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China supports Covid-hit yuan – Industry roundup: 26 April

China cuts banks’ foreign reserve requirement ratio to support yuan

China's central bank is reducing the amount of foreign exchange that banks must hold as reserves in a move to slow the depreciation of the yuan, which is at its weakest levels in a year.

The People's Bank of China (PBoC) said that from 15 May it would cut the foreign exchange reserve requirement ratio (RRR) by 100 basis points (bps) to 8%, to "improve financial institutions' ability to use foreign exchange funds", according to an online statement.

The PBOC previously raised the FX RRR for financial institutions by 200 basis points last December, to rein in a rising yuan and make it more expensive for banks to hold dollars. The partial reversal is expected to lend the tightly managed currency some support, by freeing up dollars that banks need to maintain with the central bank.

More recently the yuan has been in retreat on concerns over China’s worsening economic growth outlook caused by strict Covid-19 lockdowns in Shanghai and major cities and the loss of a yield advantage versus the dollar. In the past month it has moved more than 3% lower against the dollar and began this week at a one-year low of 6.5775.

Marco Sun, chief financial market analyst at MUFG Bank, said the yen’s recent retreat against the dollar have de-coupled the currency from China's economic fundamentals and prompted the authorities to roll out measures to prevent it from falling further.

“Market participants who see the cut as a signal from policymakers would likely to dial back on the short positions on the CNY and CNH,” Sun said. CNY is renminbi traded on mainland China, while CNH is traded offshore. He expects the yuan to trade in a range of 6.35 to 6.55 per dollar following the adjustment and believes that the currency’s recovery could be limited if, as expected, the US Federal Reserve decides on a further rate hike next month.

The spot yuan pared losses following the PBoC announcement, with both onshore and offshore yuan strengthening about 300 pips to 6.5395 and 6.5698 per dollar, respectively. However, last week both the onshore and offshore yuan suffered their worst performance since 2015 last week. The growth worries have also triggered the biggest sell-off in Chinese stocks since the pandemic-led panic-selling of February 2020.

Bahamas moves nearer mainstream crypto adoption

Global crypto adoption continues to grow as the Bahamas have now allowed citizens to pay taxes in digital assets, reports Marcus Sotiriou, analyst at the UK-based digital asset broker GlobalBlock.

Bahamas Prime Minister Philip Davis said last week: “We have a vision to transform the Bahamas into the leading digital asset hub in the Caribbean.” The announcement of their strategy to increase digital asset adoption comes ahead of the Crypto Bahamas conference, which will be attended by guests such as former UK Prime Minister Tony Blair, former US President Bill Clinton and National Football League (NFL) quarterback Tom Brady.

In addition, the government will allow residents to use the Bahamas central bank digital currency (CBDC), aka the Bahamas sand dollar, to access digital assets. Sotiriou notes that a report from PwC last year showed that amongst the 60 CBDCs that are in the works worldwide, the sand dollar is ahead of the curve. PwC ranked the top 10 retail CBDC initiatives around the world based on project maturity, with the sand dollar coming first.

CBDCs aim to increase efficiency in payments, cut costs of financial services and tighten up control on cash-enabled fraud. According to a recent report from PwC, most of the world’s central banks are considering launching a CBDC. Analysts at PwC said, “We expect that CBDCs will greatly benefit cross-border transactions and economies of all relevant jurisdictions.” Sotiriou concludes: “Despite the issues of privacy associated with CBDCs, I think they will be a significant catalyst for mainstream adoption of cryptocurrencies.”

Cryptocurrency exchange FTX moved its headquarters to the Bahamas last September, with CEO Sam Bankman-Fried attributing the move to. a “progressive and forward-thinking crypto bill” that would regulate the industry in the country.

Sovereign wealth funds play safer on investment

Last year saw a major shift by large institutional investors towards assets and markets they regard as less risky, according to a joint report by the International Forum of Sovereign Wealth Funds (IFSWF), a global network of sovereign wealth funds from 40 countries, and State Street Corporation.

The report, entitled Post-pandemic shift: Evidence from institutional-investor and sovereign wealth fund activity, reviewed the aggregated activities of long-term institutional investors representing more than US$43 trillion in assets under custody and administration at State Street. It also includes insights from interviews with several of the largest sovereign wealth funds (SWFs) across Central Asia, East Asia, West Asia, Australasia, and North America.

The report reveals institutional investors’ risk aversion in 2021, evidenced by the fact that State Street’s Behavioural Risk Scorecard – an aggregate measure of risk appetite derived from the capital flows and holdings by institutional investors across multiple asset classes and factors – turned negative in early February 2022 to reach its lowest point in two years. Institutional investors’ capital flow decisions became more broad-based, with evidence of risk-off behaviour manifesting across investors’ equity, fixed income, foreign exchange and asset allocation decisions over recent months.

“As economies around the world emerged from the long shadow cast by the Covid-19 pandemic, investors are faced with new risks,” said Neill Clark, head of State Street Associates, Europe, Middle East and Africa (EMEA). “Today, risk assets are re-pricing due to international conflict, inflation, and central bank policy responses.

“Following a period of opportunistic rebalancing and selective risk-taking during 2020, the past year has seen institutional investors moving towards safer assets and markets. Their asset allocation decisions suggest they are no longer adding to their equity exposure – which they had been doing since Q1 2020 – and instead, are adding to their fixed-income and cash balances.”

The nreport reveals that strong capital outflows from emerging markets – the largest level of selling observed over the previous five years – have been matched by robust demand for stocks in developed markets.
“When it comes to the investment strategies of SWFs, most are taking the long view, which can sometimes mean a contrarian stance, said Duncan Bonfield, Chief Executive, ISFWF. “For example, one of our members has increased its emerging-market equity positions as the value/price gap widened, as emerging-market equity was cheaper than it was six months ago relative to its fair value estimates.

In fixed income, the report reveals heightened geopolitical risk has seen capital outflows from emerging-market sovereign debt, while high-quality, developed-market sovereign bonds are maintaining stable capital inflows despite rising domestic inflationary pressures. Euro and US dollar-denominated corporate credit have also seen outflows, driven by a challenging combination of rising rates, high inflation and slower growth, tapering of quantitative easing from global central banks, and potential ripples from Russian sanctions as well. One beneficiary of the credit uncertainty and rising inflation pressures is the US Treasury Inflation-Protected Security (TIPS) market, where there has been renewed appetite from institutional investors, who also favoured currencies that displayed less negative exposure to the developing international conflicts

Clark added: “A broader set of factors are now driving financial markets, which present institutional investors with new challenges and risks on the horizon. International conflict and rising inflationary pressures now dominate the key market narratives against a backdrop of high global equity market turbulence but low systemic risk, with global equity market returns becoming driven by a wider set of factors.”

Spending discipline bolsters shale gas drillers

Two years of spending discipline and paying down debt have let shale gas drillers cut the cord between their capital-intensive operations and their banks, leaving the sector less vulnerable to coming interest rate hikes proposed by the US Federal Reserve, according to an S&P Global report that quotes sector analysts.

The Fed raised its benchmark interest rate by a quarter percentage last month and hinted that it may continue interest rate increases in increments of 0.5% per month for several months to choke off inflation,
which would mark the fastest rate since 2000.

An increase in the federal funds rate would trickle down through the credit products used by exploration and production (E&P) companies. Oil and gas E&Ps were heavy users of credit products, primarily revolving lines of credit and bonds, throughout the shale gas boom of the past two decades. They needed to borrow heavily to pay upfront costs for land, labour and rigs, with cash from oil and gas sales coming later and with the amounts dictated by commodity markets.

With the industry in “land grab” mode — leasing land and drilling expensive horizontal wells as quickly as possible — most E&Ps borrowed more money than they brought in, leaving them vulnerable to the banks and to commodity markets.

Most of the sector's first refinancing due dates are spread out over the next four years, according to S&P Global Market Intelligence data, in contrast to August 2020 when due dates were more compressed and gas drillers had US$7.7 billion coming due in 2025 alone.

By slowing the pace of drilling and production over the last two to three years, achieving positive cash flows by spending less and using the extra cash to pay down and pay off debt, shale gas drillers are expected to be cash-rich this year. Natural gas prices are up from roughly $2/Metric Million British thermal unit (MMBtu) in 2020 to more than $6/MMBtu now.

At the start of 2022, S&P Global Ratings said that while oil and gas producers would return the bulk of their increased cash flows to shareholders, they would repay what they owed and hold off on borrowing more.

Mexico aims for CBDC by 2025

Mexico’s central bank has indicated that the country expects to launch its own central bank digital currency (CBDC) within the next three years

Victoria Rodriguez Ceja, Governor of the Bank of Mexico (Banxico), said during a 21 April hearing before the Mexican Senate that the CBDC – or Moneda digital del Banxico comenzará (MDBC) – “will be in circulation” by 2025. She said that the MDBC will enable greater financial inclusion for citizens while expanding existing payment options. Banxico also expects to deploy new automation mechanisms to speed up payment processes.

“The digital currency seeks to generate means of payments aimed at financial inclusion, expand options for fast, secure, efficient and interoperable payments in the economy, and implement complementary functionalities to the (existing) means of payment, such as automation mechanisms, programmability and innovation,” said Rodriguez.

Banxico had previously indicated late last year that it envisaged a CBDC launch in 2024 but putting it back to the following year suggests that it wants to expand the scope and services of the MDBC. While Mexico’s President Manuel López Obrado has ruled out the possibility of adopting Bitcoin or any cryptocurrency as legal tender in the country, the central bank is seeking to give them greater legality through regulation.

Rodriguez said that Banxico and other central bank groups were studying the possibility of regulating the use of cryptocurrencies in the country to protect citizens when making their transactions since these are neither protected nor regulated by the central bank. The bank is working closely with the Bank of International Settlements (BIS) to develop its CBDC.

She confirmed that the bank the bank supports future regulation of the crypto industry, while stressing that cryptocurrencies are very different from CBDCs because of their decentralised nature, which allows citizens to have full control of their money. The advantage of CBDCs is that they are backed by the Government and are just a digital expression of fiat money. The MDBC would not aim to replace the traditional currency or the banknotes in circulation but offer a strategic alternative to the current means of payment.

Pakistan selects M10 platform to automate B2B payments

Pakistan’s National Institutional Facilitation Technologies (NIFT) and Silicon Valley software group M10 Networks have announced a partnership aimed at facilitating digital business-to-business (B2B) payments within Pakistan and enabling low-cost, secure, and instant cross-border transfers.

M10 provides a digital money rail for banks through its platform to tokenise regulated liabilities, such as central bank money, commercial bank money, and digital currencies, and offer fast, low cost, and secure B2B payments and instant, 24/7 cross-border transfers.

Karachi-based NIFT was established in 1995 as a joint venture between six major Pakistani banks and entrepreneurs from the private sector. It is “the leading Payment System Operator (PSO) in Pakistan for cheque clearing and the country’s foremost Digital Payment Gateway, providing an electronic platform for clearing, processing, routing, and switching of electronic transactions in Pakistan.”

The partnership between M10 and NIFT was developed in response to the 2021 overhaul of tax laws by Pakistan’s Federal Board of Revenue, which requires companies to make digital payments for expenditures of more than Rupees 250,000 (US$1,345).

Under the agreement, NIFT will act as the local operator of the M10 platform and use the M10 shared hierarchical ledger and digital authorisation technology to authorise digital payments. NIFT will settle digital payments using its existing settlement mechanisms and in compliance with local regulations. Subject to regulatory approval, M10 and NIFT will work together, along with nine local participating banks, to enable the authorisation of commercial payments between commercial entities in Pakistan.

“NIFT continues to play a vital and proactive role in modernising Pakistan’s payment system,” comments Haider Wahab, CEO at NIFT. “We are committed to delivering an efficient, swift, secure, and convenient inter-bank payment system in which economic growth can further thrive. This new partnership with M10 Networks opens a range of exciting new possibilities for Pakistan’s payment infrastructure and puts it at the cutting edge of innovation in this space.”

“M10’s turnkey solution offers central banks and participating commercial banks everywhere the ability to quickly realize the benefits of digital payments in full compliance with today’s regulation and without disruption to their conventional systems,” says Marten Nelson, CEO and Co-founder, M10 Networks. “Our shared, hierarchical ledger technology supports secure, low-cost B2B and cross-border payments and can process up to one million transactions per second. With NIFT acting as a local operator, the M10 platform will contribute significantly to the modernisation of Pakistan’s payment infrastructure and enable participating local banks to easily comply with the country’s new tax regulations.”

The project will commence in Q2 of 2022 and will be delivered in three phases with completion in H1 2023.

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