China rates cut not to plunge yuan

"Reduced expectations of a potential economic downturn are likely to lead to a pick-up in capital inflows," Nomura said in a brief report.

The cut will help reduce the debt burden and lower financial risks, Barclays' Chang said. It will also support business sentiment and sustain private demand.

The value of the yuan strengthened by 30 basis points against the US dollar in its central parity rate on Tuesday opening after a 200 basis points drop on Monday.

The interest rates cut may also dampen concerns over China's property market and local government debt, which seen by many as the biggest risks to the world's second largest economy.

The interest rates cut will allow local governments to breathe more freely when facing their trillions of debt, a big proportion of which will be due soon.

Although only a limited number of financially robust property developers can obtain loans directly from banks, the benchmark rates cut can bring down the overall social borrowing costs, thus alleviating debt burdens on the property sector.

Also, more people will likely buy homes given the lower interest rates.

While dragging down returns on yuan-dominated fixed-income products, the interest rates cut may help boost the performance of Chinese stock markets, especially with the launch of the Shanghai-Hong Kong Stock Connect.

Foreign inflows to Chinese stock markets can lead to more purchases of Chinese yuan, buffering the currency from the impact of selling.

Some bullish domestic securities firms say the interest rates cut gives one more good reason for international investors to buy relatively cheap Chinese stocks under the Shanghai-Hong Kong Stock Connect.

On Tuesday, the Shanghai Composite Index rose 1.37 percent after reaching a three-year high the day before.

But a possible stock rally may not necessarily advance the yuan against the dollar.

"Overseas inflows into Chinese equity market will not automatically push Chinese offshore yuan a spot higher," said UBS Chief China Economist Wang Tao.

She thinks many foreign institutional investors may choose to borrow rather than buy Chinese yuan to fund their purchases of Chinese mainland stocks.

"Not all flows into Shanghai equities will be foreign exchange-hedged -- only a portion will be. That, however, will still be enough to dilute any initial mutual market access induced boost," Wang said.

 

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