China Is Taking More Visible Measures to Slow Currency’s Descent
China will allow its banks to hold less forex reserves, in its most substantial moves yet to stabilize a weakening yuan.
(Bloomberg) -- China set a stronger-than-expected exchange-rate fixing for a 10th straight day and said it will allow banks to hold less foreign currencies in reserve, its most substantial moves yet to stabilize a weakening yuan.
The People’s Bank of China set the yuan’s reference rate at 6.9096 per dollar on Tuesday, trailing behind the currency’s move to a two-year low. That came a day after the central bank said financial institutions will need to hold just 6% of their foreign exchange in reserve from Sept. 15, effectively increasing the supply of dollars and other currencies onshore. The decrease of 2 percentage points is the biggest in data going back to 2004.
While the moves should limit the yuan’s declines against the greenback, they do little to suggest the central bank is trying to reverse the losses. Authorities may want to slow down the pace of depreciation but they are not “drawing a line in the sand to hold any particular level for now”, said Khoon Goh, Head of Asia Research at Australia & New Zealand Banking Group.
The question is whether there will be more firm action from the authorities should the yuan start to approach the psychological 7-per-dollar level, he said.
Betting against the yuan has been a successful strategy in the past month. The yuan has plunged 2.5%, as China’s Covid-Zero strategy hurt an already fragile economy and aggressive rate hikes by the US quicken capital outflows. The depreciation comes at a sensitive time for Beijing, which is preparing for a twice-a-decade party reshuffle next month. That’s why keeping the foreign-exchange market steady is paramount for authorities, as a disorderly plunge in the yuan could spill over to stocks and endanger financial stability.
The PBOC has stepped up efforts to stem yuan deprecation in the past two weeks. Stronger-than-expected fixings for 10 straight sessions mark the longest run of strong biases since 2019. Monday’s cut in the FX deposit ratio was twice as large as April’s reduction. Also on Monday, PBOC Deputy Governor Liu Guoqiang told reporters in Beijing that China was able to maintain the yuan at a stable level, adding that it will be a “norm” in the short term for the Chinese currency to move in two ways.
No Panic
Tuesday’s fixing marks the first time in two years that it breached the crucial 6.90 level, the last major barrier before the yuan crosses the key milestone of 7. In 2019, when the PBOC allowed the reference rate to rise above it, the offshore yuan tanked 1.8% in a single day.
The central bank’s move caused few ripples this time, with the yuan shedding less than 0.1% against the greenback both onshore and offshore. On a trade-weighted basis, a Bloomberg real-time replica of the CFETS RMB Index dropped 0.2%.
Signaling an absence of panic, bearish sentiment toward the Chinese currency, as reflected in the sensitive options market, has been waning. The one-month option premium to hedge the dollar-yuan pair’s upside versus its downside has been falling over the last two weeks and touched its lowest level since July 12 on Tuesday.
Analysts say they expect the PBOC to take more action if the yuan’s depreciation accelerates again, particularly if it triggers herd mentality among traders. Nomura Holdings Inc. expects the central bank to cut the foreign-currency reserve ratio by another 100 basis points by the end of this year, while United Overseas Bank Ltd. said the PBOC may also increase offshore bill issuance to absorb liquidity.
Although weak fundamentals may weigh on the yuan for some time, the market should bear in mind that the PBOC is “sufficient in ammunition” to manage the currency, according to Ming Ming, chief economist at Citic Securities Co.
Read More: From Fixing to Signaling, How China Manages the Yuan: QuickTake
More stories like this are available on bloomberg.com
©2022 Bloomberg L.P.