China's financial system gets huge cash injection

Beijing devalued the yuan by 1.9 per cent last week.
Beijing devalued the yuan by 1.9 per cent last week.PHOTO: EUROPEAN PRESSPHOTO AGENCY

Central bank triples amount pumped in - a sign of Beijing's worry over capital outflows

BEIJING • China's central bank tripled the amount of cash added to the financial system in its open market operations yesterday - the largest amount in 19 months - signalling Beijing's concerns about capital outflows after the recent weakening of its currency.

The central bank conducted 120 billion yuan (S$26.4 billion) of seven-day reverse-repurchase agreements, or reverse repos - a short-term loan to commercial lenders in the money market.

The cash injection is the biggest of its kind since January last year, when the People's Bank of China (PBOC) offered 150 billion yuan via the 14-day reverse repos, the Wall Street Journal reported. The interest rate was kept unchanged from last week at 2.5 per cent.

"There have certainly been capital outflows associated with the yuan's recent weakening and today's move by the PBOC is in response to the tightening liquidity conditions," said economist Suan Teck Kin of United Overseas Bank.

Central bank data released last Friday suggests that funds had been flowing out of China even before the latest currency move, due to a weakening Chinese economy and expectations of rising US interest rates.

Short-term money-market interest rates have risen sharply in view of capital flight since Beijing unexpectedly engineered a "one-off adjustment" by devaluing the yuan against the dollar by 1.9 per cent a week ago. As China continues to slow, and the PBOC spends more foreign reserves to prevent the yuan's free fall, analysts say the authorities will need to take decisive measures, such as cutting banks' reserve requirements.

"As the PBOC tries to stabilise markets, keeping liquidity ample to ensure proper functioning in the domestic financial system is essential," said DBS Group Holdings strategist Eugene Leow.

Central bank intervention to prop up the yuan removes funds from the financial system and risks driving borrowing costs higher unless the monetary authority releases additional cash.

The nation's foreign exchange reserves are expected to drop by some US$40 billion ($56.3 billion) a month for the rest of this year as the central bank buys the Chinese currency. China may cut banks' reserve-requirement ratios as liquidity tightens amid expectations for a weaker yuan, according to a China Securities Journal commentary.

Increases in the interbank money rate, drops in excess reserve levels at banks and a decrease in yuan positions will pressure cash supply, according to the article.

"The more intervention in the currency market, the tighter the money market will be," said Commerzbank AG economist Zhou Hao. "If the PBOC injects too much, the market will worry about further devaluation pressure. It's a balancing act."

The higher funding costs in the money market have also led to a spike on Chinese government bond yields, especially the short-dated ones that are typically more sensitive to policy outlook.

The yield on the benchmark one-year government bond is now at 2.3 per cent, up from 2.19 per cent before Beijing moved to devalue the yuan.

A version of this article appeared in the print edition of The Straits Times on August 19, 2015, with the headline 'China's financial system gets huge cash injection'. Print Edition | Subscribe