China: A Warning on the Currency

Published on November 30, 2021
SGH Insight
Sources in Beijing are eager to present upside pressure on the Chinese Renminbi, even as the US Dollar has also strengthened, as a reflection of powerful and positive trade flows, rebounding investor sentiment, and a long-term movement of trade settlement denominations into the RMB.
But there is a limit to the government’s tolerance for an appreciating currency as the economy recovers from a sharp Q3 2021 slowdown, and officials now warn that they will intervene “if the RMB begins to hurt exports or pose a risk to financial stability.”
Market Validation
Bloomberg 12/10/21

The People’s Bank of China set its daily yuan fixing at the weakest relative to estimates since Bloomberg began publishing the forecasts in 2018. The fixing came hours after the PBOC told banks to hold more foreign exchange in reserve, a move that effectively reduces the supply of dollars and other currencies onshore and puts pressure on the yuan to weaken. Still, it continued to strengthen in onshore and offshore markets on Friday.

Dow Jones 12/9/21

China's Central Bank to Raise Reserve Requirement Ratio for Foreign-Currency Deposits

China's central bank said Thursday that it will increase the amount of foreign-currency deposits banks have to set aside, in a bid to tame the appreciation of the Chinese yuan.
The People's Bank of China said it will raise the reserve requirement ratio, or RRR, for foreign currency deposits by 2 percentage points to 9%, effective Dec. 15.
It is the second time of the year that China's central bank has raised the FX reserve requirement ratio for financial institutions. The last hike, effective on June 15, raised the ratio to 7% from 5%.

Sources in Beijing are eager to present upside pressure on the Chinese Renminbi, even as the US Dollar has also strengthened, as a reflection of powerful and positive trade flows, rebounding investor sentiment, and a long-term movement of trade settlement denominations into the RMB.

But there is a limit to the government’s tolerance for an appreciating currency as the economy recovers from a sharp Q3 2021 slowdown, and officials now warn that they will intervene “if the RMB begins to hurt exports or pose a risk to financial stability.”

The message from these sources is as follows:

Recently, the RMB exchange rate and the US dollar have shown a “double-strong” pattern. In the context of the rising DXY [Dollar] Index, the RMB exchange rate did not depreciate at the same time, but instead appreciated, which directly pushed the three major RMB exchange rate indices to a greater upward trend.

The CFETS RMB Index, which tracks the yuan against 24 currencies, [has] gained about 6% so far this year to [hit] 100.82 on November 26, near the record high of 100.84 reached on January 22, 2016.

There are three factors behind the RMB strength: China’s exports remain strong, foreign trade enterprises’ foreign exchange demand pushed up the RMB exchange rate, and market sentiment…

China’s trade growth has remained well above pre-pandemic levels all year. Exports through October surpassed [exports for] all of 2020, and this was the 13th straight month of double-digit growth. More meaningfully, more and more foreign trade enterprises have increased the proportion of RMB settlement when signing foreign trade contracts for next year.

The RMB’s recent rally is unlikely to alter the trend of its two-way movements. [But] based on the current situation in the spot foreign exchange market, the central bank issued a notice last week. The notice strongly urged financial institutions to step up their exchange-rate risk management, restrict speculative foreign exchange trading, and to not bet on unilateral appreciation of the RMB.

Although we are becoming more and more tolerant of RMB volatility, we will certainly intervene if the rapid appreciation of the RMB begins to hurt exports or pose a risk to financial stability. 

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