China is taking action to curb the yuan slump and is poised to increase FX risk reserve ratio

SHANGHAI :  China’s central bank has announced new measures to slow the rate of the yuan’s decline in order to make it costly to bet on the currency, as policymakers weighed the economic implications of a large dollar rise.

The People’s Bank of China (PBOC) has announced it will raise the risk reserve for foreign exchange for financial institutions purchasing FX by way of currency forwards up to 20%, up from zero level, beginning on Sept. 28 to “stabilise FX market expectations and improve macro prudential management.”

Related: Japan intervenes in the market for FX to stop the yen’s fall following BOJ continues to keep rates at record lows

The decision to reinstate FX risk reserves will increase the cost of shorting the yuan in a period when the currency of the country is under new depreciation pressures as analysts and traders have said. They estimate that the cost of buying forward dollars could increase by up to 700 pip.

“So the impact of this policy change could be stronger than verbal instructions and signals by setting midpoint fix settings,” told a trader working at an international bank.

Spot yuan was not affected by the announcement. The offshore yuan was trading in the range of 7.1662 dollars, which is a significant increase from the previous close late at night at 7.1298 the previous Friday.

Related: Ahead of the Fed rate decision, Asia FX Hits Multi-Year Lows.

On Monday on Monday, earlier on Monday, PBOC has again issued a more stifling official guidelines for the 23rd straight trading session. The price was 7.0298 per dollar. This is the lowest rate since July 7 and 7. It was 279 points higher than Reuters estimates of 7.0019.

LITTLE IMPACT

The Chinese currency is being impacted due to a mix of strong dollar broad strength along with China’s weak economy, and the easing of monetary policy adopted by the authorities to support growth.

In recent months authorities have intensified efforts to limit the weakness of the yuan by repeatedly imposing more rigid than expected midpoint fixes, giving warnings verbally and delaying any immediate ease-up moves.

Related: Japanese Yen Dips After Record Trade Deficit, Asia FX Weakens

The yuan has slid by more than 4% dollars since late-August, and is now on track to overtake the psychologically significant 7-dollar mark, and is poised to record the biggest loss in a year since 1994 which was the year that China introduced a unified system of markets and official rates.

In the last month in the month of April, earlier this month, the PBOC changed its policy to reduce its requirement for foreign currency that financial institutions have to keep in reserve.

Citi analysts claimed that the policy response was historically focused on controlling the rate of yuan’s decline.

“More (of) such reactions could offer opportunities to add to the bearish CNH/CNY exposure” they wrote in a statement, reducing their forecast for the yuan down to 7.3 per dollar, down from 7.2 earlier.

Related: As the yen hits new lows, Japan’s finance minister watches FX volatility.

The yuan’s currency is among several currencies under constant selling pressures because the dollar is in high demand, aided with the U.S. Federal Reserve’s quick tightening of monetary policy. In Japan in a country where central banks has resorted to its ultra-loose policy to boost an economy in a state of decline, authorities have intervened this week in the market for currencies to purchase yen for only the second time in 1998.

China has wiped out $1 trillion in FX reserves to support the yuan during the most recent recession in the economy in 2015, after which it triggered a single currency devaluation that caused chaos in markets across the world. Since the time this central bank relied on market-driven tools to control the currency.

“Raising the FX risk reserve has shown that the PBOC is determined to stop the accelerating loss of yuan as well as stabilize markets,” stated Ken Cheung who is the director of Asian FX strategist at Mizuho Bank.

Related: South Korea tells local banks to be careful with their FX liquidity.

“It is also a sign how the central bank can take action whenever required,” he added, but he believes it is not likely to reverse the trend of depreciation of the yuan.