China Raises FX Reserve Ratio to 6% to Slow Yuan Rally, Draining About US$24 Billion

China’s central bank will require lenders to hold more of their foreign-currency deposits in reserve, a move aimed at slowing a rapid rally in the yuan, Reuters reported. The People’s Bank of China (PBOC) said on Tuesday it would lift the foreign exchange reserve requirement ratio by 2 percentage points to 6% from 4%, effective November 15.

The PBOC said the decision was intended to strengthen the management of foreign exchange liquidity at financial institutions, according to Reuters. Based on official foreign-currency deposit data, Reuters calculated that the change would pull about US$24 billion out of the financial system, while CITIC Securities chief economist Ming Ming told Xinhua it would freeze roughly US$20 billion to US$25 billion of liquidity at the bank level.

Xinhua described the hike as the first increase in nearly five years. The ratio was raised twice in 2021 to 9% and then cut three times in 2022 and 2023 to the current 4%, the state news agency said. Reuters noted that Tuesday’s move reverses the September 2023 cut.

FX Reserve – Fixing and yuan moves

The onshore yuan weakened as much as 0.37% to 6.6728 per dollar, its weakest since October 23, putting it on course for its biggest one-day drop since May 15, Reuters said. Xinhua reported that onshore spot yuan closed the official session at 6.6765 per dollar at 4:30 p.m., 307 pips weaker than the previous day, and that the offshore yuan also fell after the announcement.

The PBOC also set its daily midpoint weaker for a second straight day at 6.7150 per dollar, 661 pips weaker than a Reuters estimate and the largest weak-side gap since September 10. Reuters said the yuan had gained more than 5% against the dollar this year, putting it at its strongest since 2022, while a Reuters report carried by Business Recorder said the currency rose 0.74% in October alone. Xinhua said the onshore yuan had strengthened for 14 consecutive trading days from October 14.

Analysts see a signal on pace

“The PBOC is responding to strong market-driven yuan appreciation,” Marco Sun, chief financial market analyst at MUFG (China), told Reuters. ANZ senior China strategist Zhaopeng Xing said the move was likely to be more symbolic, adding that corporate foreign exchange settlement had created an excess of supply over demand that the hike alone would not resolve.

Zhiwei Zhang, chief economist at Pinpoint Asset Management, said in the Business Recorder report that the central bank was signalling concern over “the fast appreciation of yuan in October.” China Minsheng Bank chief economist Wen Bin told Xinhua the step would help “promote supply-demand balance in the forex market.”

Speaking at a financial forum in Hong Kong on Tuesday, PBOC Deputy Governor Zou Lan said China had insisted that the market play a decisive role in setting the exchange rate, Reuters reported.

What’s next

The higher ratio takes effect on November 15. Market participants do not expect the measure to reverse the yuan’s upward trend, Reuters said. Traders cited in the Business Recorder report pointed to a seasonal pattern in which exporters convert more foreign currency into yuan towards year-end and before the Lunar New Year, which usually supports the currency in December and January.

Xinhua said the PBOC’s October policy statement set out a focus on preventing sharp short-term swings without a preset target level, and said the central bank would introduce market-based measures if short-term moves overshoot.

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