The People’s Bank of China’s (PBoC) latest decision to lower banks’ reserve requirement ratios (RRR) for foreign exchange may help to slow the yuan’s depreciation in the short term but it will not reverse the currency’s broad weakening trend, economists said.
Due to market expectations of a 50 basis point increase in the Federal Open Markets Committee’s (FOMC) meeting on May 4, the US dollar index rose to 101.92 on Tuesday, the highest since March 2020 when the world was hit by the first Covid-19 epidemic wave.
The strong dollar has suppressed other major currencies, including the British pound, euro, Japanese yen and renminbi so far this year.
Economists said China’s central bank apparently wanted to stabilize the Chinese currency at 6.5-6.6 to one US dollar in the short run as a fast depreciation could cause a herd effect, referring to panic selling of the renminbi.
However, they added that yuan’s depreciation would probably continue for some time since the 10-year US treasury yield surpassed its Chinese counterparts on April 11. The economists also said lockdowns in Chinese cities, including a possible one in Beijing, would fuel capital outflows and further weaken the yuan.
Since China declared it had achieved its goal of zero infections in mid-2020, the Chinese currency was an upward trend vis-a-vis the US dollar. The yuan had gradually appreciated from 7.08 in June 2020 to 6.31 in late February this year.
On April 11, the yield on benchmark 10-year Chinese government bonds closed at 2.767%, while the yield on the 10-year US Treasury note ended at 2.779%. Until then, China’s government bonds had a yield advantage over comparable US notes since 2010.
Over the past week, the renminbi has weakened from 6.37 to a one-year low of 6.5775 on Monday. The PBoC said Monday it would cut the forex RRR by 100 basis points from 9% to 8% beginning May 15.
It said the move, which would inject an estimated $10.5 billion of liquidity into the banking system, was aimed at improving financial institutions’ ability to use forex funds.
The central bank said in a statement on Tuesday that it would step up monetary policy’s support for the real economy, especially for industries and small businesses hit hard by the pandemic.
The PBoC said it would promote the healthy and stable development of financial markets, provide a good monetary and financial environment and keep liquidity reasonably ample.
On Tuesday, the onshore renminbi was trading at about 6.55. The announcement of the forex RRR cut had helped push up the CSI 300 Index by 1.5% early on Tuesday but the index closed down 0.8% at 3,784 by the end of the trading session.
The Shanghai Composite Index also dropped 1.4% to end at 2,886, the lowest level since June 2020.
“[The] renminbi has been under pressure in recent days, creating an obvious expectation of depreciation,” Zhao Qingming, a specialist in international finance, told China National Radio in an interview. “The reason for this is that there may be a short-term shortage of forex supply.”
Zhao said the forex RRR reduction would restrain the current depreciation of the Chinese currency.
Guan Tao, global chief economist at BOC Securities, pointed out that the PBoC had raised forex RRR from 7% to 9% on December 15 last year due to the appreciation of the yuan.
Guan said the newly-announced forex RRR cut would help increase domestic forex liquidity, widen the interest rate spread between domestic and foreign currencies and promote the smooth operation of the domestic forex market.
“The PBoC wants to stabilize renminbi at a reasonable and balanced level and calm market sentiment to avoid a herd effect,” said Guan.
Carie Li, a global market strategist at DBS Bank, said the recent yuan depreciation was caused by the strengthening US dollar and virus outbreaks in China. Li said global investors’ risk aversion increased as the epidemic situation in mainland China deteriorated.
She said the sell-off of Chinese stocks also had a negative impact on the renminbi.
Feng Beilin, a senior research fellow at the Research Center for Finance, Chinese Academy of Fiscal Sciences, Ministry of Finance, said apart from the US rate hikes and the Chinese economic slowdown, rising global commodity prices caused by the Russia-Ukraine conflict and the monetary easing in China would also weaken the renminbi over the medium run.
On Tuesday, Beijing expanded its Covid-19 mass testing to 11 districts, on top of Chaoyang district, as the number of infections continues to rise.
China’s capital city reported 32 local symptomatic infections and one asymptomatic case on Tuesday, compared with a total of 19 on Monday.
About 21 million people are required to finish three rounds of PCR tests between Tuesday and Saturday in Beijing’s districts of Dongcheng, Xicheng, Haidian, Fengtai, Shijingshan, Fangshan, Tongzhou, Shunyi, Changping and Daxing, as well as the Beijing Economic-Technological Development Area.
On Sunday evening, Beijing residents snapped up rice, noodles, vegetables and canned food at supermarkets as many feared the city government would follow Shanghai and lock down the entire city for weeks.
Shanghai has been locked down since March 28 and currently as many as 16.8 million people cannot move freely. On Tuesday, health officials said 1,661 infections and 15,319 asymptomatic cases were identified in the largest commercial city in China.
Read: Shanghai’s lockdown fiasco headed next for Beijing
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