China has ample room to tweak policy to support credit growth in the face of volatile foreign capital flows that will inevitably see market forces play a greater role in determining the value of the yuan currency, the central bank said on Monday.
Speaking days after China posted its biggest trade deficit in at least a decade, People's Bank of China (PBOC) Governor Zhou Xiaochuan Zhou signaled that Beijing has plenty of scope to relax monetary policy to juice up the cooling economy.
His remarks support well-entrenched bets among investors that China will further reduce the amount of cash its commercial banks must hold as reserves with the central bank, to free up more money for lending.
"There is a pretty big room for RRR cuts," Zhou said at an annual press conference, referring to bank's reserve requirement ratio.
"The RRR is just over 20 percent now. We had a low RRR of 6 percent in the late 1990s, even lower than that in some countries."
But Zhou said future RRR moves will depend on the overall liquidity in financial markets, as determined by China's balance of payments and total foreign currency purchases by the central bank and Chinese commercial banks.
"The biggest uncertainty in the international economy is, as we all know, the recovery, and especially with regards to Europe's economy and the euro sovereign debt crisis," Zhou said.
Zhou did not comment on speculation that China is ready to widen the yuan's trading band to give the currency more flexibility, even as Beijing pushed the yuan sharply lower on Monday.
It has set a weaker trading midpoint for the currency in five of the last six trading sessions, fueling some speculation in financial markets that Beijing may rely more on foreign exchange policy to stimulate exports and broader growth.
Yi Gang, deputy governor at the central bank and who oversees the management of China's $3.2 trillion foreign exchange reserves, said China's trade performance last month was evidence that the yuan is close to a "balanced level.
The yuan's value has been a lightning rod for disputes between China and its biggest trade partners including the United States, who accuse Beijing of deliberately holding down the currency for trade advantage.
China has always denied those allegations, and increasingly says it is allowing market forces to have a bigger sway over the yuan as it nears its fair value, an argument reiterated by Zhou.
"The closer the yuan is to a balanced level, the bigger role market forces will play in the exchange rate," he said.
"We will allow and encourage market forces to play a bigger role, and the central bank will reduce its intervention in the market in an orderly manner," Zhou said, but declined to comment on whether the yuan may soon stop rising.
"Whether the yuan's appreciation is over, I think that is mainly up to market demand and supply. It won't be that simple."
Data over the weekend showed China's trade balance plunged $31.5 billion into the red in February as imports swamped exports. It followed reports on Friday that inflation cooled in February while retail sales and industrial output fell below forecast, all pointing to a gradual cooling.
The trade data "means a bigger need to stimulate domestic demand - via fiscal stimulus and monetary easing," said Dariusz Kowalczyk, senior economist and strategist for Asia ex-Japan at Credit Agricole CIB, in a note.
"So we expect 200 bps more in RRR cuts and 50 bps in interest rate cuts later this year."
The central bank had cut the RRR by 50 basis points each in November and February to foster economic growth and ease credit strains arising from tight monetary conditions, a shrinking trade surplus and slower hot money inflows.
The ratio is now 20.5 percent, just 100 basis points below all-time highs of 21.5 percent struck in June 2011 when Beijing was tightening policy to combat three-year high inflation.
A recent Reuters poll showed analysts expect Beijing to cut the RRR by a further 150 basis points this year when the world's No. 2 economy is set to clock its slowest growth in a decade of between 8 and 9 percent.
MORE REFORMS NEEDED
The central bank forced the yuan's mid-point down by its second-biggest single-day decline on Monday, reviving talk that China is ready to enlarge the yuan's trading band.
China wields tight control over the yuan through regular market interventions, and by having the central bank set its daily mid-point before the start of trade.
This anchors the yuan's value against foreign currencies as the yuan can only rise by a certain margin from the mid-point on any trading day. The yuan can only rise or fall 0.5 percent from the mid-point against the dollar, for instance.
But Beijing wants to relax its grip on the yuan, also known as the renminbi, to have it basically convertible by 2015 in the hope that it would lay the ground for China's ambitions to be a global financial center by 2020.
Many analysts argue much work still needs to be done, saying China needs to free its interest rate market before it frees its currency. Some are skeptical that China has the political will to push through rate reforms that may hurt the health of its giant state-owned banks.
China de-pegged the yuan from the dollar in a landmark move in July 2005 and it has since appreciated some 30 percent against the U.S. currency, though some critics in the West say Beijing is still keeping too tight a grip on the yuan in order to aid the country's exporters.
"Steady progress will be made to promote capital account convertibility," the central bank said before the press conference.
The statement said Beijing will work on getting more firms to settle their cross-border trade in yuan, and expand the type of yuan products available.
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