China is using measures not used since the global financial crisis to temper a rally in its currency as the country battles rising commodity prices and slowing growth, analysts predicting more actions to come .
A decision by the People’s Bank of China that will force lenders to hold more foreign currency indicates that policymakers want to curb the renminbi’s gains after it hit its highest level against the dollar in three years last week. This marked a reversal from the years of the Trump administration, which called Beijing a currency manipulator in 2019 after the renminbi weakened beyond the significant level of Rmb 7 per dollar.
The central bank’s action, announced on Monday evening, will raise the reserve requirements of Chinese financial institutions from 5 to 7 percent of total foreign currency deposits “in order to strengthen the management of foreign currency liquidity,” according to the PBoC.
According to analysts, this is the biggest increase of its kind on record and the first since the global financial crisis. The strength of the renminbi has created an additional headache for Chinese policymakers already grappling with soaring commodity prices and the risks of high leverage in the economy.
The Chinese currency has strengthened nearly 11 percent against the dollar over the past 12 months. The shore-traded renminbi was little changed at Rmb6.3696 per greenback on Tuesday, but analysts said more currency market intervention was likely.
“This move aims to slow the rapid appreciation of the onshore renminbi by reducing [foreign currency] liquidity in the system, ”said Becky Liu, Chinese macro-strategist at Standard Chartered, who estimated that the increase would undermine about $ 20 billion in liquidity in the country’s forex market.
The requirement will restrict the domestic supply of foreign currency, making it more difficult to use dollars to buy renminbi onshore, which could alleviate demand for the Chinese currency.
“PBoC action highlighted its stance against the rapid appreciation of the renminbi and the indices [at] more steps to come, ”said Ken Cheung, chief Asian currency strategist at Mizuho Bank.
However, some policymakers in China have argued for a stronger renminbi. A PBoC official wrote an editorial this month, which was later deleted, saying the central bank should allow the currency to appreciate to counter soaring global commodity prices. A stronger Chinese currency could make its imports of foreign raw materials cheaper.
Rising commodity prices pushed up ex-factory prices in China and fueled fears of inflation. A cabinet meeting chaired by Premier Li Keqiang last month said steps should be taken to stop inflation in producer prices, which rose 6.8% in April, spilling over into inflation. consumer prices, which remains low. Producer prices fell for most of 2020.
There are also signs that China’s strong economic recovery from Covid-19 is cooling off. On a quarterly basis, the economy grew only 0.6% in the first three months of the year, according to the National Bureau of Statistics, well below expectations.
Chinese exports, which theoretically benefit from a weak renminbi, have exploded over the past year despite the currency strengthening. Exports rose 32% year on year in dollars in April, reflecting China’s dominance in world trade given its rapid recovery from the pandemic.
However, “the general strength of the renminbi is likely to undermine the competitiveness of China’s export sector,” Cheung added.