Destabilizing speculation

As the yuan strengthens, China has tools to manage the currency

As China’s central bank pulls out of direct intervention in its forex market, officials are reverting to old tools for managing the yuan.

Authorities on On Wednesday, they announced they had provided an additional $ 10 billion in funds to invest in securities overseas, raising the quota for capital outflows to a record $ 147 billion. On Monday, the People’s Bank of China said lenders will need to hold more foreign currency in reserve, a move that will reduce the supply of dollars on land. Officials have pulled several levers to influence the yuan since October, when China cut the cost of shorting the currency to zero and removed a key factor used by banks to calculate the daily benchmark rate.

The PBOC seeks to curb a rise in the yuan without derailing a plan to liberalize the currency and promote its global use. Removing the threat of intervention can fuel one-way bets, however. With the yuan close to its three-year high against the dollar and the With the engines of its recent outperformance remaining in place, the PBOC will be under pressure to take further action to slow the pace of gains. The currency is also close to the strongest since 2016 against a basket of trading partners.

“On the one hand, the PBOC wants the yuan exchange rate to be more market oriented,” said Larry Hu, head of the Chinese economy at Macquarie Group. “But on the other hand, he doesn’t want to see an aggressive one-sided rally either.”

Other measures he could take could include making it more difficult to bet on the yuan via derivatives or signaling via its daily fixing. Wednesday, the PBOC weakened its daily benchmark yuan rate from Tuesday’s fix, following movements in the spot rate.

The currency has appreciated about 12% against the dollar since a low last year in onshore markets.

If the central bank wants to slow the yuan’s rise again, here are four key tools it could use in more detail:

Reduction in dollar supply

The reserve requirement ratio for foreign currency deposits could be further increased. At 7% as of June 15, it remains well below the 12.5% ​​rate for yuan deposits. This would further tighten the liquidity of the landed dollar, slow the pace of foreign currency lending and reduce the yield spread between the greenback and the yuan, said Becky Liu, head of macro strategy for China at Standard Chartered Plc.

The PBOC could also allow lenders to exchange their yuan reserves for foreign currencies, or encourage higher interest rates on foreign currency deposits to increase the attractiveness of holding dollars.

Yuan derivatives

The central bank could impose a tax on bullish speculative transactions. One way to do this is to make it more expensive to bet on the appreciation of the yuan with derivatives. This would look like what happened in October, when the central bank drastically reduced the cost of short-circuit the yuan.

Capital outflows

China has unilateral control of the capital account. Exits are limited while entries are encouraged, which has boosted demand for the yuan. In recent months, Beijing has taken steps to let more money out by granting additional quotas for funds to invest in overseas securities – as it has done this week – but authorities could do much more. .

Beijing could allow residents to buy more than the annual quota of $ 50,000 in foreign currency, according to Citic Securities Co. Hong Kong’s plan to allow mainland investors to trade bonds in the city through a trading channel to the south, which should be launched as soon as July, would also favor exits.

“If China needed to manage yuan expectations further, it would likely choose to ease capital restrictions on exits,” said Stephen Chiu, strategist for Bloomberg Intelligence. “Other means – like a much lower fixation – are less preferable because it would defeat the goal of getting a more market-oriented currency.”

Daily signals

The easiest way for the central bank to influence the currency is to use its daily benchmark rate, known as the fixation, which is set at 9:15 a.m. The yuan is then allowed to move 2% in both directions. This would be considered a direct intervention, and it is the tool used by the central bank to devalue the currency in 2015.

PBOC may use daily fixing to influence yuan

The PBOC has been tracking the yuan’s closing moves when fixing the fixing recently, with rates largely in line with average Bloomberg survey estimates. This suggests that the central bank is either comfortable with the strength of the yuan or has changed its strategy. In January, the PBOC set the peg at 0.15% below the average estimate of traders and analysts in a Bloomberg survey. It was the the biggest bias on the weak side since Bloomberg started compiling the data in June 2018.

Another way to set weaker fixings is to encourage dips at the official close at 4:30 PM. This is because the rate is taken into account in the next day’s fixing formula. While this can be an effective way to influence the yuan without sending a strong signal on politics or destabilizing the markets, there has been little sign of it lately.

– With the help of Qizi Sun, Yujing Liu and Fran Wang

(Add the last quota change to the 2nd paragraph)

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