Explainer: What's inside China's toolbox to curb excessive yuan weakness?

Explainer: What’s inside China’s toolbox to curb excessive yuan weakness?

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SHANGHAI, Sep 21 (Reuters) – The Chinese yuan is facing renewed downward pressure from a rising US dollar, a hawkish Federal Reserve and a monetary divergence between the world’s two largest economies.

The yuan has lost about 4% against the dollar since mid-August, weakening after a psychologically important level of 7 per dollar. The local currency is also set to take its biggest annual loss since 1994, when China unified official and market exchange rates.

The rapid fall of the yuan prompted the People’s Bank of China (PBOC) to lower the amount of foreign exchange that financial institutions must hold as reserves to curb the weakness. read more

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WHAT ELSE IS THE PBOC DOING TO SLOW DOWN THE RMB?

Since late August, the PBOC has been setting firmer-than-expected daily fixes for the yuan midpoint to prevent the yuan from weakening too much as the spot yuan on land can only trade in a tight 2% range around the midpoint.

Market participants take any significant discrepancy between market forecasts of what the correction might be and where the NBK actually places it as an indication of how the central bank wants to pull the market.

Senior central bank and currency regulator officials have also stepped up efforts, warning the market of strong unilateral rates against the local currency through word of mouth.

Wang Chunying, a spokesman for the State Administration of Foreign Exchange (SAFE), last week quoted state broadcaster CCTV as urging companies not to speculate in the currency.

WHAT OTHER OPTIONS DO THE PBOC HAVE BEYOND DIRECT INTERVENTION?

** INCREASED TRADING VALUE

The NBK could increase the cost of short yuan positions in derivatives markets for financial institutions by raising the reserve ratio for currency risk when buying dollars through forwards.

The central bank adjusted risk reserve requirements several times over the past few years before lifting them in October 2020 when the yuan soared.

** MORE OFFSHORE LIQUIDITY

The central bank may issue yuan-denominated bills in Hong Kong to take the yuan out of the offshore market and raise the cost of rates against the Chinese unit.

“The Chinese authorities leave no doubt about their determination to ease pressure on the yuan due to depreciation,” said Hong Guoh, head of Asian studies at ANZ.

“If the depreciation pressure continues, the PBOC may raise reserve requirements for forward contracts to 20% or increase the issuance of RMB notes in Hong Kong to make offshore RMB short positions more expensive.”

** COUNTERCYCLIC FACTOR IN RMB DAILY RECOMMENDATION

The NBK introduced a countercyclical factor for the first time in its formula for daily average fixing of the RMB/USD exchange rate in 2017.

Regulators said the factor was an attempt to better reflect market supply and demand, reduce a possible herd effect in the market, and help the market focus more on macroeconomic fundamentals. The central bank adjusted the methodology several times before suspending it in October 2020.

“We do not expect the counter-cyclical adjustment factor to be officially restored in its daily fix until the Chinese yuan’s valuation becomes much cheaper,” Becky Liu, head of China macroeconomic strategy at Standard Chartered, said in a note earlier this month. .

Liu expects the PBOC to further cut its foreign exchange reserve requirement by another 200 basis points.

The yuan has weakened nearly 10% against the dollar this year, but its value against major trading partners has fallen only about 0.7% since the start of the year.

** HIGH TRANSBOUNDARY INFLOW

Regulators may adjust the parameter of cross-border corporate financing as part of their macroprudential assessments to limit the ability of domestic companies to seek foreign financing.

“The level of the yuan’s exchange rate in itself is not the most important thing, the bottom line is whether China’s cross-border capital flows will remain stable,” said Zhong Zhengsheng, chief economist at Ping An Securities.

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Shanghai Newsroom Reporting, edited by Vidya Ranganathan and Sam Holmes

Our standards: Thomson Reuters Trust Principles.

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