China tries to curb yuan recovery as exports weaken

BEIJING – China has started working to curb the yuan’s post-coronavirus recovery as upward pressure on the currency begins to reduce exports, a crucial engine of economic growth.

The People’s Bank of China announced Monday that it will increase the share of foreign currency deposits that banks with branches in the country must reserve from 5% to 7% from June 15. This is the first increase in the exchange rate. reserve requirements since 2007.

The move represents a shift from the central bank’s wait-and-see stance on the currency, a sign that Beijing is seeing the downsides of a strong yuan starting to outweigh the benefits of some degree of isolation from the upside. commodity prices.

China’s foreign currency deposits totaled around $ 1 trillion at the end of April, according to the PBOC, which means an additional $ 20 billion should be set aside. This move aims to drain liquidity from this market, increase yields and less incentive for investors to sell foreign currencies to buy yuan.

The policy change was announced shortly after the yuan hit a three-year high in the 6.35 range against the dollar on Monday night. The currency weakened 0.3% in three hours.

The currency had risen 13% during the year from its lowest level in May 2020, as China’s relatively rapid return to economic normality after the coronavirus outbreak boosted bond yields relative to other economies. Net capital inflows peaked in seven years in the first quarter of 2021.

A stronger yuan weighed on export demand, a key driver of China’s economic growth. © Reuters

The PBOC had insisted on remaining standing despite the rally. Just a week before the policy change, on May 23, Deputy Governor Liu Guoqiang said the bank would keep the exchange rate “basically stable at a reasonable and balanced level.”

A strong currency, according to opinion, helps dampen import price inflation – a particularly important point amid this year’s widespread rise in international commodity markets.

Official manufacturing purchasing managers index data for May released on Monday showed both commodity and producer prices rising. But the former has grown much faster, leading to the larger gap between the two metrics in comparable data going back to 2016 and suggesting that costs are rising faster than manufacturers’ ability to pass them on to customers.

“There are significant negative impacts, such as pressure on profits, for small businesses, where price competition is particularly intense,” said Yoshino Tamai of Mizuho Research & Technologies in Japan.

The State Council, China’s highest administrative authority, said last week that it would not tolerate hoarding or price hikes by big business.

The central bank’s change in approach this week was boosted by signs that a stronger yuan is starting to affect exports. In May PMI data, the new export orders index fell below the expansion or recession line of 50.

Exports are a key part of China’s “dual circulation” strategy of China’s latest five-year plan, which calls for cultivating domestic demand while remaining economically engaged abroad. A collapse of the latter category could cripple efforts to establish this new economic framework.

It is not yet known whether the PBOC’s decision will actually limit the appreciation of the yuan. The currency remained high on Monday at around 6.36 to 6.38 against the dollar.

“The upward pressure on the yuan will not weaken unless the United States begins to reduce its quantitative easing and the spread between US and Chinese interest rates narrows,” Takamoto said. Suzuki of the Chinese branch of the Japanese trading house Marubeni.

But the fact that the PBOC is moving to counter the rally can be significant in itself.

If the yuan continues to appreciate, it could cross the 6.25 per dollar threshold for the first time since August 2015, when the central bank unexpectedly devalued the currency.

The bank has recently put more emphasis on allowing market forces to move the yuan as part of its efforts to internationalize the currency. What it will do if the yuan climbs to uncomfortable levels remains to be seen.

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