BEIJING – China has started to act to curb the post-coronavirus rally in the yuan as upward pressure on the currency begins to reduce exports, a crucial engine of economic growth.
The People’s Bank of China announced on Monday that it will increase the share of foreign currency deposits that banks with branches in the country must set aside from 5% to 7% as of June 15. This marks the first increase in the exchange rate. reserve required since 2007.
The move represents a deviation from the central bank’s expectation of the currency, a sign that Beijing is seeing the downsides of a strong yuan starting to outweigh the benefits of some insulation from rising prices of raw materials.
China’s foreign currency deposits totaled around $ 1 trillion at the end of April, according to the PBOC, which means an additional $ 20 billion should be set aside. This move aims to drain liquidity from this market, increase yields and less incentive for investors to sell currencies to buy yuan.
The policy change was announced shortly after the yuan hit a three-year high in the 6.35 range against the dollar on Monday night. The currency weakened 0.3% in three hours.
The currency had risen 13% during the year since its most recent low in May 2020, as China’s relatively rapid return to economic normalcy after the coronavirus outbreak boosted bond yields relative to d ‘other savings. Net capital inflows reached a seven-year high in the first quarter of 2021.
The PBOC had insisted on staying upright despite the rally. Just a week before the policy change, on May 23, Deputy Governor Liu Guoqiang said the bank would keep the exchange rate “basically stable at a reasonable and balanced level.”
According to the thought, a strong currency helps dampen import price inflation – a point especially important in the context of the general rise in international commodity markets this year.
Official manufacturing purchasing managers index data for May released on Monday showed commodity and producer prices to be on the rise. But the former has grown much faster, resulting in the largest gap between the two metrics in comparable data going back to 2016 and suggesting that costs are rising faster than manufacturers’ ability to pass them on to customers.
“There are significant negative impacts, such as profit pressure, for small businesses, where price competition is particularly intense,” said Yoshino Tamai of Mizuho Research & Technologies in Japan.
The State Council, China’s highest administrative authority, said last week that it would not tolerate hoarding or price gouging from big business.
The central bank’s change in approach this week was boosted by signs that a stronger yuan is starting to affect exports. In May PMI data, the new export orders index fell below the expansion or recession line of 50.
Exports are a key part of China’s “dual traffic” strategy of China’s latest five-year plan, which calls for cultivating domestic demand while remaining economically engaged abroad. A collapse in the latter category could hamper efforts to establish this new economic framework.
It is not known whether the PBOC’s decision will actually limit the appreciation of the yuan. The currency remained high on Monday around 6.36 to 6.38 against the dollar.
“The upward pressure on the yuan will not ease unless the United States begins to reduce quantitative easing and the spread between US and Chinese interest rates narrows,” said Takamoto Suzuki of the Chinese subsidiary of the Japanese trading house Marubeni.
But the fact that the PBOC is working to counter the rally can be significant in itself.
If the yuan continues to appreciate, it could cross the 6.25 per dollar threshold for the first time since August 2015, when the central bank unexpectedly devalued the currency.
The bank has recently put more emphasis on allowing market forces to move the yuan as part of its efforts to internationalize the currency. It remains to be seen what he will do if the yuan hits uncomfortable levels again.