Caixin
Jun 01, 2021 07:33 AM
FINANCE

China Takes Most Visible Step Yet to Curb Yuan’s Rise

Investors at a securities brokerage in Shanghai
Investors at a securities brokerage in Shanghai

(Bloomberg) — China forced banks to hold more foreign currencies in reserve for the first time in more than a decade, its most substantial move yet to rein in the yuan’s surge.

The nation’s financial institutions will need to hold 7% of their foreign exchange in reserve starting June 15, the central bank said Monday. That’s an increase of 2 percentage points and the first such hike since 2007. The move, which the People’s Bank of China (PBOC) said will help liquidity management, effectively reduces the supply of dollars and other currencies onshore, putting pressure on the yuan to weaken. The Chinese currency fell 0.2% at 7:06 p.m. in Hong Kong on Monday.

Although analysts said the direct impact may be small, the move is the clearest signal yet by the PBOC that it’s unhappy about the yuan’s surge to a three-year high against the greenback. Authorities had until now limited their response to rhetoric. A former central bank official and a state-media commentary talked down the currency over the weekend.

“The PBOC wants to show the market — if the rally keeps going, it has many measures to slow it down, and the market will fail if it wants to make speculative bets,” said Zhou Hao, an economist at Commerzbank AG in Singapore. “It’s more of a symbolic move, as no matter how the PBOC boosts funding costs on foreign exchange, the rate on the yuan will almost always be higher.”

Betting on the yuan has been a successful strategy in the past year. The currency has surged 13% against the dollar since May 2020, when it was near its lowest level since 2008 amid the effects of the pandemic and the trade war with the U.S. Brokerages including Citic Securities Co., Scotiabank and Westpac Banking Corp. said they expect the currency to climb to 6.2 yuan against the dollar from the current 6.3736. That would be the strongest since a 2015 devaluation.

The yuan is supported by China’s economic recovery, and its higher-yielding markets are attractive to global investors. A backdrop of imported inflation is bolstering the argument for a stronger yuan. Against a basket of trading partners, the Chinese currency is the strongest since 2016.

The foreign-exchange reserve ratio hike is likely to freeze about $20 billion of liquidity, according to Guan Tao, a former official at the State Administration of Foreign Exchange. The increase demonstrates the Chinese central bank’s strong determination to curb rapid appreciation of the yuan, and the PBOC has more tools if speculation emerges in the currency market, he said.

Recent history shows that traders should be wary. In the wake of the devaluation, the yuan fell about 11% by the end of 2016 and surged 11% through its 2018 peak before reversing again to sink 13% by September 2019. When momentum in the yuan became too extreme, authorities often took steps to arrest the moves. In early 2018, for instance, the yuan fell the most in two months as authorities gave banks the green light to submit quotes for weaker fixings.

Beijing seems to be sticking to its goal of liberalizing markets as part of President Xi Jinping’s plans to reduce moral hazard. It’s not just the yuan where direct intervention is now an unusual sight. The “national team” of state-backed funds is rarely seen in the $12 trillion stock market anymore unless moves risk turning into panic or mania. Even in the commodities market, where officials are struggling to cool prices, efforts have largely been verbal rather than direct.

If the central bank takes additional assertive actions, such as setting dramatically weaker fixings, that could reinforce the belief that only heavy-handed intervention is worth paying attention to. Yet the Communist Party has made it clear it will act to reduce speculation and guard against risks to financial stability.

“We don’t see this as a one-off change but likely the start of a trend,” said Becky Liu, head of China macro strategy at Standard Chartered, of Monday’s move by the PBOC. “It could be seen as a new mechanism to manage the yuan in the medium term, together with other counter-cyclical measures.”

Contact editor Bob Simison (bobsimison@caixin.com)

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