PBOC lifts FX reserve ratio to 6% in signal to slow yuan gains

The PBOC's decision indicates Beijing is uneasy about how quickly the yuan has been strengthening. It provides a floor for USD/CNY and USD/CNH near present levels without changing the overall trend. The liquidity impact is small, so markets are likely to view it as a cautionary signal, with the daily reference rate as the key indicator for further action. The effect spreads: when the PBOC resists yuan appreciation, it tends to dampen gains in other Asian currencies that move with the yuan, including the Korean won and the Taiwan dollar. It can also slightly affect the Australian dollar, which frequently trades as a proxy for Chinese growth. The timing is significant because the US dollar has already weakened on hopes for Iran diplomacy. If the dollar declines more, the PBOC may need stronger measures to maintain its desired level.

Earlier:

• PBOC and regulators to discuss stock market support following 12-week slide

By reducing the availability of dollars within China, the central bank is attempting to curb the yuan's rise. Although the measure is small, it sends an unmistakable sign about the currency direction Beijing prefers.

Key points:

• From November 15, the PBOC will increase the foreign exchange deposit reserve ratio for banks to 6%, up from 4%.
• The central bank stated the measure aims to improve oversight of foreign currency liquidity in the banking sector.
• The ratio determines the portion of foreign currency deposits banks must keep as reserves. An increase reduces the amount of dollars available in the domestic market.
• Historically, the PBOC has increased the ratio to moderate yuan gains and lowered it to buttress the currency during periods of weakness.
• On Monday, the PBOC set the USD/CNY reference rate at about 6.71, substantially weaker than the Reuters forecast of approximately 6.66, providing further evidence the central bank is resisting yuan appreciation.
• The impact on liquidity is limited, meaning the policy message will probably influence markets more than the technical details.

Banks in China will be required to set aside a bigger percentage of their foreign currency deposits as reserves. This technical step tightens domestic dollar liquidity, and markets will probably interpret it as a sign that Beijing wishes to temper the yuan's ascent.

The PBOC announced a 2-percentage-point increase in the foreign exchange deposit reserve ratio for financial institutions, moving it to 6% from 4% effective November 15. The central bank described the action as a measure to enhance management of foreign exchange liquidity within the banking system.

This ratio functions similarly to the more familiar reserve requirement on yuan deposits, but applies to foreign currency deposits, predominantly US dollars. When the ratio is increased, banks must deposit more of those dollars with the central bank, reducing the amount they can lend, invest, or sell. As dollars become scarcer, they grow more costly relative to the yuan, easing some upward pressure on the Chinese currency.

The PBOC employs the tool in both directions. It increased the ratio twice in 2021 during a period of strong yuan appreciation, and lowered it in 2022 and again in 2023 when the currency was weakening and the central bank aimed to bolster it. Since the last reduction, the ratio had been at 4%, so this is the first rise in several years.

The scale of the adjustment is limited. When the PBOC similarly reduced the ratio by 2 percentage points in 2022, ANZ calculated that it would inject roughly $20 billion in foreign currency into the market, a small sum compared with China's overall currency market. The key element is the message, not the actual liquidity change.

Additional signals align. On Monday, the PBOC's daily USD/CNY fixing was approximately 6.71, significantly weaker for the yuan than the Reuters model survey estimate of about 6.66. This indicates the central bank was already pushing back against yuan appreciation. The PBOC has further stated its goal of maintaining general yuan stability and preventing excessive exchange rate movements.

For market participants, the practical implication is that Beijing is indicating a desire for more gradual yuan appreciation. It is not trying to reverse the currency's trend. The daily reference rate will be the most transparent indicator of whether additional measures will be taken, especially if the US dollar continues to fall.