China’s foreign-exchange reserves probably rose 4 percent to $2.76 trillion in the fourth quarter, adding to pressure on the central bank to drain cash from the economy and allow the yuan to strengthen.
The world’s largest currency holdings jumped $112 billion after a $194 billion gain in the third quarter, according to the median estimate in a Bloomberg survey of nine economists before the central bank releases the data this week. Reserves probably climbed $361 billion for the year, compared with $453 billion in 2009.
People’s Bank of China Governor Zhou Xiaochuan ordered lenders to increase funds on deposit at the authority six times in 2010, as the yuan’s interest-rate advantage over the dollar attracted capital that stoked inflation. The yuan may gain the most among currencies in the so-called BRIC nations, rising 5.4 percent by year-end, compared with a 0.8 percent drop for Brazil’s real, a 0.3 percent increase for Russia’s ruble and 5 percent advance for India’s rupee, according to Bloomberg surveys of strategists.
“We will probably see a round of pretty intense tightening in the first half,” said Ren Xianfang, an economist in Beijing for Lexington, Massachusetts-based research company IHS Global Insight. “The yuan’s appreciation in 2011, particularly in the first half, should be faster than last year.”
The reserves, which exceeded $1 trillion in 2006 and $2 trillion in 2009, will reach $3 trillion by June 30, according to UBS AG estimates. Hong Kong’s holdings stood at $268.7 billion, Singapore’s at $225.8 billion and Thailand’s at $172.1 billion, government data released Jan. 7 show.
Policy Dilemmas
Premier Wen Jiabao is seeking to sustain the economy’s growth to create millions of jobs each year, while preventing rising prices for homes and food from fueling social unrest. Benchmark borrowing costs for Chinese banks have risen to a two- year high, fuelling an 11 percent decline in the benchmark Shanghai Composite Index of stocks in the past 12 months.
While a stronger currency and higher rates may help tame inflation, they also risk attracting capital from abroad. In November, consumer prices rose 5.1 percent from a year earlier, the most in 28 months, food costs jumped 11.7 percent and property prices gained 7.7 percent, government data show.
The cost of insuring the government’s dollar debt for five years climbed 6 basis points yesterday to 75, up from a 2 1/2- year low of 52 basis points on Oct. 13, according to CMA prices. Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent if the government fails to adhere to debt agreements.
Yield Premiums
The yield on the 3.77 percent yuan government bond due in December 2020 fell 1 basis point, or 0.01 percentage point, to 3.82 percent on Jan. 7, data compiled by Bloomberg show. The extra yield investors demand to hold the debt rather than similar maturity U.S. Treasuries has dropped to 54 basis points from 101 on Dec. 1. China’s 2.75 percent one-year deposit rate is a record 1.955 percentage points more than that of the U.S., the highest in at least 14 years, after two increases last quarter.
The yuan appreciated 3 percent versus the dollar since a two-year peg was relaxed in June, and non-deliverable forwards show traders are betting on a 2.5 percent increase in the coming 12 months. The currency hit 6.5896 per dollar on Dec. 31, the strongest level since 1993. The yuan slid 0.58 percent to 6.6280 per dollar last week.
Capital Curbs
The State Administration of Foreign Exchange said Dec. 31 it was expanding a program to let exporters keep revenue overseas, easing pressure for appreciation. On Jan. 6, SAFE said it would step up monitoring of cross-border capital flows.
The government’s purchases of foreign exchange from exporters results in extra yuan being pumped into the financial system, money that the central bank drains away by selling bills or raising reserve requirements
Officials will use differentiated reserve ratios to improve liquidity management, Governor Zhou said in an interview published by China Finance magazine on Jan. 4. The system involves setting separate requirements for lenders according to their balance sheets.
“The risk of a widening interest-rate gap attracting hot money inflows may be part of the reason behind the central bank’s inclination to use the reserve ratio tool more frequently than interest rates,” said Wen Pengyong, an economist at Essence Securities Co., a Shenzhen-based brokerage.
Reserve Requirements
Reserve requirements for the biggest banks, such as Industrial & Commercial Bank of China Ltd., stand at 18.5 percent. UBS and Citigroup Inc. expect the ratio to pass 20 percent this year.
Li Wei, an analyst at Standard Chartered Plc. in Shanghai, estimates that the trade surplus accounted for 60 percent of reserve accumulation in the quarter, with foreign direct investment and speculative capital accounting for the rest. The dollar’s gain against the euro eroded the value of European assets and slowed the reserve increase.
China will keep raising interest rates this year even at the risk of attracting more capital because of the threat of inflation, according to Standard Chartered and IHS Global. The central bank may raise the one-year deposit rate to 3.5 percent by year-end, according to the median estimate in a Bloomberg News survey of 13 economists last month.
The one-year interest-rate swap, the fixed cost needed to receive the floating seven-day repo rate, dropped 2 basis points on Jan. 7 to 3.17 percent, according to data compiled by Bloomberg. It has climbed from last year’s low of 1.97 percent on Aug. 12.
Rate Pressure
The seven-day repurchase rate, which measures interbank funding availability, averaged 2.75 percent in the fourth quarter, the highest level since the third quarter of 2008. The rate plunged to 2.82 percent last week from 6.34 percent on Dec. 31 as a year-end financing crunch eased.
“The increase in the foreign-exchange reserves will pile pressure on the government to allow faster currency gains,” said Liu Li-Gang, a Hong Kong-based economist at Australia and New Zealand Banking Group Ltd., who previously worked at the Hong Kong Monetary Authority and the World Bank.
--Paul Panckhurst, Zheng Lifei, Jay Wang. Editors: Paul Panckhurst, Sandy Hendry
To contact Bloomberg News staff for this story: Lifei Zheng in Beijing at +86-10-6649-7560 or lzheng32@bloomberg.net
To contact the editor responsible for this story: Paul Panckhurst in Hong Kong at ppanckhurst@bloomberg.net
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