MNI: PBOC Aims To Slow, Not Stop, Yuan Weakening-Advisors

The modest scale of Monday’s cut in Chinese foreign exchange reserve requirements after the yuan’s biggest weekly fall against the dollar since 2015 indicates the People’s Bank of China may be increasingly tolerant of a weaker exchange rate, though it will prevent sell-offs from turning into a one-way trade and has plenty of tools to slow depreciation if necessary, policy advisors and FX traders told MNI.

A lower level for the yuan would be in line with softening fundamentals in a country grappling with a serious Covid outbreak, which has now spread to parts of Beijing after prompting lockdowns in economically key cities including Shanghai, and as the trade surplus narrows, said one advisor, adding that this would also be in line with the dollar’s broad strengthening. (See MNI: Yuan To Weaken As Exports Soften-Advisors) The PBOC is unlikely to defend any particular level but the range between 6.6-6.7 to the dollar will be crucial over the rest of the year, and a breach of 6.7 could trigger further sharp depreciation, he said.

The plunge in Chinese equity markets over recent days contributed to fears that a rapid slide in the yuan could destabilise financial markets, the advisor said, but he noted that the central bank has shown more tolerance for a weaker currency this year, with the CNY fixing dropping 1,870 pips against the dollar since April 19.

MODEST BOOST TO DOLLAR LIQUIDITY

The onshore yuan closed at 6.5473 at 16:30pm Beijing time on Tuesday, 71 pips lower than on Monday. USDCNY had dropped by 300 pips in the morning trading session while the offshore USDCNH rate fell by over 400 pips.

On Monday, the PBOC said it was cutting bank’s FX reserve requirement ratio to 8% from 9%, effective on May 15, a move is which is expected to free up USD10.5 billion in foreign exchange. It only partially reversed the twin 2-percentage point increases made last year when the yuan was strengthening.

The dollar liquidity unlocked by the reserve requirement cut is relatively modest, said a trader at a big commercial bank, pointing to spot volumes averaging about USD36.7 billion per day since April 20, which have jumped by more than 80% from the first half of April. But the PBOC has sent a signal of the limits of its tolerance to markets, he said.

The yuan could trade around 6.6 for some time, he went on, in line with the periods following last year’s two reserve requirement adjustments, which had only limited impacts on dollar interest rates in the domestic market and the yuan/dollar swap price.

The recent yuan depreciation was also driven by yen purchases, the trader said.

COMFORTABLE WITH WEAKER YUAN

The PBOC would be comfortable with a weaker yuan, which would allow it more space to ease monetary conditions as the economy weakens, so long as it depreciates at a measured pace and there is two-way volatility, another advisor said.

The central bank has multiple tools to curb any sell-off which becomes a one-way trade, he said, including further cuts in FX reserve requirements, or an increase in the reserve requirement for FX forwards, which were cut to zero from 20% in October, 2020, in order to increase the cost of shorting the yuan. It could also restrain Chinese lenders and companies from lending yuan abroad, or instruct big Chinese banks to buy yuan in the offshore derivative product market. Last but not least, it could reintroduce the so-called “counter-cyclical factor” into the fixing formula, the advisor said, adding that the PBOC’s moves bear careful watching in coming weeks.