September is set to be a hard month for China’s money markets, handing the nation’s central bank the tricky task of adding just enough liquidity without prompting renewed weakness in the yuan.
Funding costs usually spike at this point, as banks hoard cash for quarter-end regulatory checks. Adding to the pressure now is a requirement to buy a flood of local government bond issuance, mandated to shore up infrastructure spending as the economy slows. A large amount of the People's Bank of China's existing funding is also maturing, and all told, liquidity needs could hit around 980 billion yuan ($143 billion) according to Bloomberg calculations.
That leaves policy makers with a decision on how and when to meet those needs, without giving currency traders fresh reason to sell the yuan, now that policy tweaks have seen the exchange rate bounce off its 19-month low in August. While the PBOC has met funding needs by easing banks’ reserve requirements three times already this year, that might not be the first choice this time around.
“The PBOC’s goal will be ensuring ample cash supply while not triggering strong easing expectations, which will send the yuan tumbling,” said David Qu, Shanghai-based economist at Australia & New Zealand Banking Group. “It will likely add liquidity via open-market operations and medium-term lending facility next month while cutting the reserve-ratio requirement again as early as October.”
China’s local governments will issue a total of 2.45 trillion yuan of debt between August and December, compared with net sales of 1.85 trillion in the first seven months of 2018, according to Yang Chen, a rates strategist at Bank of America Merrill Lynch in Hong Kong. The finance ministry of recently ordered regional authorities to ramp up funding to boost building projects.
Other than that, seasonal factors are also acting to drain liquidity in September. Banks need to repay 2.1 trillion yuan of short-term loans, the second-highest monthly maturity this year, and get ready for official checks and a tax season starting in October. Money market rates have been climbing of late, with the overnight repurchase rate jumping 85 basis points from a three year low in August.
Yet in choosing how to add funds, the PBOC will be wary of appearing as if it is easing monetary policy on a broad basis, something that a cut to reserve ratios risks doing. Instead, a narrower, targeted injection via the medium-term lending facility could achieve the task without looking like a bigger easing step that could weaken the currency.
A reserve requirement ratio-cut sends too strong an easing signal, especially in a month when the Federal Reserve is widely expected to raise borrowing costs, ANZ’s Qu said.
The yuan has tumbled more than 6 per cent over the past three months -- making it the worst performer in Asia. In response, officials have taken actions including the reinstatement of a factor used to decide the daily fixings, giving them better control over the exchange rate. A reserve requirement that makes shorting the yuan costlier with forwards has also been reintroduced. The currency rebounded 1.5 per cent since hitting the lowest since January 2017 earlier this month.
“With the yuan not being a top concern, for now, the central bank sees bigger room to manoeuvre monetary policy to react to the domestic economy,” said Fan Ruoying, an analyst at the Bank of China’s Institute of International Finance in Beijing.
Still, the PBOC is seen conducting an RRR reduction after it follows the Federal Reserve in boosting borrowing costs in September, Guotai Junan analysts led by Qin Han wrote in a note last week. Lu Ting, chief China economist at Nomura International in Hong Kong, sees a reduction of one percentage point by the end of this year. The ratio currently stands at 15.5 per cent for major banks.
“RRR reduction still looks necessary because the move provides cheaper and longer-term funding without the need for collateral, particularly to smaller lenders that may not have access to the MLF,” said Bank of America’s Chen. That’s unlikely to imply significant pressure on the yuan, as “officials have placed tight capital controls and rolled out other defensive measures,” she said.