(Yicai Global) Sept. 11 -- China’s state bank, the People’s Bank of China, has lowered the reserve requirement for forward foreign currency purchases for Chinese and foreign financial institutions from 20 percent to zero, and also removed a requirement that offshore banks participating in yuan transactions hold deposit cash reserves in domestic banks, effective from today.
The yuan’s exchange rate against the dollar closed 355 basis points higher at 6.4617 at 4.30 p.m. on Sept. 8, representing its highest level since December 2015.
The new policy is unlikely to have a major impact on the foreign exchange market, but it is a sign that the Chinese authorities do not want to see a rapid rally of the yuan, and the move will effectively reign in the yuan’s appreciation by guiding market expectations, one expert said.
The government introduced the forex reserve requirement two years ago to put a curb on foreign exchange speculation and capital outflow by raising the cost of forward foreign currency purchases. Banks were required to pay a certain percentage of foreign currency purchases that they process for clients using the US dollar for reserves. The removal of the reserve requirement means that the banks will no longer receive the interest subject to the dollar reserves.
The banks will pass the extra cost arising from foreign currency tied up as reserves on to enterprises purchasing foreign currencies thereby boosting profitability. The central bank dealt a significant blow to yuan bears and cross-border arbitrage schemes by indirectly increasing the cost of forward purchases, said Li Qilin, general manager and chief macroeconomic analyst at Lianxun Securities.
“It was imposed as a temporary macro-prudential measure after a sharp rise in forward foreign exchange purchase and short yuan positions,” said Xie Yaxuan, chief macroeconomic analyst at China Merchants Securities. However, supply and demand on the forex market have stabilized since August so it’s time to restore normal policies,”
Expectations regarding the yuan’s devaluation derive from various factors, including a strong dollar. We will likely see a rally in the value of the dollar by year’s end, Xie added, and the exchange rate between the yuan and the dollar will fluctuate in both directions, putting an end to the former’s winning streak seen over the last couple of months.