The Chinese Yuan is trading around its lowest level in more than two years. On the freely tradable foreign market, it is worth about 6.95 to the US dollar, so it has fallen more than 8% against the dollar since the beginning of the year.
The People’s Bank of China has therefore decided to cut the foreign exchange reserve requirement ratio by 2% to 6% from September 15. Chinese banks will therefore no longer have to sell such a large amount of Chinese yuan to buy foreign currency. This should release approximately $19 billion into the country. The 2% drop is also the biggest drop since 2004, this gives us a clear signal that China is not going to condone the weakening of its currency.
This is the second reduction in the reserve requirement ratio this year. We saw the first 1% cut in April.
PBOC introduces strong fixings of its currency
The People’s Bank of China (PBOC) has been showing us the longest streak of strong fixings of its currency since 2019 over the past two weeks. It has now made stronger-than-expected fixings 10 times in a row. The last reference rate for the yuan was set at 6.9096 yuan per dollar.
However, over the past week, the yuan has fallen 2.5% against the dollar, and with the current rate of 6.95 yuan per dollar, it is approaching the psychological 7 yuan per dollar threshold at which we could already see more and bigger moves by the PBOC. There could be even more reductions in foreign exchange reserve requirements or perhaps an increase in the issuance of foreign currency notes to help absorb liquidity in the market.
China is now economically hampered mainly by its Covid-Zero policy. This, coupled with the US Fed’s aggressive rate hikes, is causing rapid capital outflows from the country and thus putting pressure on the Chinese currency.
China will be electing its ruling party officials next month. Although no change in the head of state is expected and Xi Jinping is likely to be elected again. Still, it will be useful to have its currency at least partially stabilized for a smooth transition.