From the South China Morning Post:
The People’s Bank of China is reluctant to further reduce the required reserve ratio for fear of such a move resulting in the weakening of the yuan, according to a leaked document.
The information, reportedly leaked from minutes of Tuesday’s meeting between the central bank and commercial lenders, was shared widely after it was published on major mainland online portals including Sina.com and Netease.com.
…The memo sheds light on the challenge the PBOC faces in trying to achieve two conflicting goals. It has to ease monetary supply to raise liquidity to boost the ailing economy. But it also has to stop the yuan from weakening too much, which could happen in the case of increased liquidity.
“A too-loose liquidity situation may result in relatively big pressure on the yuan exchange rate…”According to the memo, Zhang Xiaohui, an assistant central bank governor in charge of monetary policy, told commercial bankers that the PBOC had to be very careful in maintaining the renminbi’s exchange rate stability when managing liquidity.
A key lesson for the central bank was the aftermath of its move in late October to cut interest rates and the reserve ratio. The move greatly loosened liquidity conditions, and “increased yuan depreciation expectations and added pressure on the yuan to weaken”, Zhang said.
The PBOC had to balance ensuring sufficient liquidity in the banking system and managing the stability of the yuan exchange rate, the official said.
“A too-loose liquidity situation may result in relatively big pressure on the yuan exchange rate,” Zhang was quoted as saying. “A cut in the required reserve ratio would be too strong a signal [to send to the market], and we can use other tools to provide the market with liquidity.”
The central bank could therefore be expected to increase liquidity in the economy through open-market operations that were less drastic than cutting the reserve ratio, the memo said.
Which we are already seeing with huge injections late last week. But that is not going to be enough as China’s old economy continues to slow around the wind down of the real estate building boom, the glide slope for which will need to supported via cheaper debt.
Recall that China is up against the “impossible trinity” here, that a country cannot control floating interest rates, the currency and capital flows all at once.
Like its ad hoc capital controls, I expect that liquidity injections will prove inadequate after a while and the PBOC will be forced to ease again. And if it has any brains it’ll know that. This is about spreading the pain over a manageable period of time – the glide slope as I call it – not preventing the adjustment from happening. The alternative of no easing and a supported yuan will simply bring on the hard landing all the quicker.
It’s called the impossible trinity for a reason.
