China Foreign Exchange Trade
The offshore yuan dropped to its lowest level this month after China forced banks to hold more foreign currencies in reserve for the second time this year, its most substantial move yet to rein in the surging yuan.
Financial institutions will need to hold 9% of their foreign exchange in reserve starting Dec. 15, the central bank said in a statement Thursday evening Beijing time, a 2 percentage-point increase. Earlier in the day, the People’s Bank of China had signaled a limit to its tolerance for the recent advances by setting its reference rate at a weaker-than-expected level.
The move prompted the offshore yuan to fall to 6.3839 on Thursday, the lowest since Nov. 30. It was little changed at 6.3783 at 8:12 am in Hong Kong. It came one day after the yuan advanced to its strongest level against the dollar since May 2018, bolstered by strong inflows from robust exports and foreign investment in onshore bonds. On a trade-weighted basis, the yuan reached the strongest since 2015, according to the China Foreign Exchange Trade System.
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The reserve-ratio hike, which the PBOC said will help liquidity management, effectively reduces the supply of dollars and other currencies onshore — putting pressure on the yuan to weaken. The increase is the second rise this year, after the central bank hiked the ratio by 2 percentage points in June, the first increase since 2007.
Analysts doubt that the hike alone was enough to weaken the yuan too much when the onshore market is awash with dollars. Foreign-currency deposits have surged 15% this year to a record $1 trillion, thanks to the trade and investment inflows. While the FX reserve ratio in June did briefly halt the yuan’s rally against the dollar, the trade-weighted basket has since strengthened about 5%.
“A 2% increase in reserve requirement for foreign exchange deposits is not likely to bring any material change to the flush U.S. dollar liquidity onshore, but it sends a clear sign that PBOC is discomfortable with recent surge of the yuan and wish to curb its appreciation,” Tao Chuan, chief macro analyst at Dongwu Securities. “Yuan’s advance could also hurt China’s competitiveness in exports should more countries reopen next year. Those should be the reasons that PBOC is stepping in to send a clear warning.”
“However, China’s trade surplus is still huge and onshore dollar liquidity still abundant, it is hard to see yuan weaken much in the short term,” he said. “The central bank may continue to take more measures to guide the yuan weaker and reduce radical bull bets on yuan.”
