REPEAT: MNI: State Researcher: Now Is Time To Reform Yuan FX

Repeats Story Initially Transmitted at 09:05 GMT Feb 13/04:05 EST Feb 13

--Tight Credit Condition Boost Overseas Borrowing

--Capital Inflows Could Hamper Monetary Policy Options

--Currency Baskets Rate Should Weight Less in Exchange Rate Mechanism

     BEIJING (MNI) - China should decisively reform its forex management to

prevent an influx of foreign money from hamstringing its economy, a government

policy advisor told MNI in an exclusive interview.

     Zhang Bin, senior fellow at the China Academy of Social Sciences, the top

think tank of the Chinese government, said the recent surge in the value of the

yuan against the U.S. dollar, combined with tight domestic credit conditions, is

attracting more overseas capital, while the yuan's inflexible managed exchange

rate regime encourages a one-way bet on the further appreciation of the

currency.

     Zhang is also a research fellow with the China Finance 40 Forum, an

advisory body comprised of 40 influential economists, including former central

bank officials and advisers.

     --INFLOW CONCERNS

     While capital inflows may sound positive, too much of it hurts exports,

pressures interest rates, fans inflation and severely damages the economy in the

case of sudden correction, Zhang warned. It leads to China's loss of

independently setting its monetary policy, such as when to raise interest rates,

he said.

     Indeed the Chinese economy seems to be having too much of a good thing.

Last year, fears of large capital outflows from China drove policymakers to give

"window guidance", a euphemism of unspoken orders, asking banks to implement

strict rules, such as enforcing the $50,000 individual Forex quotas.

     Now inflows are expected to rise further given higher capital returns have

pushed up by tight domestic credit conditions, so companies are willing to

increase overseas borrowing and reduce or postpone overseas asset purchases.

     According to research by the China International Capital Corporation, the

ongoing reversal of the yuan depreciation expectation has already fuelled the

incentives for currency arbitrage by the corporate sector, posing potential

challenges of capital flow management in the future, "USD-denominated bond

issuance offshore by Chinese corporate reached $286 billion in 2017 alone," the

state-own investment bank said in a note.

     There are already signs that SAFE is quietly encouraging overseas

investments again. Economists like Guan Tao, another CF40 fellow, told MNI

earlier this month the outbound direct investment has seen a jump last December.

     --FREE-FLOATING YUAN

     However, these policy reversals cannot replace the ultimate solution, which

is to allow a completely free-floating yuan exchange rate mechanism, and let the

market balance the capital flows, Zhang said, readdressing an issue he has

raised in the past.

     Zhang acknowledged the People's Bank of China won't give up its tight rein

anytime soon. A less drastic approach is reducing the PBOC's influence via the

weighting of the currencies basket, and letting the market exert a greater share

of the weight allocation, Zhang said.

     After the yuan plunged over 7% against the greenback in 2016, the PBOC

stepped up its support of the yuan last year via both draining the liquidity in

the offshore yuan market and adding a so-called "counter-cyclical factor" into

its daily reference rate against the U.S dollar.

     The key to exchange rate reform is that the PBOC should refrain from

overstepping its boundary and not get into the forex market too soon and too

frequently, Zhang said.

     "That isn't to say the PBOC should completely forego forex management, but

tolerate a wider, and longer-term variance, such as 10 percent annually," said

Zhang.

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