China will increase the FX risk reserve ratio to 20% in order to stop the depreciation of the yuan

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Last Updated on September 26, 2022 by Bitfinsider

On September 26, China’s central bank announced actions to limit the rate of the yuan’s recent decline by increasing the cost of betting against the currency.

The People’s Bank of China (PBOC) said that as of September 28th, it would increase the foreign exchange risk reserves for financial institutions when purchasing FX through currency forwards from zero to 20%.

According to a statement posted online, the PBOC stated that its steps are aimed at “stabilizing FX market expectations and enhancing macro prudential control.”

According to traders and commentators, the decision to reinstate FX risk reserves will inadvertently increase the cost of shorting the yuan at a time when the local currency is under new depreciation pressure.

Spot Yuan didn’t react much to the news. In contrast to Friday’s previous late-night close of 7.1298, the onshore yuan traded at 7.1485 per dollar on Monday. As of 01:55 GMT, its offshore counterpart had last traded at 7.1522 after temporarily rising to 7.13.

For the 23rd consecutive trading session, the PBOC issued official advice earlier on Monday at 7.0298 per dollar before the market opened, which was the lowest level since July 7, 2020. It outperformed Reuters’ prediction of 7.0019 by 279 pip.

Authorities have intensified their efforts in recent months to limit yuan weakening by consistently establishing midpoint fixes that are firmer than anticipated, issuing verbal warnings, and delaying immediate easing measures.

Since mid-August, the yuan has lost more than 4% of its value against the dollar, breaching the psychologically significant 7-to-1 barrier. It is now on pace to suffer its worst yearly loss since 1994, when China combined its official and market currency rates.

A combination of the strong dollar overall, China’s shaky economy, and looser monetary policy undertaken by the government to support growth have hurt the value of the Chinese yuan.

After the PBOC cut key interest rates in August to further distance itself from other sizable economies that are agressively rising rates, the yuan’s decline accelerated.

The PBOC’s action on Monday represents the latest policy step to stabilize the currency after it earlier this month reduced the amount of foreign currency that banking institutions were required to retain as reserves.

In October 2020, when the yuan appreciated significantly, China’s central bank abolished the risk reserve requirements.

The dollar is in high demand due to the U.S. Federal Reserve’s swift monetary tightening, and the yuan is one of many currencies that are constantly being sold off. Authorities in Japan intervened in the currency market last week to buy yen for the first time since 1998 as part of the country’s ultra-easy monetary policy, which the central bank is adhering to in an effort to rescue a faltering economy.

However, Cheung pointed out that the measure is unlikely to stop the yuan depreciation trend given the increased dollar interest rates and the Fed’s relentless increase in borrowing costs.

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