LDN - Business

China, following Fed, lifts short-term rates to steady yuan, battle debt

[March 16, 2017] By John Ruwitch and Winni Zhou

SHANGHAI (Reuters) - China's central bank raised short-term interest rates on Thursday in what economists said was a bid to stave off capital outflows and keep the yuan currency stable after the Federal Reserve raised U.S. rates overnight.

The increase in rates was China's third in as many months, and came a day after the end of the annual session of parliament where leaders warned that tackling risks from a rapid build-up in debt would be a top policy priority this year.

Hours earlier, the Fed raised its benchmark policy rate, as had been widely expected, and signaled more hikes were on the way as the U.S. economy picks up steam.

"The timing says it all. China is no longer insulated from the Fed and, more generally, from international financial conditions," said Alicia Garcia Herrero, chief Asia Pacific economist at Natixis.

The People's Bank of China (PBOC) has left its benchmark lending rate unchanged since an October 2015 cut, and said specifically that Thursday's action should not be seen as full-blown policy tightening, like that of the Fed.

But analysts and investors believe the PBOC is increasingly using money market rates and other policy tools as it struggles to contain financial risks from years of debt-fueled stimulus and raise the costs for speculators betting against the yuan.

China's banks tend to rely heavily on short-term, interbank lending, which connect strong banks with weaker counterparts and shadowy lenders. The PBOC has been allowing repo rates to rise since late 2016 by adjusting the amount of funds it injects.

"The higher U.S. rates and tightening of U.S. monetary policy could trigger further capital outflows and have some negative impact on China's financial system," Nomura economist Yang Zhao said.

"I think they want to stabilize the currency at this time."

The PBOC also strengthened the yuan's daily mid-point reference rate by the most in about two months on Thursday. The yuan ended the day up 0.2 percent.

But benchmark 10-year treasury futures closed at their highest in over two months, as a big central bank cash injection calmed market jitters after the rate rises.

Last year the yuan fell 6.5 percent against a resurgent dollar and uncertainty over China's economy, prompting the government to clamp down on capital outflows to ease a drain on its foreign exchange reserves.

The yuan has been largely stable this year as the dollar has paused, but China's government has remained alert as many market watchers expect the dollar will eventually resume its climb.

STRONGER ECONOMY GIVES POLICYMAKERS MORE ROOM

After years of super-loose policy, the PBOC has cautiously shifted to a modest tightening bias in recent months, though it is treading cautiously to avoid hurting growth. The economy is on steadier footing now, giving policymakers more room.

PBOC Governor Zhou Xiaochuan said on Friday that China's corporate debt levels are too high but stressed it will take time to bring them down to more manageable levels.

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A Chinese national flag flutters outside the headquarters of the People's Bank of China, the Chinese central bank, in Beijing, China April 3, 2014. REUTERS/Petar Kujundzic/File Photo

In keeping with that cautious approach, most of the increases on Thursday were a very modest 10 basis points (bps), or a tenth of a percentage point, the same as moves in various short- and mid-term policy instruments in January and February.

The rate on open market operation reverse repos for seven-, 14- and 28-day tenors was bumped up for the second time in six weeks, with the seven-day rising to 2.45 percent.

The PBOC insisted the moves did not indicate a change in its monetary policy, though some economists say the seven-day reverse repurchase rate has become a de facto policy rate.

Flexibility in rates is favorable for deleveraging, "deflating bubbles" and risk prevention, the PBOC said.

"(The market) does not need to over-interpret the amount and price of each operation," it said. "Changes in rates are normal and do not indicate a change in direction for monetary policy."

Economists expect further modest hikes in the seven-day rate over the course of the year, with ANZ expecting another 20 bps rise by year-end and London-based Capital Economics forecasting another 55 bps.

The weighted average rate for the seven-day reverse repo rose to 2.7641 percent, from Wednesday's 2.5697 percent.

CASH INJECTIONS TO CALM THE NERVES

The PBOC also raised the borrowing rate on its medium-term lending facility (MLF) loans, with the six-month rate now 3.05 percent and the one-year at 3.20 percent, after a similar move in late January. The MLF is a supplementary policy tool it uses to manage liquidity conditions in the banking system and money markets.

Completing the daily triple-play, sources said the PBOC also raised rates on its standing lending facility (SLF) short-term loans later in the day.

The rate increase for overnight SLF loans was twice that of the other instruments at 20 bps, possibly signaling concern that very short-term funding was still being used in riskier ways despite pledges of a crackdown. The PBOC had no immediate comment.

The central bank also injected a large amount of fresh funds into the financial system to maintain liquidity.

It lent 113.5 billion yuan ($16.47 billion) of six-month MLF loans and 189.5 billion yuan of one-year MLF loans to 17 financial institutions on Thursday.

Economists polled by Reuters earlier this year expected China would keep its benchmark lending rate steady through at least the second quarter of 2018.

(Additional reporting by Elias Glenn in BEIJING; Editing by Kim Coghill)

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