Editor’s Note: Jimmy Zhu is chief strategist at Singapore-based Fullerton Research. The article reflects the author’s opinion, and not necessarily the views of CGTN.
The Chinese yuan pared some of its earlier gains after the People’s Bank of China (PBOC) decided to adjust the foreign exchange (FX) reserve requirement for banks. Moving forward, many factors suggest further massive gains in yuan value are not likely in the coming months.
Onshore financial institutions will need to hold 9 percent of their foreign exchange in reserve starting December 15, a 2-percentage-point increase, the Chinese central bank said in a statement earlier last week. Onshore yuan declined over 300 percentage points to 6.38 against the U.S. dollar after the announcement.
The PBOC’s decision clearly demonstrates the authorities are not comfortable with the recent gains in currency. Since the end of the first half of the year, the yuan has gained around 1.4 percent versus the dollar even with the dollar index rising around 4 percent during this period. Also, the yuan has outperformed all other emerging markets’ currencies since the beginning of the second half of this year.
The adjustment for FX reserve ratio itself should not have direct impact on the level of yuan exchange rate, but the policy will force some companies to purchase dollars instead of borrowing from the banks. For example, a company that needs $1 million in cash to pay suppliers may find it more difficult to borrow from banks now, as commercial lenders must hold more dollars to fulfill their FX reserve ratio requirement.
In the end, this company may either purchase dollars from their yuan holdings or get this dollar amount from somewhere else. As a result of that, onshore dollar liquidity is expected to be tighter than before, increasing the upward pressure on the dollar value versus the yuan.
Still, the FX reserve ratio’s adjustment itself will not have much sustainable impact on the yuan, as the currencies will continue to be driven by various fundamental factors, including the dollar’s outlook, interest rate differentials and cross-border capital flows.
Over a long period of time, the yuan’s moves versus the greenback have been closely tracking the dollar index. For the next 12 months, the dollar index may continue to move higher amid policy divergence between the Federal Reserve and European Central Bank (ECB). Recent inflation readings in the U.S. have strengthened the case for the Fed to accelerate its tightening pace this week, paving the way for it to raise policy rates as soon as next May.
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