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China acts to rein in yuan slump, set to raise FX risk reserve ratio to 20%

China acts to rein in yuan slump, set to raise FX risk reserve ratio to 20%

FILE PHOTO: People wearing face masks walk past the headquarters of Chinese central bank People's Bank of China (PBOC), April 4, 2020. REUTERS/Tingshu Wang/

SHANGHAI: China's central bank on Monday (Sep 26) announced steps to slow the pace of the yuan's recent depreciation by making it more expensive to bet against the currency.

The People's Bank of China (PBOC) said it would raise the foreign exchange risk reserves for financial institutions when purchasing FX through currency forwards to 20 per cent from the current zero, starting on Sep 28.

In explaining its actions, the PBOC said it is "stabilising FX market expectations and strengthening macro prudential management", according to an online statement.

The move to resume FX risk reserves would effectively raise the cost of shorting the yuan at a time the local currency is facing renewed depreciation pressure, traders and analysts said.

"The move will make the cost of forward dollar buying more expensive," said a trader at a foreign bank.

"So, the effect of the policy move may be more powerful than verbal guidance and signal through midpoint fixing settings."

Spot yuan hardly budged on the announcement. The onshore yuan traded at 7.1485 per dollar, versus the previous late night close of 7.1298 on Friday. Its offshore counterpart briefly bounced to 7.13 before last fetching 7.1522 as of 0155 GMT.

Earlier on Monday, the PBOC again set firmer-than-expected official guidance for the 23rd straight trading session, at 7.0298 per dollar before market opening - the weakest level since Jul 7, 2020. It was 279 pips stronger than Reuters' estimate of 7.0019.

LITTLE IMPACT

Over recent months, authorities have stepped up efforts to rein in yuan weakness through persistently setting firmer-than-expected midpoint fixings, verbal warnings and holding off immediate easing moves.

The yuan has slumped more than 4 per cent to the dollar since mid-August to breach the psychologically important 7 per dollar level, and is on course for its biggest annual loss since 1994, when China unified official and market exchange rates.

The Chinese currency has been hit by a combination of broad dollar strength, China's wobbly economy and an easier monetary bias adopted by authorities to prop up growth.

The downturn in the yuan has picked up speed after the PBOC lowered key interest rates in August to further widen its policy stance from other major economies that are raising rates aggressively.

Monday's announcement by the PBOC marks the latest policy measure to stem the faltering currency after earlier this month it moved to lower the amount of foreign exchange that financial institutions must hold as reserves earlier.

China's central bank scrapped the risk reserve requirements in October 2020, when the yuan rose sharply.

The yuan is among a swathe of currencies facing relentless selling pressure as the dollar enjoys broad demand, underpinned by the U.S. Federal Reserve's rapid monetary tightening. In Japan, where the central bank is sticking to ultra-easy policy to revive a fragile economy, authorities last week intervened in the currency market to buy yen for the first time since 1998.

"Raising FX risk reserve showed the PBOC wants to stem the rapid yuan loss and stabilise the market," said Ken Cheung, chief Asian FX strategist at Mizuho Bank.

"It also shows that the central bank will step in whenever it is needed."

However, Cheung noted that given the higher dollar interest rates, with the Fed raising borrowing costs aggressively, the move is unlikely to reverse the yuan depreciation trend.

Source: Reuters/gs

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