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Update: China PBOC Three-Year Sale Could Signal Yuan Depeg

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littlekracker



Wednesday, April 7, 2010 - 05:22
Update: China PBOC Three-Year Sale Could Signal Yuan Depeg



BEIJING (MNI) - The People's Bank of China may have given the strongest indication yet that the government plans to allow the yuan to start appreciating again during the current quarter, bond traders said.

The central bank confirmed Wednesday that it plans to reintroduce the sale of three-year paper on alternate weeks, with Thursday's CNY15 billion sale to mark the first since June 26, 2008.

Traders in the interbank market said that the move to reintroduce three-year paper could be part of the bank's effort to lay the groundwork and preempt greater inflows of speculative "hot money" expected during the build-up to, and after, the period in which the yuan is depegged from the U.S. dollar.

"The market consensus is Chinese yuan will resume appreciation in the second quarter. The central bank needs to be pre-emptive in draining the expected increase in hot money inflows," said a senior trader with a "big four" state-owned lender based in Shanghai.

But government economists played down the signficance of its reintroduction. They said that the decision to sell three-year paper is motivated by concerns about domestic economic concerns and does not signal any move on the yuan.

"There isn't much of a relationship between three year bills and yuan appreciation," said Xia Bin, an economist with the Development Research Center, a Beijing-based think tank, and newly appointed member of the monetary policy committee under the People's Bank of China.

"There's currently a lot of liquidity in the financial markets... I think (the reintroduction) is because of worries about inflation, economic overheating and property bubbles."

Nonetheless, speculation about the timing of the resumption of the yuan's appreciation against the U.S. dollar has been building since Chinese export growth returned to positive territory late last year.

U.S. Treasury Secretary Timothy Geithner said at the weekend that he is delaying the release of a politically-sensitive report on the policies of major U.S. trading partners pending a series of high-level meets with Chinese leaders in the coming weeks.

That has only fueled speculation that China will bow to international pressure and allow the currency to strengthen.

"The U.S. has announced that it's delaying the currency report, kicking the ball back. Now it's time for China to make its move," said Lu Zhengwei, chief economist of the Industrial Bank.

Whatever the motivation for the possible reintroduction of three- year bills, liquidity management lies at its heart.

A three-year bill sale would be in line with the PBOC's recent moves to expand its open market operations in order to lock up greater volumes of the interbank market liquidity which would otherwise be used by banks to make loans (a return to gradual yuan appreciation could increase foreign exchange inflows in search of yield which, according to the mechanics of China's exchange rate regime, would be mostly converted into yuan and find its way into the banking system).

The government said in March that it will keep its "appropriately loose" monetary policy unchanged this year, but will tweak that stance according to changing economic conditions.

With the recovery proving ever-firmer and inflation expectations on the rise, analysts expect the magnitude of Beijing's tightening measures to grow, culminating in a rise in benchmark interest rates before the end of this year.

The reintroduction of longer-dated sterilization paper marks another move to tighten up policy and lock up liquidity on a more extended timeframe.

The central bank has already raised the commercial bank reserve requirement twice this year, by a combined 100 basis points.

Stephen Green, head of China research at Standard Chartered Bank in Shanghai, said that smaller banks are complaining about their difficulty in meeting further increases in the reserve requirement.

"Three-year paper locks up liquidity for a little while and doesn't involve across-the-board reserve requirement hikes which smaller banks are tense about," he said.

"It's a more market-friendly way of withdrawing liquidity."

Non-deliverable forward contracts were quoting the yuan at 6.6360 in 12 months versus Tuesday's close at 6.6250.

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