China yuan’s pressure to ease, but ‘internal fundamentals’ remain amid coronavirus battle

People’s Bank of China will cut the foreign exchange deposit reserve requirement ratio for banks by 1 percentage point to 8 per cent from next month
The move is an attempt from the central bank to slow down the depreciation of the yuan and reduce the incentive to hold onto the US dollar

Yuan

Amanda Lee

Published: 8:00pm, 26 Apr 2022

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Moves to steady the yuan amid record outflows from Chinese stocks and bonds is seen as an effort to ease pressure on the currency, but may only affect sentiment, with “internal fundamentals” still a factor as China battles its worst coronavirus outbreak in two years.

The People’s Bank of China (PBOC) on Monday announced a 1 percentage point cut to the foreign exchange deposit reserve requirement, which will see the ratio fall to 8 per cent from 15 May.

It is an attempt from the central bank to slow down the depreciation of the yuan and reduce the incentive to hold onto the US dollar.

“The move will release more foreign currency liquidity into the onshore market and ease pressure on the yuan depreciation, coming on the back of recent measures to stabilise the market and prevent a hard landing to the economy as China struggles to contain the spread of Covid-19,” UOB Group said on Tuesday.

The move is a reversal of the last increase of the ratio in December, when the central bank was concerned about the yuan being too strong against the US dollar.

In the onshore market, the yuan closed at 6.5436 against the US dollar on Tuesday, strengthening slightly from the close of 6.5593 on Monday after China’s currency had weakened by more than 1 per cent last week.

In the offshore market, the yuan last traded at 6.5799 against the US dollar on Tuesday afternoon, after breaking the level of 6.6 a day earlier before the central bank intervention.

The depreciation pressure on the yuan has been growing amid record amounts of fund outflows from China’s stock and bond markets since the start of Russia’s invasion of Ukraine at the end of February.

China sees ‘unprecedented’ capital outflows after Russia invades Ukraine

The benchmark Shanghai Composite Index has lost 10 per cent over the past month following a series of heavy sell-offs.

The PBOC said on Tuesday that the volatility in the markets is “mainly affected by investor expectations and sentiment” and that it will keep liquidity reasonably ample in financial markets.

China’s economy is expected to suffer as it battles with the coronavirus, while imminent US monetary tightening could exacerbate fund outflows from yuan-denominated assets.

China’s financial hub of Shanghai has been in lockdown for several weeks, while mass testing in Beijing has been expanded from one district this week to most of the city of nearly 22 million. It has also started to impose social distancing and lockdowns in some areas.

We still see scope for yuan depreciation owing to the zero-Covid strategy, a crippled property sector and falling export growth

Nomura

A weaker yuan could help stabilise China’s growth and boost exports, but Beijing is also wary of a rapid and large depreciation at the same time, according to Nomura.

“We still see scope for yuan depreciation owing to the zero-Covid strategy, a crippled property sector and falling export growth, but from the PBOC’s [foreign exchange] policy perspective, we expect the PBOC will reject a fast and big depreciation this year compared with previous episodes of depreciation,” the Japanese bank said on Tuesday.

“We expect additional interventions by the PBOC in coming months.”

The US dollar has been gaining strength over the past few weeks, hitting a two-year peak, while the yuan on Monday plunged to a one-year low against the US dollar before the PBOC’s announcement.

“Adjusting the foreign exchange reserve requirement ratio mainly affects sentiment, and the medium-term trend of the exchange rate still depends on internal fundamentals,” Huachuang Securities said on Tuesday.

Global investors have withdrawn money from China on an “unprecedented” scale since the start of the Ukraine war, according to a report by the Institute of International Finance (IIF) last month.

The IIF estimated that in March outflows from bonds totalled US$11.2 billion, while equities dropped by US$6.3 billion.

Last week, China’s securities regulator urged more investment in equities to help limit short-term market fluctuations while contributing to economic restructuring.