China will encourage the value of its yuan currency to be set by the market and step back from intervention "in an orderly manner", while keeping policy flexible to support credit growth in the face of volatile capital flows, 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 said monetary policy moves would respond to liquidity conditions determined by the balance of payments, demand for yuan in markets and international capital flows.
"The closer the yuan is to an equilibrium, the bigger role market forces will play in the yuan exchange rate. We will allow and encourage market forces to play a bigger role, and the central bank's participation and intervention in the market will decrease in an orderly manner," Zhou said. Zhou did not comment on speculation that China is ready to widen the yuan's trading band to create 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. Zhou's remarks support well-entrenched investor views of an imminent reduction in the amount of cash commercial lenders must keep with the central bank, following cuts of 50 basis points each in November and February that brought the required reserve ratio (RRR) down from June 2011's record high of 21.5 percent.
"There is a lot of room for RRR cuts," Zhou told the central bank's annual conference held on the sidelines of China's annual meeting of parliament, the National People's Congress. "But we need to look at whether it's necessary... and look at market liquidity. We cannot raise or cut RRR at will when we think there is room. We need to look at the liquidity condition, which is related to FX purchases and our international balance of payments."
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 eased in February while bank lending, retail sales and industrial output fell below forecast, all pointing to a cooling economy.
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. 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 full year of growth in a decade of between 8 and 9 percent.