China bagged foreign direct investment at a record-setting pace in the first three months of 2012, but an easing in its monthly momentum and a difficult trade outlook will keep monetary policy poised to compensate for any dip in capital inflows.

The first quarter inflow of $29.8 billion leaves China on course to surpass 2011's $116 billion record, even though inflows compared with a year earlier have fallen for five successive months, Commerce Ministry data showed on Tuesday.

A 53 percent leap in inflows to $11.8 billion in March from February - typical after the Lunar New Year - was a fresh sign that capital flow is firming enough to underpin money supply growth, following a $124 billion first-quarter jump in foreign exchange reserves, providing policy stays on its current pro-growth bias.

I don't think this changes anything for monetary policy, Alistair Thornton, economist at IHS Global Insight in Beijing, told Reuters.

China's government has been fine-tuning economic policy settings since the autumn of last year as the outlook for the global economy darkened, export growth sank and capital inflows - a core component of money supply - stalled.

The People's Bank of China (PBOC) has cut by 100 basis points the ratio of deposits banks are required to keep as reserves (RRR) to keep credit and money supply growth steady. The two moves added an estimated 800 billion yuan ($127 billion) of lending capacity to the economy.

The PBOC said last week that broad money supply rose 13.4 percent in March from a year earlier, stronger than market expectations for 12.9 percent and ahead of the previous month's 13 percent pace.

Economists forecast another 150 bps, or 1.2 trillion yuan in RRR cuts for the rest of 2012 to help cushion China's worst slowdown since the global financial crisis of 2008-09.

There are signs that the economy has reached a bottom, but there's nothing to suggest in recent data that equity investors should be positioning for a strong rebound or anything like a V-shaped recovery, Thornton said.

EXTERNAL DEMAND

China's economic growth has slowed for five straight quarters. The annual growth rate in the first quarter eased to 8.1 percent from 8.9 percent in the previous three months, below an 8.3 percent consensus forecast in a Reuters poll.

Reasonably strong FDI and a return to an overall trade surplus of $5.35 billion in March heralds the prospect that a revival in global growth is lifting overseas demand just in time to compensate for a slowdown in the pace of domestic activity.

FDI is an important gauge of the health of the external economy, to which China's vast factory sector is orientated, but is a small contributor to overall capital flows compared to exports, which were worth about $1.9 trillion in 2011.

Ministry of Commerce spokesman, Shen Danyang, told a news conference on the FDI data that the government was confident of achieving its target for trade growth in 2012 despite a difficult international economic backdrop.

China targets 10 percent growth for exports and imports in 2012, but both goals were missed in March when imports rose 5.3 percent and exports increased 8.9 percent over a year earlier.

Beijing has pledged to bring its current account into balance as it refocuses the economy more towards domestic consumption and away from volatile foreign demand for manufactured goods.

China's two biggest export markets faltered through 2011. Demand from the European Union was dogged by the sovereign debt crisis, while a U.S. recovery was slow to take hold, especially among consumers.

For the first quarter as a whole, Customs Administration data from China shows the value of total exports was $430.02 billion, while imports were $429.35 billion - bringing the trade account roughly into the balance targeted by the government.

If we want export growth to be stable, we must ensure that policies are stable, Shen said. If there are any policy adjustments, these adjustments will be more towards pro-exports rather than limiting exports.

CURRENCY RISKS

But he said some exporters were nervous about the outlook for their business, particularly after China loosened its tightly controlled currency regime by doubling to 1 percent the daily trading band for the yuan against the dollar.

Some exporters are a little bit worried, so they are not so sure about taking long-term orders, but only took short-term orders, mainly because they are not confident in managing exchange rate fluctuations, Shen said.

The change, a crucial one as China further liberalizes its nascent financial markets, underlines Beijing's belief that the yuan is near its equilibrium level, and that China's economy is sturdy enough to handle important, long-promised, structural reforms despite its cooling growth trajectory.

Slower growth is cautiously welcomed by China's leadership as it allows them to make reforms, particularly to prices the government sets, with a reduced risk of igniting inflation that the ruling Communist Party fears could trigger social unrest.

The widening of the yuan's trading band is the most significant adjustment made to China's currency regime since a landmark decision in 2005 to de-peg the yuan from the dollar, which set the Chinese unit on an appreciating path that has seen it gain about 30 percent against the dollar.

In tandem, China has encouraged direct settlement of international trade in yuan, amounting to 2.08 trillion yuan ($333 billion) in 2011, more than triple that in 2010, central bank data shows.

Dariusz Kowalczyk, senior economist and strategist at Credit Agricole CIB in Hong Kong, said 11.7 percent of March FDI flows were settled in yuan, up from 9.5 percent in February, 8.5 percent in January and 3.2 percent for all of 2011.

Direct investment has become a new frontier for Chinese yuan internationalization, he wrote in a note to clients.

Beijing targets $120 billion in FDI inflows for each of the next four years, drawing up new rules to encourage foreign investment in strategic emerging industries, particularly those that bring new technology and know-how to China.

The Q1 numbers are on course to achieve that.

For foreign investors, China remains attractive compared to other countries, Zhao Hao, economist at ANZ Bank in Shanghai, said.

China's efforts to expand its own direct investments in foreign countries are surging. Outbound FDI rose 94.5 percent in the first quarter versus a year earlier to $16.55 billion.

In the future, the trend is that FDI inflows will pick up while outbound FDI will rise even faster, so the net inflows will fall, Zhao said.

(Editing by Neil Fullick)

China Foreign direct investment