China ‘hits back at the yuan bears’, but forex market intervention signals disquiet
- The People’s Bank of China (PBOC) announced it would raise the risk reserve requirement ratio for forward-exchange sales to 20 per cent
- Analysts say it indicates greater determination to defend the yuan and prevent negative sentiment spreading across forex, stock and bond markets
China’s swift action to stabilise the yuan on Monday may signal deeper worries about the impact of a surging US dollar and desire to maintain positive market sentiment ahead of the highly anticipated 20th party congress.
The People’s Bank of China (PBOC) announced it would raise the risk reserve requirement ratio for financial institutions when purchasing foreign exchange through currency forwards to 20 per cent from zero, starting on Wednesday.
The policy tool, which was last employed during foreign exchange market turbulence in 2015, will increase purchasing costs and, it is hoped, dampen speculative demand, thus helping stabilise expectations in the foreign exchange market amid aggressive rate hikes by the US Federal Reserve.
More interventions could be rolled out, with offshore market liquidity the next possible target
“This will hit back at the yuan bears,” said Serena Zhou, a senior China economist with Mizuho Securities.
“More interventions could be rolled out, with offshore market liquidity the next possible target.”
The US Federal Reserve has raised rates 300 basis points over the past six months.
Investors have turned bearish on the yuan because of the US central bank’s hawkish rate projection, meaning the US dollar is likely to strengthen further, testing the yuan’s value and cross-border capital flows in coming months, Zhou said.
Policymakers have recently allowed the yuan exchange rate to become more flexible, helping it absorb external shocks, but tight control over capital outflows has been maintained.
The Chinese currency has dropped about 4 per cent against the US dollar in the past week and the exchange rate is at a two-year low.
Chinese economists tend to attribute depreciation pressure largely to the extraordinarily high US dollar index, which has hit a 20-year record of 113.9.
“It is part of countercyclical adjustments to maintain the supply-demand balance in forex markets,” said Wen Bin, chief economist of China Minsheng Bank.
China’s central bank set the yuan’s midpoint against the US dollar at 7.0298 on Monday, down from 6.9920 on Friday and the lowest level since early July.
Though the yuan has weakened significantly, it has performed better than other major currencies. The Japanese yen dived to a 22-year low of 146 per US dollar last week, while the British pound plunged to an all-time low on Monday.
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The China Foreign Exchange Trade System index, which measures yuan’s value against a trade-weighted basket of currencies, weakened by 0.5 per cent last week and has fallen 0.9 per cent so far this year.
The onshore yuan opened lower at 7.1380 per US dollar and finally closed at 7.1464 on Monday.
Policymakers are also moving to prevent a one-way bet that the currency will decline further in value.
Raising the risk reserve requirement suggests the PBOC is looking to slow yuan depreciation ahead of the 20th party congress, analysts from Goldman Sachs wrote in a note on Monday.
However, policymakers do not seem to have a target to defend the currency at any fixed level, especially given the depreciation has been driven by strengthening of the broad US dollar, the investment bank said.
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Chinese authorities have resources at their disposal, including a large war chest of foreign exchange reserves and tight capital controls.
But the central bank only cut the required reserve ratio for onshore deposits by 1 percentage point in May and another two percentage points earlier this month to increase the supply of foreign currencies in the onshore market.
The country’s forex reserves, the world’s largest, stood at US$3.05 trillion at the end of August, government data showed.
Meanwhile, portfolio investment outflows have abated in recent months and are small compared to the exodus recorded in 2015.
However, the biggest concern for the Chinese economy is the implications of Beijing’s zero-Covid policy.
A persistent yuan depreciation is not supported by economic fundamentals
“A persistent yuan depreciation is not supported by economic fundamentals. China’s economic activities are picking up in September,” Zhou said.
“Although pandemic control policy won’t have an immediate change after the party congress, the economy is certainly moving up higher on the government agenda.”
Foreign banks and credit rating agencies have moved to scale back China’s full-year growth estimates.
On Monday, S&P Global Ratings slashed its 2022 forecast by 0.6 percentage points to 2.7 per cent, and lowered next year’s by 0.7 percentage points to 4.7 per cent.
