Yuan Hits 4-Year High, Prompting China’s Central Bank to Raise FX Reserve Requirement Ratio from 4% to 6% — BigGo Finance

China’s central bank has moved to cool the yuan’s strength by raising its foreign exchange reserve requirement ratio for the first time in about five years. With the yuan surging to its highest level against the dollar in more than four years, the People’s Bank of China has deployed a foreign exchange market tool aimed at slowing the pace of the rally.

The People’s Bank of China announced that it will raise the foreign exchange reserve requirement ratio for financial institutions from the current 4% to 6%, a 2-percentage-point increase, effective November 15. It is the first increase in the FX reserve requirement ratio since December 2021. The central bank described the purpose of the measure as strengthening financial institutions’ management of foreign currency liquidity, but markets are interpreting it as a signal that Beijing wants to curb appreciation pressure and slow the yuan’s ascent.

The FX reserve requirement ratio is the share of foreign currency deposits that banks receive from customers and must set aside at the central bank. A higher ratio reduces the dollars banks can release into the market. When dollar supply dries up, the dollar’s value rises relative to the yuan, easing further upward pressure on the Chinese currency. As of the end of September, foreign currency deposits at Chinese financial institutions stood at about $1.2 trillion, and the hike is estimated to lock up roughly $24 billion (about 32.1 trillion won) in additional foreign currency liquidity. Reuters described the move as a forceful policy response aimed at containing the yuan’s long-term upward trend.

The backdrop to the central bank’s direct signal is the recent steep move in the exchange rate. On the previous trading day, the onshore yuan closed at 6.6458 per dollar, its strongest level since June 2022. In the offshore market, the yuan also rose to 6.6425 per dollar. So far this year, the yuan has appreciated about 5% against the dollar.

Driving the strength are strong exports and capital inflows. Chinese exporters converting overseas dollar earnings into yuan have boosted demand for the currency, while foreign investment in Chinese stocks and bonds has also supported the exchange rate. The problem is the pace. If the yuan rises too quickly, exporters earn less in yuan terms even when selling products at the same dollar price, hurting their profitability. That is an uncomfortable shift for China’s economy, which has become more dependent on exports amid weak domestic demand.

The yuan reversed course immediately after the announcement. In onshore trading on the following day, the exchange rate rose to 6.6728 per dollar intraday, with the yuan falling as much as 0.37%. In the offshore market, the dollar also climbed to 6.6666 yuan before trading around 6.6639. The People’s Bank of China set the day’s daily fixing at 6.7150 per dollar, slightly weaker than the previous day’s 6.7146.

This is not the first time the People’s Bank of China has reversed course on the FX reserve requirement ratio. In September 2023, it cut the ratio from 6% to 4% to increase dollar supply in the market and stem yuan weakness and capital outflow pressure. This time it has done the opposite, reversing that move after about two years.

Markets see the measure as focused on managing the pace of appreciation rather than engineering a trend reversal in the yuan. Zhang Zhiwei, chief economist at Pinpoint Asset Management, told the Hong Kong-based South China Morning Post that the central bank has sent a clear signal to the market that it is concerned about the yuan’s rapid rise in October. Barclays, the British investment bank, also analyzed that Chinese authorities are likely to tolerate gradual appreciation while restraining sharp further gains.

External factors also loom. The United States and the European Union have repeatedly raised concerns that China’s exchange rate policy affects its export competitiveness, while China maintains that its exchange rate is determined by market supply and demand. Some analysts also see a link to the political calendar, namely the U.S. midterm elections. Fiona Lim, senior FX strategist at Maybank, told Bloomberg that the timing of the move may not be unrelated to the global political situation. She said that given the measure came just before the U.S. midterm elections, it may be intended to prevent a sharper yuan rally in case falling oil prices and a sweeping Democratic victory create an environment unfavorable to the dollar.

The measure is expected to raise dollar funding costs in China’s financial markets in the near term. If foreign currency liquidity is locked up, interbank dollar rates will come under upward pressure, and volatility in the yuan-dollar exchange rate may widen for a time. Still, because the move does not target the trade surplus and capital inflows that underpin the yuan’s strength, the prevailing view is that it will merely slow the pace of appreciation rather than reverse the currency’s direction.

Key exchange rate indicators are as follows.

Note: Exchange rates are quoted as yuan per dollar.

Some observers say Chinese authorities appear intent on restraining sharp appreciation that would burden exporters, in order to offset weak domestic demand. A Beijing financial industry official said the goal appears to be managing the pace of the rise rather than the exchange rate level itself. If yuan strength continues, exporters in South Korea and other countries competing with China could face greater price-competition pressure, but if Chinese authorities step up efforts to slow the pace, volatility across Asian currencies is likely to increase further.