 basis points (bps).  

     --STRONG SIGNAL

     While some market participants see 5 bps as modest, the underlying message

shouldn't be overlooked, Peng said. "It's a strong signal that policymakers have

no intention to guide money market rates lower, and that deleverage and

preventing financial risks remains the priority," Peng said.

     By choosing to adjust open market operations' rates, rather than adjusting

benchmark rates, the PBOC attempts to purse a more accommodative policy, Peng

said. 

     More across-the-board RRR cuts/OMO swaps and targeted RRR cuts are likely

to be seen if GDP growth tests 6.5%, he said.

     The PBOC holds as much as CNY25 trillion of banks' required reserves while

lending out about CNY10 trillion to banks by various monetary tools. That leaves

about 200 bps spread of the interest rates on two sides of the central bank's

balance sheet, drawing a lot of criticism, Peng said.

     --BALANCE SHEET DISTORTION

     "The balance sheet distortion makes it hard for the PBOC to claim that it

keeps a 'neutral' stance," said Peng. A "prudent and neutral" monetary policy

said by policymakers should not just refer to money supply, but also fairer

overall policy, he said.

     There is room for the PBOC to cut its RRR by 200-300 bps to swap its CNY3

trillion maturing monetary policy tools in one year, and in the long run, RRRs

should be kept below 5% from currently about as high as 16% for big banks, he

said.

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

--MNI Beijing Bureau; +86 10 8532 5998; email: william.bi@mni-news.com

--MNI Beijing Bureau; +86 (10) 8532 5998; email: marissa.wang@marketnews.com

--MNI Beijing Bureau; +86 10 85325998; email: he.wei@marketnews.com

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