March 22, 2013 / 1:46 AM / 7 years ago

CHINA MONEY-Capital inflows spur premature tightening worries

* PBOC shifts to draining cash from money markets

* Expected to use quantitative tools to control liquidity

* Repos, bills and reserve ratio rises in sequence

* Interest rate rises unlikely this year - traders

By Lu Jianxin and Pete Sweeney

SHANGHAI, March 22 (Reuters) - The sudden surge of capital inflows into China this year has sparked worries that Beijing will move to sterilise them by tightening monetary policy in the near term, damaging a tenuous equity rally and cramping economic recovery.

So far the inflows appear manageable without recourse for blunt measures such as raising long-term interest rates, which would put a durable choker on liquidity at the possible expense of growth.

Changes in the behavior of the People’s Bank of China (PBOC) during open market operations have thrown some market observers. After months of relying solely on reverse repos to inject short-term cash, it shifted draining cash using longer-term forward repos in February.

It has drained a net 649 billion yuan ($105 billion) from the market so far this year, in distinct contrast from 2012, when it injected a net 1.438 trillion yuan through open market operations and injected an additional estimated 800 billion yuan through reductions to banks’ reserve requirement ratios (RRR).

Despite the drain, China’s money market rates have largely remained at low levels, indicating an abundance of cash, although China’s interest rate swaps still refrain from implying any interest rate rise in the coming year. Now some economists expect Beijing to reintroduce long-term bills for the first time since late 2011 if inflows do not abate, and Yi Gang, a deputy PBOC governor, said as much in early March.

China has set targets for its gross domestic product (GDP) growth at 7.5 percent this year, a moderate goal by Chinese standards, and for inflation to pick up to 3.5 percent for the year.

In spite of the increased capital inflows, data for January and February show little signs of outperforming these targets, much less the sort of overheating that would require a rate hike.

CAPITAL INFLOWS

Propelled in part by signs of a mild recovery in exports, the PBOC’s foreign exchange assets rose by 351.51 billion yuan in January, the biggest rise since April 2011, Reuters calculations based on central bank data on Tuesday showed.

PBOC data showed that the central bank, along with other Chinese banks, bought a net 683.7 billion yuan worth of foreign exchange in January, an all-time high, toppling the previous record of 654 billion yuan recorded in January 2008.

As Beijing tries to keep the exchange rate relatively stable, the PBOC and major state-owned banks must buy up foreign capital inflows that would otherwise push the exchange rate up.

But by buying up foreign currency with yuan, the banks effectively inject cash into the monetary base, expanding liquidity through the money multiplier. China’s money multiplier stood at a high of 3.86 percent at the end of last year, up 0.07 percentage points from a year earlier.

These inflows are not expected to endure, but if they do it may necessitate a deeper dip into the monetary toolbox, because Beijing remains wary of a return of destabilising price inflation, in particular in the food and housing categories.

“If heavy capital inflows continue over the next six months or more, the PBOC is very likely to resume bill issuance to mop up liquidity. If liquidity becomes even more abundant, it could even raise bank reserve ratios to get cash out of the system,” said a dealer at a European bank in Shanghai.

But regulators will likely stop short of raising interest rates in the absence of spectacular overheating.

“We expect the central bank to rely entirely on quantitative tools this year,” said a trader at a state-owned bank in Beijing. “With inflation set to remain within the target range, the likelihood of the PBOC to use pricing tools like interest rates is minimal.”

$1=6.21 Yuan Editing by Jacqueline Wong

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