China's central bank has directed financial institutions to hold more foreign exchange in reserve for a second time this year, with markets interpreting it as an attempt to slow down a recent rapid appreciation of the yuan.
The People's Bank of China (PBOC) said it will raise the foreign exchange reserve requirement ratio (RRR) by 200 basis points (bps) to 9% from 7% from Dec. 15 to strengthen FX liquidity management at financial institutions.
The move would force banks to set aside more of their FX deposits, which stood at $1.02 trillion at end-November, and markets widely believe the decision is intended to slow the yuan's recent rapid appreciation.
The yuan CNY=CFXS has risen more than 2% against the dollar since late July. In trade-weighted terms .CFSCNYI it is at its strongest since late 2015.
"The hike in FX RRR shows the PBOC thinks the appreciation of the RMB is too strong and too quick," said Gary Ng, economist at Natixis in Hong Kong.
"The move will increase the cost of speculation and forces banks to hold more foreign currencies instead of converting them into the RMB. With the upcoming downward economic pressure, a excessive strong RMB may not bode well for growth, especially with the high base in Q1 2022."
With the adjustment coming into effect on Dec. 15, the PBOC's decision earlier this week to cut the RRR in local currency deposits for banks by 50 bps would also be effective to free up 1.2 trillion yuan ($188.20 billion) in long-term liquidity to bolster slowing economic growth.
However, some market analysts and traders said the PBOC's move caught them off guard as the authorities have appeared to have a higher tolerance for a stronger yuan over the past few months.
"It was a surprise as the U.S. Federal Reserve is already on course for the first post-pandemic interest rate hike next year," said Ken Cheung, chief Asian FX strategist at Mizuho Bank in Hong Kong
"The PBOC's insistence on raising the RRR for FX deposits suggested it is keen to stabilise the FX market."
Still, some traders said the move showed the authorities have become uncomfortable with pace of recent yuan appreciation, especially at a time corporates had higher demand for yuan towards the year-end.
"It's just freezing about $20 billion and should not pile too much downside pressure," said a trader at a Chinese bank.
"We believe that companies' FX settlement into yuan has not yet come to an end," said Marco Sun, chief financial markets analyst at MUFG Bank, expecting the yuan to trade in a range of 6.34 to 6.40 per dollar in the near term.
The PBOC previously raised the FX reserve requirement ratio for financial institutions by the same margin in June to make it more expensive for banks to hold dollars.
($1 = 6.3762 Chinese yuan)
(Reporting by Kevin Yao, Winni Zhou, Andrew Galbraith and Beijing newsroom Editing by David Goodman, Kirsten Donovan and Bernadette Baum) ((email@example.com; +8610 5669 2128;))