(Yicai Global) April 17 -- China will maintain its neutral monetary policy and some financial sector defaults are normal, said Fan Gang, an adviser to the People's Bank of China.
Such defaults are no cause for alarm because their overall scale is limited, Prof. Fan said in an interview with CBN TV China. Fan serves on PBOC's monetary policy committee.
It is hard to tell whether an interest rate cut is in order given the different contributing factors, but it would be perfectly normal to cut banks' required reserve ratio (RRR), he said. The ratio is at 17 percent because China's foreign exchange reserves used to grow by hundreds of billions of dollars a year, and a certain amount of that needed to be brought back and put aside, he added. That was the RRR's purpose, he said.
Now that the country's forex reserves have fallen to USD3 trillion from USD4 trillion with further reductions planned, the ratio also needs to be lowered to avoid a monetary shortage, Fan said. Under current circumstances, a cut in the ratio would not amount to a looser monetary policy, he said. That policy will remain neutral, he added.
Defaults are largely caused by overcapacity and high leverage, not by monetary policy, and are more of a regulatory issue than a monetary phenomenon, Fan said. They are the aftereffects of economic overheating some years ago, he added. We should brace ourselves for defaults and not panic, he said. It would be more worrying if there were no defaults as that would mean the problem was not exposed.
As for the drop in forex reserves, Fan said it is great that the figure has fallen to USD3 trillion. Even USD2 trillion would be too much, Fan added. After the inclusion of the yuan in the International Monetary Fund's Special Drawing Rights (SDRs), it has become a hard currency, he said. In the past, China needed to maintain holdings in other currencies because the yuan was not widely trusted, but now China does not need it, he added. The yuan has been internationalized, so China does not need to hold such large reserves, he said.
Fan also said there is no need to keep the current exchange rates either, noting that China will never peg its currency to the US dollar again, and the yuan's exchange rates will be increasingly flexible in the future.
From the short-term perspective, Fan said the dollar would remain strong on the back of tax cuts and increased infrastructure investment implemented by the Trump administration to attract investors to the US. A strong dollar may lead to rallies in global crude oil prices and commodity markets, he added.
In the long run, the dollar is on a downward trajectory given rising inflation and mounting debts in the American economy, Fan said. China should be prepared for such a long-term trend, he added.