China: Policy Targets, and a Strong Currency

Published on August 4, 2017

When it comes to liquidity and rates, the People’s Bank of China has been transparent and steady – to the point of boring – as it manages the “prudent and neutral” course the leadership in Beijing has set for its monetary policy.

The bigger question is to what extent the leadership in Beijing will, in its efforts to rein in credit growth, now manage new loan growth for the remainder of the year, and whether, as the dollar weakens against the backdrop of recent trade and political frictions between the US and China, the Chinese Yuan will be allowed to keep strengthening.

*** On the credit side, from what we have learned, the leadership in Beijing has, in a series of recent meetings, targeted new loan growth for H2 2017 at 5.3 trillion Yuan, nearly 200 billion CNY more than the 5.12 trillion target for the same period last year. That would make new loan growth for 2017 the largest yet on record. ***

*** And on the currency front, after a series of meetings with US Treasury Secretary Steve Mnuchin, Chinese officials have been left with the distinct impression the Trump Administration favors a weak dollar and, with it, a strong Renminbi. They suggest the RMB could strengthen even further, to break the 6.70 level, and trade in a 6.60-6.70 range by the end of the year – assuming, that is, the two countries maintain good bilateral relations, at least on the economic front. ***

Setting Second Half Targets

With the all-important 19th National Congress of the Communist Party of China  looming large, China’s Central Financial Leading Group held the third of its eight summer meetings on July 25, in Zhongnanhai, to set monetary policy for the second half of 2017.

That meeting came on the heels of another meeting the day before of the Political Bureau of the CPC Central Committee to formulate broad guidelines of macroeconomic policy, chaired by President Xi Jinping himself.

The meetings endorsed the continued implementation of the PBOC’s “prudent and neutral” monetary policy, noted the more positive momentum in the Chinese economy than initially expected for the first-half of 2017, and sought an essentially unchanged monetary policy stance through the second half of 2017.

The PBOC was urged to keep the current monetary policy orientation, and draw on the flexibility of multiple monetary policy tools to provide a “neutral and temperate” liquidity environment to induce risk prevention and structural reform, ensuring no drastic easing or tightening of liquidity through the second half of 2017. However, targeted measures would continue to be expected to be used to boost market vitality and generate growth.

On the credit side, the meeting endorsed a new loan target for the PBOC of 5.3 trillion Yuan for the second half of 2017, nearly 200 billion higher than the same period last year. If achieved, that would put new loan growth at 13 trillion Yuan for the year, the highest on record.

The central bank was directed to conduct open market operations to withdraw or inject liquidity in markets as needed, but is not expected to raise benchmark interest rates, at least, for certain, not through August.

The July 24 Politburo meeting also affirmed the current sound economic situation, and Premier Li Keqiang reportedly predicted Q3 GDP growth to end up at around 6.8%, especially in light of the strong indicators that are already in for July.

Currency Politics and Levels

On the currency front, with the economy on a steady growth path, and an outlook that remains positive, the leadership in Beijing continues to see less of a need for the PBoC to intervene in the markets, and sees FX market forces playing a bigger role in determining the spot Renminbi interbank rate for the second half of 2017.

One of the top priorities for the PBoC will be the continued internationalization of the RMB (note rumors recently swirling that the PBOC may be widening the RMB daily trading band to 3%), and to keep the RMB relatively stable through the second half of 2017.

Beijing expects that with a continued weak dollar, and a relatively healthy bid under the RMB, FX reserves, which had depleted sharply in 2016, will continue to reverse that trend, and increase further in H2 of 2017.

But after a 2.4% appreciation of the RMB in the first half of 2017 against the dollar, authorities will encourage more frequent two-way swings in the RMB, albeit unanimously ruling out a large or sharp depreciation against the dollar.

Indeed, Chinese officials, having met US Treasury Secretary Mnuchin three times since April, were left with the distinct impression the Trump Administration was not too keen on a strong dollar, and asked that China maintain a relatively strong RMB.

Some Chinese officials now suggest the RMB could break above (USD/RMB below) the 6.70 level, to trade in the 6.60-6.70 range, by the end of the year, if, that is, the two countries maintain normal and good bilateral relations.

Targeting Flows for Politics

Finally, on the domestic side, the PBoC was encouraged after the meetings to continue to promote the diversified operations of its FX reserves, and to support and encourage companies planning to invest in countries along China’s strategic “Belt and Road.”

The PBoC and related departments were also asked to closely monitor capital outflows, and to prohibit excess investment in real estate, entertainment, sports, media, arts, fashion and cultural sectors overseas – especially in developed countries.

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