MNI INTERVIEW: Yuan To Firm, Fed On Hold -Ex PBOC Official

China's yuan should strengthen moderately against the dollar by the end of the year, driven by capital inflows as the Federal Reserve keeps rates on hold to keep U.S. government borrowing costs low, a former high-ranking People's Bank of China official told MNI.

Inflows driven by the yield spread between U.S Treasuries and Chinese government bonds will continue to support the currency for the foreseeable future, Sheng Songcheng, former director of the PBOC's statistics department, said in an interview, in which he added that China's central bank will make few adjustments to its policy this year as it steers the economy towards normal.

While short-term volatility could result from broad moves in the dollar index, the yuan should be "moderately stronger" in the second half of 2021 compared to its current levels, despite its roughly 2% depreciation against the dollar since the end of January, said Sheng, now professor of Economics and Finance at China Europe International School. USDCNY closed at 6.5407 at 16:30 in Beijing on Friday, rising 67 pips from the previous day.

The Fed's monetary policy is likely to remain loose, given the scale of U.S. government borrowing, he said.

OVERSEAS DEMAND

While any resumption of the significant yuan strength seen from last May through to early this year would pressure exports, that is unlikely to prompt the PBOC to intervene in the foreign exchange market, Sheng said, noting that a stronger yuan was favourable for Chinese importers at a time of strong demand for oil, iron ore and foreign high-tech goods.

But he cautioned that a major source of uncertainty for China's economy this year was whether international demand would remain robust as overseas factories come back on line following Covid disruption.

The PBOC is likely to keep its main policy settings on hold this year as it steers the economy back towards normality as the pandemic eases. Policy remains expansive after the central bank left benchmarks including the loan prime rate unchanged for 11 consecutive months, Sheng said, pointing to February's acceleration of annual growth by M2, total social finance and RMB loans of 10.1%, 13.3% and 12.9% respectively.

Growth in these three indicators should slow to about 10% for the whole year, in line with nominal GDP. Real GDP should expand by 16% y/y for the first quarter and by more than 8% for the whole year.

"A key for 2021 economic growth is whether consumption recovers at a fast pace," Sheng said, "We need to keep policy stable."

TARGETED EASING

But, while the PBOC should avoid changes to policy rates, or sweeping cuts to banks' reserve requirement ratios, it could provide some targeted easing, to boost small business or encourage the growth of green finance, he said.

Market speculation over a possible cut in reserve requirement ratios for smaller lenders may be misguided, according to Sheng, who noted that liquidity is currently ample and that small banks already have record low reserve requirements of only 6%. Any further reduction in this ratio would be limited, he said.

Rising commodity prices will have only limited impact on consumer inflation given weak domestic demand, he said, but added that capital inflows could spark inflation if authorities are not careful. The risk of feeding disruptive capital inflows would also rule out any chance of PBOC rate hikes, he said.