China's central bank and commercial banks bought a net $4 billion in foreign exchange in February, marking a second straight month of net capital inflows despite a trade deficit. But analysts say the central bank may have to cut the amount of cash banks must hold as reserves to compensate for weak capital inflows into the world's second-largest economy due to global and domestic economic risks and slower rises in the yuan.
China made net foreign exchange purchases of 25.1 billion yuan ($3.97 billion) in February, according Reuters calculations based on central bank data published on Friday. The net inflows came despite China posting a $31.5 billion trade deficit in February, its largest in at least a decade, and falling foreign direct investment (FDI).
"Some short-term funds may be returning to China but capital inflows will not be strong this year," said Zhang Xinfa, an economist at Galaxy Securities in Beijing. February's net buying of foreign exchange marked an 82 percent slide from January's 140.9 billion yuan, as capital flowed into the economy after three months of net outflows.
Net foreign exchange purchases in February and January were smaller than the monthly average for 2011 of 231.6 billion yuan and the 2010 average of 272.4 billion yuan. The inflow of foreign capital is a basic component of money supply in the financial system, and a fall in its level implies a need to expand domestic credit creation by easing monetary policy in order to keep money supply growth steady.
The central bank could continue to cut banks' reserve requirement ratio (RRR), its favourite policy tool, to crank up credit creation, but is not expected to move before the end of March, according to a Reuters poll. China's State Administration of Foreign Exchange has forecast that China will continue to see an international payment surplus in 2012, partly as it remains an attractive destination for long-term investors.