China’s central bank plans to reduce the mandatory foreign currency reserves held by financial institutions, which reflects their commitment to bolster the weakening renminbi. The currency has declined by over 5% against the US dollar this year, mainly due to concerns surrounding China’s economic recovery, which has been sluggish since they lifted COVID-19 restrictions at the beginning of 2023. This adjustment brings the reserve requirement ratio back to the 2006 level.
China is introducing new measures to improve the economy
China policymakers have accelerated the introduction of new measures to bolster the country’s currency and economy, focusing on the property sector. This week, Guangzhou and Shenzhen made obtaining mortgages easier for first-time homebuyers.
However, concerns about financially strained property developers like Evergrande and Country Garden have dampened interest in Chinese securities. It has led investment banks to revise their downward predictions for the renminbi’s dollar exchange rate.
The People’s Bank of China announced that it would reduce the foreign exchange reserve requirement for banks from 6% to 4%, effective September 15, to enhance the ability of financial institutions to use foreign exchange funds. The move caused the renminbi to appreciate up to 0.2% against the dollar.
Reducing reserve requirements increases the availability of dollars in the local market, allowing commercial banks to lower the interest rates on dollar deposits. That is intended to make converting renminbi into dollars less attractive, as such conversions have pressured the Chinese currency.
Becky Liu, who heads China’s macro strategy at Standard Chartered, estimated that the reduction would release approximately $16 billion of US dollar liquidity. She emphasized that the primary impact of this move lies in signalling the central bank’s commitment to supporting the renminbi, as the liquidity injection itself is relatively insignificant in terms of liquidity and dollar rates.
Liu further noted that these recent measures, including the reserve requirement cut, aim to stabilize the renminbi and reduce speculative positions rather than altering the currency’s depreciation trend against the dollar.
Foreign investors offloaded $12 billion in stocks
Data from Hong Kong’s Bond Connect investment scheme reveals that foreign investors have sold a net Rmb148 billion ($20 billion) worth of Chinese government bonds in the first seven months of this year. The selling trend has been driven by China’s monetary easing measures and the US Federal Reserve’s interest rate hikes, which have widened the interest rate gap between renminbi and dollar-denominated debt.
In addition to bond sales, foreign investors offloaded a record $12 billion in Chinese stocks in August. During a visit to Beijing, US Commerce Secretary Gina Raimondo cautioned that American companies were beginning to view China as an “uninvestable” market.
Sean Callow, a senior currency strategist at Westpac, noted Chinese authorities’ challenges in restoring confidence in the currency. The resilient US dollar and weak data from the domestic property sector have made this task easier. While significant, the recent adjustment in the foreign exchange ratio is not expected to be a game-changer in this context.
The yuan’s exchange rate has been under pressure due to China’s slowing economy, concerns about the property market, and local debt stress. It recently weakened to below 7.3 per US dollar, the lowest since the 2008 global financial crisis. Notably, the foreign exchange ratio reduction is one of the tools that Beijing can employ to defend the yuan.
Following the announcement, the offshore yuan exchange rate strengthened by 200 basis points to above 7.26 per US dollar. Meanwhile, Chinese authorities have consistently asserted that they possess various tools to maintain the basic stability of the yuan. They also believe that a flexible currency can help absorb external economic shocks.
On Friday, the yuan midpoint, a daily reference rate set by China’s central bank, was established at 7.1788 against the US dollar, slightly stronger than the previous day’s rate of 7.1811. The previous reduction in the foreign exchange ratio, a two percentage point cut, was implemented in September 2022, following a peak of 9 percent in December 2021. China’s outstanding foreign exchange deposits decreased to $821.8 billion by the end of July, marking a 13.8 percent decline from the previous year.
