Chinese Central Bank Raises Foreign Deposit Reserve Ratio for First Time in 14 Years to Stem Renminbi Appreciation

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The People’s Bank of China (PBOC) has resorted to the use of a rarely employed policy tool to deal with a recent rise in the renminbi to a three-year high against the US dollar.

On 31 May PBOC announced that starting from 15 June 2021 it would raise the forex reserve ratio for domestic financial institutions by two percentage points to 7% from 5% previously.

The last time that the ratio was adjusted was 14 years ago in 2007, when PBOC lifted the figure to 5% from 4%.

“On this occasion the central bank has not made use of forex risk reserves or other policies tools commonly used in recent years, but has instead employed the forex deposit reserve ratio – a tool which has been rarely used in the past,” said Guan Tao (管涛), global chief economist with BOC International, to Securities Journal.

“This indicates that the central bank still has many tools in its toolkit, and has ample space to choose freely.”

PBOC said that the move was intended to “strengthen the management of forex liquidity amongst financial institutions,” as well as to stabilise the exchange rate and contain an excessively rapid rise in the renminbi against the US dollar.

Last Friday the renminbi rose against the US dollar to 6.3858, hitting its highest level since May 2018.

Guan Tao said that the move by the Chinese central bank sent two clear signals to the market concerning the renminbi exchange rate.

“The first is that the central bank will not allow the renminbi to appreciate too quickly, and when required will take resolute action,” said Guan.

“The renminbi has already risen considerably against the dollar since the end of May last year, and continued appreciation could cause the value of the renminbi to diverge from fundamentals.

“The pandemic’s impact on China’s economy has yet to disappear completely, and continued large-scale appreciation could have a sizeable, negative effect upon exporting enterprises.

“The second [signal] is that when the central bank acts it will do so vigorously.

“In the past when the central bank has adjusted the renminbi reserve ratio it has normally been by 0.5 percentage points on each occasion, so the current upward adjustment in the forex reserve ratio of two percentage points is obviously larger than the scale of adjustments in the renminbi reserve ratio, clearly evidencing the central bank’s resolve.”

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