(Yicai) Nov. 3 -- China’s central bank will raise the foreign exchange reserve requirement ratio this month for the first time in nearly five years. This is expected to freeze up to USD25 billion in foreign exchange liquidity, according to an authoritative expert.

The People’s Bank of China announced today it will raise the forex RRR -- the share of foreign currency deposits that financial institutions must deposit with the PBOC under regulations -- to 6 percent from 4 percent from Nov. 15 to strengthen forex liquidity management for financial institutions and ease pressure on the appreciation of the Chinese yuan.

The last adjustment, from 6 percent to 4 percent, was made in September 2023, while the last increase, from 7 percent to 9 percent, was conducted in December 2021.

The PBOC’s decisive action will likely freeze about USD20 billion to USD25 billion in foreign exchange liquidity within the banking sector, balancing supply and demand in the domestic forex market, an authoritative expert told Yicai. Moreover, it is expected to dispel unilateral appreciation illusions among certain market entities, stabilize market expectations, and ensure the smooth operation of the forex market.

After the adjustment, the offshore Chinese yuan appreciated against the US dollar. The offshore yuan-US dollar exchange rate was 6.667 as of 10.27 a.m. today, up 0.2 percent from before the announcement. The central parity rate of the yuan against the US dollar was 6.715 today, weakening 4 basis points from yesterday.

Raising the forex RRR will freeze more foreign currency funds in the banking system, thus helping balance foreign currency supply and demand and achieve relative yuan exchange rate stability, Zhao Qingming, chief economist at Beijing Longhe Investment, told Yicai.

The trajectory of the yuan remains highly uncertain, with several factors poised to exert downward pressure on the currency, especially the inverted United States-China interest rate differential, which remains at a historic high, and the non-negligible impact of geopolitical conflicts, the authoritative expert noted.

The PBOC’s latest policy shift aligns with its Oct. 8 stance on the yuan exchange rate, the expert said. The stance underscores that the central bank will introduce market-based measures to prevent disruptive, short-term overshooting if the currency experiences sharp volatility driven by “herd behavior” and irrational market expectations, without presetting a target level for the exchange rate, he explained.

All three Chinese yuan exchange rate indexes rose last week. The China Foreign Exchange Trade System RMB Index closed at 103.77 on Oct. 30, up from 103.41 a week earlier and hitting a 4.5-year high. The Bank for International Settlements Currency Basket RMB Index rose to 111.57 from 111.02, setting a new record, and the Special Drawing Right Currency Basket RMB Index climbed to 98.85 from 98.56.

In October, the central parity rate of the Chinese yuan against the US dollar strengthened 213 basis points to 6.7138 from 6.7351.

Editor: Futura Costaglione