BEIJING (MNI) - Capital flows of speculative "hot money" are being
lured into China by the attraction of rising asset prices and not the
slow, gradual appreciation of the yuan, a People's Bank of China
official told Market News International.
The comments of the official, who asked that his name not be
published, suggest that the central bank has largely abandoned a
long-standing pillar of exchange rate reform policy and point to a
greater willingness to use interest rates in Beijing's efforts to bring
economic activity under control.
"Hot money in China doesn't care about the small (interest) rate
gap. China's economic development is good," he said, noting the 11.5%
growth rate in the first half of 2005.
"Speculators won't move their money here and there just because of
small changes in the rate gap."
Several Chinese central bank officials, including Assistant
Governor Yi Gang, have noted in the past the importance of maintaining a
spread between China and the international markets.
It was a central plank of the PBOC's strategy for unschackling the
yuan from its dollar peg on July 21, 2005, based on the idea that
investors would be deterred from parking money in China to profit from
appreciation if the carry costs were high enough.
Some analysts continue to believe that maintaining a sizeable rate
gap is an important part of Chinese monetary policy-making.
But the massive gains to be had in a resurgent stock market, along
with property investment returns, have dwarfed the single-digit returns
available on straight currency appreciation.
Yields on benchmark one-year sterilization paper issued by the
People's Bank of China were driven to a record low of 1.33% in the weeks
following the July 2005 yuan revaluation.
Based on the equivalent US Dollar London Interbank Offered Rate
(LIBOR), the rate gap widened to over 340 basis points in early November
2005.
Since then, the Federal Reserve has paused its tightening campaign,
while the PBOC has only stepped up the pace of interest rate hikes, with
the most recent adjustment on July 21.
That adjustment saw the gap narrow to 213 basis points, based upon
last Tuesday's one-year PBOC paper auction.
Analysts said that it is likely to narrow further. Last Saturday's
rate hike was the fifth since April 2006, and at least one more 27 basis
point move is expected before the end of this year.
Furthermore, expectations that the Federal Reserve could cut rates
soon is likely to rise if problems in sub-prime mortgage market begin to
hit overall US growth.
But the PBOC official, while acknowledging that the rate gap has
shrunk in recent months, noted that the US economy's recent performance
has exceeded expectations.
"It's better than the forecasts were at the beginning of the year
so US interest rates may not fall sharply," he said.
Irene Cheung, a currency strategist with ABN Amro in Singapore,
said that the increased pace of interest rate tightening by the PBOC
seen since April last year, and particularly since the start of this
year, points to the reduced emphasis the central bank is placing on the
rate gap.
"They've come around to realize that the money coming in is not
looking for interest rate returns and the fact that interest rates in
China are lower than in the US has not helped turn away inflows," she
said.
As things currently stand, the outlook for Chinese and US interest
rates does not suggest that the PBOC is going to have a change of heart
any time soon and sacrifice control over the domestic economy to defend
the exchange rate, she said.
"You see two or three percent in a day on the stock market so
what's 25 or 50 basis points?," she said.
Hot money is believed to flow into China via the current and
capital accounts. Notoriously difficult to track, PBOC officials
routinely acknowledge its existence but have refused to provide
any official estimates as to the size of the inflows.
Chinese foreign exchange reserves increased by $266 bln in the
first half of this year to $1.333 trln. Of that, an estimated $94 bln is
unaccounted for by trade flows, foreign direct investment and the
estimated returns on foreign exchange reserve holdings.
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