China’s central bank raises FX risk reserve ratio from zero to 20% to stabilize yuan exchange rates
A staff member presents banknotes and coins included in the 2019 edition of the fifth series of the renminbi at a branch of the Industrial and Commercial Bank of China (ICBC) in Beijing, capital of China, Aug 30, 2019. ( Photo: Xinhua)
To stabilize China’s foreign exchange market and shore up the value of the yuan, the country’s central bank, the People’s Bank of China (PBC), announced that it would increase the foreign exchange (FX) risk reserve ratio for currency trading. forward exchange of 0 to 20%, effective from Wednesday.
This will increase the cost of forward foreign exchange transactions by banks, reduce demand for forward currency purchases in the market to stabilize yuan exchange rates, economists said.
The central bank’s decision sent a strong signal to stabilize yuan exchange rates and keep market expectations steady in a recent volatile market, Guan Tao, global chief economist at BOC International, told the Global Times on Monday.
This could promote balance between supply and demand in the foreign exchange market and avoid excessive “pro-cyclical behavior” and “herd effect” among companies, Guan noted.
The move came amid an increasingly volatile foreign exchange market, with the US dollar index hitting a 20-year high, putting increasing pressure on other currencies.
The Chinese yuan’s central parity rate weakened 378 basis points to 7.0298 against the US dollar on Monday, according to the China Foreign Exchange Trade System. The offshore yuan closed at 7.1173 on the previous trading day.
After PBC announced the increase in the foreign exchange risk reserve ratio, the offshore yuan against the US dollar rose more than 300 points and stood at 7.1659 in the middle of the trading day.
Interest rate hikes in the United States have hit global financial markets, depreciating currencies other than the dollar around the world and driving capital outflows from many countries and regions, Sun Lijian, managing director, told the Global Times on Monday. from the Shanghai Fudan University Financial Research Center.
By increasing the risk reserve ratio, Chinese banks will be able to improve their ability to weather the risks caused by rising US interest rates and reduce the potential fallout within a controllable range to avoid any systematic risk, Sun noted.
For example, some Chinese companies, which have issued dollar-denominated debt, will come under increasing repayment pressure when the US Federal Reserve raises interest rates. Under these circumstances, it is crucial that Chinese banks are prepared to cover potential corporate defaults, Sun added.
Additionally, a higher FX risk reserve ratio for FX forwards could dampen speculative forces seeking to short the Chinese yuan, Sun said.
By stepping up efforts to build risk-resilient capacity, China’s financial market will strive to ensure healthy development despite volatile foreign exchange markets, Sun said.
The forward sale of currencies is a currency hedging product provided by commercial banks to foreign trade companies. In the event of an anticipated depreciation of the yuan, companies will use this tool to lock in the cost of buying currencies in advance, in order to avoid losses.
The PBC reduced the foreign exchange risk reserve ratio to zero from 20% in October 2020 when the onshore yuan spot exchange rate hit a 17-month high.