* China to manage $3.2 tln FX reserves in new ways -c.bank
* Says to work on freeing rates, currency market
* Comments come as cbank sets yuan midpoint sharply lower
* Eyes on trade, yuan after biggest deficit in a decade
By Nick Edwards and Zhou Xin
BEIJING, March 12 China will encourage the
value of its yuan currency to be set by the market and step back
from intervention "in an orderly manner", while keeping policy
flexible to support credit growth in the face of volatile
capital flows, the central bank said on Monday.
Speaking days after China posted its biggest trade deficit
in at least a decade, People's Bank of China (PBOC) Governor
Zhou Xiaochuan Zhou said monetary policy moves would respond to
liquidity conditions determined by the balance of payments,
demand for yuan in markets and international capital flows.
"The closer the yuan is to an equilibrium, the bigger role
market forces will play in the yuan exchange rate. We will allow
and encourage market forces to play a bigger role, and the
central bank's participation and intervention in the market will
decrease in an orderly manner," Zhou said.
Zhou did not comment on speculation that China is ready to
widen the yuan's trading band to create more flexibility, even
as Beijing pushed the yuan sharply lower on Monday.
It has set a weaker trading midpoint for the currency in
five of the last six trading sessions, fueling some speculation
in financial markets that Beijing may rely more on foreign
exchange policy to stimulate exports and broader growth.
Zhou's remarks support well-entrenched investor views of an
imminent reduction in the amount of cash commercial lenders must
keep with the central bank, following cuts of 50 basis points
each in November and February that brought the required reserve
ratio (RRR) down from June 2011's record high of 21.5 percent.
"There is a lot of room for RRR cuts," Zhou told the central
bank's annual conference held on the sidelines of China's annual
meeting of parliament, the National People's Congress.
"But we need to look at whether it's necessary... and look
at market liquidity. We cannot raise or cut RRR at will when we
think there is room. We need to look at the liquidity condition,
which is related to FX purchases and our international balance
Data over the weekend showed China's trade balance plunged
$31.5 billion into the red in February as imports swamped
exports. It followed reports on Friday that inflation eased in
February while bank lending, retail sales and industrial output
fell below forecast, all pointing to a cooling economy.
The trade data "means a bigger need to stimulate domestic
demand -- via fiscal stimulus and monetary easing," said Dariusz
Kowalczyk, senior economist and strategist for Asia ex-Japan at
Credit Agricole CIB, in a note.
"So we expect 200 bps more in RRR cuts and 50 bps in
interest rate cuts later this year."
The central bank's cuts so far ease back some of the
tightening to rein in inflation that hit a three-year high in
July 2011, helping foster economic growth by easing credit
strains that are exacerbated by a shrinking trade surplus and
slower foreign capital inflows.
RRR CUTS ANTICIPATED
A recent Reuters poll showed analysts expect Beijing to cut
the RRR by a further 150 basis points this year when the world's
No. 2 economy is set to clock its slowest full year of growth in
a decade of between 8 and 9 percent.
Zhou was more nuanced about whether markets should be
anticipating a move in outright interest rates.
"The PBOC has always paid attention to price tools. It
raised the benchmark interest rate five times from the fourth
quarter of 2010 to the third quarter 2011. But when we use the
tool, we need to consider some constrains. One consideration is
the impact on capital flows," he said.
China is reluctant to encourage speculative inflows of money
to its closed capital account financial system as they require
sterilisation by the issuance of yuan-denominated bonds that can
drive up money supply and increase inflationary pressures.
Substantial inflows generated by China's huge export-focused
factory sector are problematic enough. The country ran a current
account surplus of $201.1 billion in 2011, though it has been
shrinking steadily as a proportion of GDP since around 2007.
The foreign reserves China earns will continue to be
diversified to ensure safe, stable returns, the head of the
State Administration of Foreign Exchange (SAFE), told the same
The portion of China's $3.2 trillion of reserves invested in
euro zone assets had increased in value, making returns above
the rate of inflation, and more would go into yen-denominated
assets if the timing was right, SAFE chief Yi Gang said.
Yi repeated the long-standing official backing for Europe's
efforts to resolve a festering debt crisis that began rumbling
in 2009 and has rocked the foundations of the monetary union
that underpin the single European currency.
But he gave no clear indication of whether the process of
reserve diversification had seen SAFE -- which administers the
world's largest stash of foreign wealth -- increase or decrease
the portion that it allocates to euro zone assets.
YUAN CLOSE TO EQUILIBRIUM
SAFE chief Yi said China's trade performance last month was
evidence that the yuan was close to a "balanced level."
The yuan's value has been a lightning rod for
disputes between China and its biggest trade partners including
the United States, who accuse Beijing of deliberately holding
down the currency for trade advantage.
China has always denied those allegations, and increasingly
says it is allowing market forces to have a bigger sway over the
yuan as it nears its fair value, an argument reiterated by Zhou.
China wields tight control over the yuan through regular
market interventions, and by having the central bank set its
daily mid-point before the start of trade. It can rise or fall a
maximum of 0.5 percent against the dollar from the mid-point.
But Beijing wants to relax its grip on the yuan, also known
as the renminbi, to have it basically convertible by 2015 so as
to expand its influence on global financial policymaking.
China de-pegged the yuan from the dollar in a landmark move
in July 2005 and it has since appreciated some 30 percent
against the U.S. currency, though some critics in the West say
Beijing is still keeping too tight a grip on the yuan in order
to aid the country's exporters.
"Steady progress will be made to promote capital account
convertibility," the central bank said in a statement before the
news conference, adding that Beijing would work to get more
firms to settle cross-border trade in yuan and expand the type
of yuan investment products available.
Many analysts argue much work still needs to be done, saying
China needs to free its interest rate market before it frees its
currency. Some also are sceptical that China has the political
will to push through rate reforms that may hurt the health of
its giant state-owned banks.