MNI Analysis: PBOC Reduces Risk Provision On Currency Forwards

     BEIJING (MNI) - The People's Bank of China (PBOC) has effectively

eliminated the foreign-exchange risk provision of currency forward contracts,

the Financial News, a publication under the PBOC, reported on Monday, with the

change taking effect immediately.

     The rule that had imposed a risk provision on currency forward contracts

was announced in 2015, when the yuan started coming under heavy depreciation

pressures. The rule demanded that financial institutions who take part in

forward buying and selling put aside a 20% provision in a PBOC account with a 0%

interest rates, which effectively raised the opportunity costs for investors

speculating on the depreciation of the yuan and also restricted dollar

purchases.

     The required risk provision now stands at 0%, although the PBOC could elect

to increase it again if the yuan were to come under pressure.

     According to the data from China International Capital Corporation (CICC),

the monthly trading volume of forward contracts dropped 83.2% when the risk

provision rule took effect in October 2015.

     The move by the PBOC to drop the risk provision apparently pointed its

worries over the suddenly strengthening yuan. 

     "The PBOC said in its second-quarter monetary policy report that it will

keep the yuan generally stable at a reasonable level, while the yuan has risen

too much against the dollar recently," Li Qilin and Zhong Linnan, analysts at

Lianxun Securities, said in a report on Saturday. "So the aim for lowering the

risk provision is to interrupt the trend of yuan appreciation and prevent the

expectations for the yuan to continue appreciating from growing too much."

     The yuan has strengthened rapidly against the dollar recently, hitting

6.4617 on Friday from 6.9057 on May 9. 

     The PBOC could be worried that investors are now universally betting on a

stronger yuan, pushing it to even higher levels.

     "I think the PBOC does not want to see one-sided yuan appreciation

expectations," a Shanghai-based forex trader at a commercial bank told MNI.

"Naturally, Chinese people need the yuan [as consumers] rather than the dollar.

So if appreciation expectations become stronger, more people will choose to sell

the dollars they have, pushing the yuan even higher."

     "Actually, the yuan fixing for the past two trading days has been weaker

than it should be, so the PBOC has begun to take action to prevent the yuan from

rising too fast," the trader continued.

     The PBOC set yuan fixing at 6.5032 and 6.4997 on Friday and Monday,

respectively, while the dollar index was 91.326 and 91.512.

     However, analysts said the latest PBOC move is more symbolic than

realistic, and that it is difficult to see the measure itself curbing the rising

yuan momentum.

     "Data suggested the volume of forex forward contracts is generally no

higher than 20% of that in the spot market, and Chinese companies do not have a

strong will to avoid exchange-rate risks by using financial derivatives," China

Construction Bank (CCB) said on Monday. "So the decrease in costs to buy forex

forward contracts will not necessarily stimulate the demands for forward

contracts."

     "Also, because of the fading yuan depreciation pressures, speculators do

not have the motivation to use forward contracts to bet on the depreciation of

the yuan," CCB said. "So the real effect might not be significant."

     Sun Guofeng, director general of the People's Bank of China's research

institute, said in an email to MNI on Monday that the PBOC's move was intended

to strengthen the price-discovery mechanism in the forex market. Sun also said

the yuan exchange rate is moving toward an even balance, and that market

expectations are becoming more rational.

     The PBOC also canceled the required reserves for foreign banks who

participate in yuan business abroad on the same day, the Financial News

reported.

     The yuan last traded at 6.5220 on Monday, significantly weaker than

Friday's close of 6.4617.

--MNI Beijing Bureau; +86 10 85325998; email: he.wei@marketnews.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

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