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Thoughts on China's RRR and RMB

          We do see some softness in capital inflow, including the reduction in the RMB amount induced by the foreign exchange purchase in October and the weaker RMB NDF reading. Nonetheless, the growth in foreign exchange loans remains stable. It is too early to conclude that China will encounter a sustained capital outflow.

Our take is the future RRR decision will hinge on the capital inflow data. If the capital inflow drops to under 50 bil RMB per month during this couple of months, then we are likely to see a universal RRR cut within 3 months. If the capital inflow can stabilize at around 200 bil RMB per month, the PBoC probably can keep the current RRR rate and do some short term liquidity adjustment through open market operations.

Our composite indicator for RMB appreciation pressure grasped the RMB moves this year quite well. The composite indicator contains three factors, China’s domestic CPI, the degree of external imbalance, and the dollar strength against a basket of currencies. Based on our current forecast for CPI and imports/exports for Y2012, we see the RMB will continue to appreciate against USD, but at a slower rate during the 1H2012.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.