UPDATE 2-China sees more capital inflows in H2, uncertainties linger

Wed Jul 23, 2014 1:04am EDT

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(Recasts, adds c.bank data, details, quotes)

BEIJING, July 23 (Reuters) - China may see more capital inflows in the rest of 2014 after experiencing some money flight in recent months, the country's foreign exchange regulator said on Wednesday, as the yuan recovers due to improved confidence in the economy.

Guan Tao, the head of the department of international payments at the State Administration of Foreign Exchange (SAFE), also said at a news conference that China's rising foreign exchange reserves could stoke long-term inflationary pressures.

"The domestic economy is stabilising, which helps boost market confidence, and the foreign trade situation has started improving, and the interest rate differential remains. These factors could lead to pressure on capital inflows," he said.

But capital flows could remain volatile in the second half as the economy still faces uncertainties, along with risks from monetary policy adjustments in major economies.

"The renminbi (yuan) exchange is now near equilibrium and two-way cross-border capital flows have become a new norm," he said.

China's economy grew slightly faster than expected in the second quarter as a flurry of government stimulus measures kicked in, but analysts said Beijing will likely need to offer further support to meet its 7.5 percent economic growth target for 2014.

China was under pressures from capital inflows in the first quarter, but the tide turned in the second quarter as volatility in the yuan fuelled outflows, Guan said.

The central bank was seen intervening to weaken the yuan in February and March as a means to punish speculators. The PBOC was concerned about punters skirting China's capital controls to bring foreign currency into the country and profit from expected yuan appreciation.

The yuan has shown some signs of stabilising in recent weeks but is still down 2.3 percent so far this year. Traders are unsure when authorities will allow it to return to a gradual appreciation path.

China's central bank and commercial banks sold 88.3 billion yuan ($14.3 billion) worth of foreign exchange on a net basis in June, according to a Reuters calculation based on central bank data released on Tuesday.

China's current account surplus may widen in the second quarter, but net inflows under its capital account may decline sharply, or even show a deficit, Guan said.

The SAFE is closely watching the country's rapid rise in short-term foreign debt, but the level of foreign debt is manageable given China's huge foreign exchange reserves.

Even though China's capital account is not open, there are leaks in the system and illicit inflows and outflows are common in the world's second-biggest economy.

Worried that a surge in funds entering or leaving China may hurt its economy and complicate its monetary policy, the currency regulator said in January that authorities are considering introducing a Tobin tax.

The Tobin tax is in effect a tax on foreign exchange transactions.

Turning to China's $3.99 trillion foreign exchange reserves, the world's largest, Guan warned that further rapid rises in the cash pile may stoke inflation in asset price rises, he said.

"The large rise in foreign exchange reserves has led to a big rise in the central bank's base money, which could bring about inflationary pressures as well as pressures on asset prices," he said.

Premier Li Keqiang said in May that China's war chest of foreign exchange reserves had become a headache as its continued rise could stoke inflation in the long term.

Guan said China should gradually reduce its trade surplus and encourage more outbound investment to help limit the rapid accumulation of foreign exchange reserves. (Reporting by Kevin Yao; Editing by Jacqueline Wong & Kim Coghill)

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