China:PBOC press conference confirms tightening bias

PBOC governor Zhou, deputy governor Yi Gang, deputy governor (also SAFEgovernor) Pan Gongsheng and other senior officials held a press conference today.

Here are the key points and our interpretation of these points:1. On the exchange rate and reserves: Governor Zhou believes that this year’sRMB exchange rate will be relatively stable and “managed floating exchange rateregime is beneficial”. He said that from this year, there is no basis for RMBdepreciation and market sentiment has adjusted. The reduction in FX reserves isnormal and it is unnecessary to have too many reserves. Mr Zhou thinks speculationon exchange rates due to short-term interest rate differentials will not persist. Healso thinks people should watch the US dollar index and noted that the fluctuationsin the US dollar will impact RMB. Deputy governor Yi stated it is beneficial to use FXreserve to keep the RMB exchange rate broadly stable.

These comments are consistent with our view that in the short term the CNYUSDexchange rate is mainly a function of USD TWI. There are some early signs that theCNY has started to move against the USD in recent days, as USD has beenstrengthening since early February. The statement that the “managed floatingexchange rate is beneficial” appears to be an explanation for past interventions. It islikely that the preference of the governor and the central bank is for more flexibility,in our view, but the relative stability of the actual exchange rate reflects the fact thatthis issue is not only the call of the central bank. The Government Working Reportput less strong emphasis on exchange rate stability and wrote less on the topiccompared with last year’s GWR, which likely reflects greater recognition of the needto be relatively flexible going forward.

2. On capital flows: Governor Zhou commented that China will not deliberatelypursue a bond index inclusion, though China will move towards further opening up.

The governor also stated there are many outward investments which are irrationaland therefore some curbs are needed. Deputy governor Pan commented that “moreopening up of the bond market is not a matter of great hurry, China should promotefurther opening in the bond market, in a steady way.”Our interpretation of the comment on irrational outward investments is that it ispartially a justification for the administrative controls on capital outflows to date, andalso leaves enough room to take further actions to curb capital outflows. Besides, we expect there to be other capital opening measures to encourage inflows. This willhelp to offset outflow pressures and help the image of capital account liberalization.

3. On monetary policy stance: Governor Zhou reiterated the “prudent and neutral”monetary policy stance. He also stated monetary policy should be “more” neutral asexcess credit supply is not helpful in terms of reform. Corporates instead should opt forreform to reduce the dependence on credit. When asked about whether there could beinterest rate hikes, Governor Zhou didn’t respond directly. Instead he said the financialsector is also going through supply-side structural reform and people should also look atreal prices (real interest rates) besides nominal prices (nominal interest rates), and realprices (real interest rates) are influenced by inflation and other factors.

On deleveraging, Governor Zhou thinks it is related to capacity reduction, anddeleveraging should be a medium-term task, instead of short-term, because of the largedebt overhang. Deputy governor Yi also commented that on deleveraging, the first goalshould be to stabilize the leverage ratio so that each year the increase in leverage ratio issmaller/slower. “Direct financing should be promoted to lower China’s leverage ratio andbetter manage risks- more debt to equity swaps are needed for corporates”, hecommented.

The central bank’s hawkish policy bias is evident its recent policy actions such assuspending open market operations and maintaining a higher interbank rate, but today’scomments are a clear reflection that it faces constraints as well.

4. On financial regulation: Governor Zhou commented that there are three problems -first in the wealth management product market; second, the communication andcooperation between regulatory bodies are insufficient, and last is that there is toomuch money circulation within the financial system instead of servicing the realeconomy. Governor Zhou commented that the regulatory institutions will work on these,and management will be more efficient after regulatory institutions reach an agreement.

The Deputy Governor also said nonbank financial institutions accumulated manyproblems and risks.

We think these comments reflect the concern of the central bank, which is why it is ingeneral expected to release new policy to regulate these wealth management products.

On coordination between regulatory institutions, recent comments made by seniorofficials (Guo Shuqing of CBRC) indicate the merger of the regulators is a “rumor” andhence unlikely to happen, but the level of coordination is likely to rise. The appointmentof chairman Guo, an aggressive reformer, means possible policy actions from the CBRCdeserve more attention. CBRC vice Chairman Cao Yu said their policy would be morestringent than the one by the PBOC. Both PBOC and CBRC policies are yet to bereleased but already drafted.