China’s Central Bank Moves to Slow Yuan Depreciation

China’s central bank has cut the amount of foreign exchange banks must keep in reserve, an attempt to bolster the country’s rapidly weakening currency.

The yuan is trading around its lowest level in more than two years. It is worth around 6.94 per U.S. dollar in the more freely traded offshore market, taking its year-to-date decline against the dollar to 8.4%, according to FactSet.

The People’s Bank of China said on Monday it would cut the foreign-exchange reserve requirement ratio by 2 percentage points to 6% from Sept. 15. That will release around $19 billion into the country, said analysts, meaning Chinese banks will no longer need to sell yuan to buy that amount of foreign currency.

The decision to cut the foreign-exchange reserve ratio was a sign that China’s central bank isn’t willing to stand by and continue to watch the yuan fall, said

Zhiwei Zhang,

president and chief economist of Pinpoint Asset Management.

“The Chinese economy is facing quite a lot of headwinds, and some people in the market have been arguing that perhaps the central bank will want to take the chance and depreciate the yuan to help exports,” he said. “But this action shows that the People’s Bank of China is not willing to tolerate sharp yuan depreciation against the U.S. dollar.”

It was the second time the central bank had cut the foreign-exchange reserve requirement ratio this year, after a 1 percentage point cut in April, during another period of yuan weakness.

The latest reduction in the ratio will have a negligible impact on the supply of dollars in China, said Frances Cheung, an analyst at OCBC Bank.

“The amount released is not significant but it sends a signal,” said Ms. Cheung.

The signal appeared to work, at least in the short term. The central bank announced the move at around 5 p.m. Beijing time, when the dollar was worth more than 6.95 yuan in the offshore market. Minutes after the announcement, it had strengthened to around 6.94 per dollar.

Becky Liu, head of China macro strategy at Standard Chartered, said the size of the cut was bigger than expected but the move won’t stop the yuan’s depreciation by itself.

Ms. Liu said the divergence of monetary policy between China and the U.S. and the economic pressure facing China due to its dogged zero-Covid policy could weaken the yuan further.

The dollar has soared this year against almost all currencies, after an aggressive campaign of interest-rate increases by the Federal Reserve. The Fed increased rates by three-quarters of a percentage point in June and July and many economists expect it to continue at a strong pace. The benchmark federal-funds rate is now at 2.25% to 2.50%, compared with 0% to 0.25% at the start of the year. China’s central bank has gone in the other direction, making cuts to two key interest rates in August.

“This may also be in anticipation of a 75 basis points interest rate increase from the Fed, in order to offset the widening interest rate differential between the U.S. and China and avoid capital outflow due to expectations of yuan depreciation, which would be a vicious cycle,” said Mr. Zhang at Pinpoint Asset Management.

The Real Effective Exchange Rate for the dollar, which considers inflation when measuring the dollar’s strength, passed a previous peak hit two decades ago, according to the Bank for International Settlements.

Chinese central bank officials said in a press conference on Monday that the country is capable of strengthening its currency and the fluctuation in the yuan is normal.

Many analysts expect the yuan to hit 7 against the dollar in the next few months, if not sooner. Both the offshore and onshore yuan last crossed that level at the end of July 2020.

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