Net purchases skyrocket nearly fourfold to 441.6b yuan as central bank seeks to reduce liquidity

A surge in net purchases of foreign exchange in October reflects rising interest among international holders of capital to conduct cross-border arbitrage in China, and that may lead the central bank to curtail domestic liquidity in the short term, analysts said.

The net purchases, also described as new funds outstanding for foreign exchange, surged last month to 441.6 billion yuan ($72.47 billion) from 126.4 billion yuan in September.

That was the second-largest monthly increase this year since the rise of 683.66 billion yuan in January.

The figure represents net purchases of foreign exchange by the People's Bank of China and other banks in the nation. The PBOC is ultimately in charge of purchasing foreign exchange assets to keep the yuan's exchange rate stable.

Analysts said that a rapid inflow of speculative international capital - so-called hot money - may account for last month's surge.

Li Huiyong, an analyst at Shenyin and Wanguo Securities Co Ltd, said that speculative capital inflows in October might have reached $39.81 billion, or $38.39 billion more than in September.

"The recent improvement of China's overall economic situation has raised expectations of further appreciation of the Chinese currency against the US dollar.

"Together with relatively higher interest rates in the mainland market, these expectations attract hot money," Li said.

Another factor, he said, was the 5.6 percent rise in October exports to 1.14 trillion yuan, which led market participants to sell foreign currencies, he said.

As for the international environment, the US Federal Reserve Board has yet to begin tapering off its quantitative easing policy. Meanwhile, the Europe an Central Bank cut its benchmark interest rate to a record low of 0.25 percent.

These factors provide relatively abundant liquidity in overseas markets.

Chinese policymakers should realize that international speculative capital may move into the domestic market in the guise of export orders and cause volatility in the financial system if it flows out suddenly, according to Chen Hufei, a researcher at Bank of Communications Ltd.

Song Guoqing, a professor of the National School of Development at Peking University and an advisor to the PBOC, said that the central bank's monetary policy is likely to move further to a more "neu tral" or even "tighter" setting, considering the current liquidity situation.

There are signs that the PBOC may intend to tighten monetary conditions, said Zhang Zhiwei, chief economist in China at Nomura Securities Co Ltd. Signals include the continued rise of bond yields, Zhang said.

The PBOC locked up longer-end liquidity by rolling over maturing three-year bills amounting to 30 billion yuan. It also injected short-term liquidity totaling 9 billion yuan via a seven-day reverse repurchase operation, with a rate of 4.1 percent - higher than the interbank rate of 3.7 percent.

"The central bank is likely to continually encourage gradual deleveraging , and the overall credit environment is expected to remain tight in November and December," said Zhang.

"In this situation, GDP growth may slow to 7.5 percent year-on-year in the fourth quarter and 6.9 percent in 2014," he said.