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The People’s Bank of China is expected to impose controls to prevent a rapid depreciation of the yuan against the US dollar. Photo: AP

Explainer | China yuan: what can the central bank do to prevent the currency weakening against the US dollar?

  • Analysts expect the People’s Bank of China (PBOC) to impose more controls to prevent a rapid depreciation of the yuan
  • The PBOC may cut banks’ forex reserve requirement again and it could restore the so-called countercyclical factor, experts say

The yuan has weakened by more than 10 per cent against the US dollar this year amid large capital outflows from the world’s No 2 economy and aggressive rate hikes by the US Federal Reserve.

Although Beijing keeps a tight grip on money going in and out of the country and manages the yuan exchange rate carefully, it has gradually liberalised cross-border transactions and allowed its exchange rate regime to become more market based over the years.

The International Institute of Finance (IIF) estimated in August that China saw outflows worth 7.7 billion yuan (US$1 billion) in debt, but 1 billion yuan of inflows for equities. Between February and July, China recorded net outflows of US$81 billion via the Stock and Bond Connect programmes, the IIF said.

Analysts expect the People’s Bank of China (PBOC) to impose more controls in the coming weeks to prevent a rapid depreciation of the yuan.

What has China’s central bank done to slow the depreciation of the yuan?

The PBOC has been setting firmer-than-expected midpoint guidance rates since August, a sign that authorities are trying to halt the currency from weakening.

The central bank has also moved to curb one-way bets against the yuan.

On Monday it announced it would raise the foreign exchange risk reserves for financial institutions when purchasing foreign exchange through currency forwards to 20 per cent from zero, starting on September 28.

The PBOC has twice cut the foreign exchange reserve requirement ratio, which determines the amount of foreign currency deposits banks need to set aside. Another cut to the ratio will boost the supply of foreign currency, thus propping up the yuan.

What else might China do to support the yuan?

Becky Liu, head of China macro strategy at Standard Chartered, said in a note earlier this month that the PBOC could cut the foreign exchange reserve requirement ratio by another 200 basis points from 7 per cent to 5 per cent.

Analysts believe another cut to the ratio is likely and authorities may also step up issuance of yuan-denominated bills in Hong Kong to withdraw liquidity from the offshore market and raise the cost of betting against the currency.

The central bank could also bring back the so-called countercyclical factor to its daily midpoint fixing, a tool that can significantly influence the value of the yuan.

The PBOC never disclosed how it calculated the countercyclical factor, but the adjustment has been used to keep the yuan’s daily midpoint fixed to a relatively stable value.

Liu said she does not expect the countercyclical adjustment factor to be restored until the yuan’s value becomes “much cheaper”.


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What other tools does China have to halt capital flight and prop up the yuan?

China has the world’s largest foreign exchange reserves, which could cushion shocks to the currency.

As a result of strong export growth over the past few years, there is also a significant “dollar pool” in the banking system – deposits held by exporters and companies – that is likely to limit the upside for the dollar versus the yuan.

During 2015-16, China suffered serious capital flight when the central bank surprised markets by devaluing the yuan by more than 3 per cent. It spent nearly US$320 billion of its foreign currency reserves to quell market panic and reduce the risk of a stampede away from the yuan.

Capital-outflow concerns keep Beijing on guard against external shocks

In 2016, the Chinese government sought to limit the level of outbound direct investment by scrutinising the money leaving the country more closely.

In 2017, banks and financial institutions in China had to report all domestic and overseas cash transactions of 50,000 yuan or more, down from 200,000 yuan. Any overseas transfers by individuals of US$10,000 or more also required reporting.

Other less formal measures include regulators asking lenders to review their foreign exchange position to “improve risk management”, and selling and buying significant amounts of yuan in the foreign exchange market through state-owned banks.

How will PBOC intervention be viewed in the US?

The strength of the yuan has become a point of contention between Beijing and Washington over the years amid deteriorating relations between the two countries.

When the PBOC shocked markets in 2015 by devaluing the yuan, the move was condemned by US lawmakers as an attempt to gain unfair export advantage and triggered global concern about a possible currency war.

In 2019, the US Treasury designated China a currency manipulator after the PBOC allowed the yuan to fall in response to new tariffs that were imposed by the US.

Though Washington eventually dropped the designation, Mark Sobel, a former American Treasury official and US chairman of the Official Monetary and Financial Institutions Forum, wrote in a blog post earlier this month there has been “long-standing suspicions in the international community” about China’s management of the yuan to gain competitive advantage.