China Ditches Deleveraging, Posing Yuan Hit, Citigroup Says

(Bloomberg) -- China’s moves to boost liquidity in an effort to safeguard economic growth are eroding the country’s yield premium over the U.S., putting “renewed pressure” on the yuan, according to Citigroup Inc.

“Going by its latest policy moves, China has likely halted or even abandoned its financial-deleveraging program” amid the trade war with the U.S., Liu Li-Gang, chief China economist at Citigroup in Hong Kong, wrote in a note. The People’s Bank of China has pumped 3.4 trillion yuan ($492 billion) into the banking system so far this year through regular open-market operations and cuts in lenders’ required reserve ratios, Citigroup estimates.

China Ditches Deleveraging, Posing Yuan Hit, Citigroup Says

The good news for China’s economy is that growth may hold up at 6.5 percent for the second half of 2018 thanks to monetary stimulus, fiscal spending and initiatives by local governments that have ramped up bond issuance, Liu wrote. The costs will be a wider fiscal deficit, greater concerns about China’s debt sustainability and an increased danger of capital flight, he said.

“Capital flight from China could increase in the future, but capital inflows would reduce” thanks to sharply narrowing interest-rate differentials, Liu wrote. The bad news for the yuan is that authorities probably don’t view 7 per dollar as any “psychological threshold to defend any more,” he said. “When needed, it could be allowed to weaken.”

The yuan was at 6.9188 per dollar in onshore trading Tuesday, down almost 6 percent for the year and near the weakest since early 2017.

Most market players surveyed by Bloomberg expect Chinese officials to keep the yuan from hitting 7 per dollar this year -- a level it hasn’t seen since 2008. But HSBC Holdings Plc analysts agree with their Citigroup counterparts in seeing 7 as just another number.

“Punching through 7, in itself, won’t blow the lights out,” Frederic Neumann, co-head of Asian economics research, wrote in a note Monday. “There seems to be a tad too much attention focused on the ‘7 threshold.”’

©2018 Bloomberg L.P.