China is asking onshore banks to hold more foreign currencies in reserve for the first time in 14 years. Analysts say the move is a sign that Beijing may be mulling more measures to stem the recent strength of the yuan, which could hurt the country's export competitiveness.
Starting June 15, financial institutions in the country will have to hold 7% of their foreign exchange in reserve, up from 5%, according to a statement by the People's Bank of China, or PBoC, on May 31. The PBoC last raised the reserve requirement ratio on foreign currencies for banks by one percentage point in May 2007.
"It will pare back the onshore supply of foreign currencies, including dollars, and therefore help weaken the yuan," said Bruce Pang, Hong Kong-based macro and strategy research head at China Renaissance Securities.
The Chinese currency has strengthened by about 10.6% against the U.S. dollar in the 12 months ended on May 31, according to S&P Global Market Intelligence. The PBoC set the daily reference rate of the onshore yuan at about 6.37 per dollar on May 31, the highest in three years, according to Pang.
The strengthening of the yuan has been largely due to "China's containment of COVID-19, impressive exports and rapid growth recovery," Nomura said in a June 1 report.
"We believe this hike reflects increasing PBoC concerns over the rapid appreciation of [the] yuan and its potential damage to exports," the report said. It added that the hike will likely withdraw $20 billion of foreign-currency liquidity from the onshore banking system, which could force banks to raise foreign currency funding and pressure the yuan to weaken.
China's export increased 30.6% year over year in March to $241.13 billion, according to the National Bureau of Statistics.
"If this measure is proven less effective later on, the PBoC could further step up its policy measures in [the] coming months," the report added, without specifying what other measures could be in place.
China Renaissance's Pang also said, "Beijing has [the] reasons and means to curb the yuan's rapid appreciation, considering the country's pledge on the yuan's further internationalization."
Pang expects China to roll out more policies to mitigate the yuan's strength, including facilitating cross-border investment activities with more asset class products available and lifting restrictions on outbound direct investment.
As of May 31, US$1 was equivalent to 6.37 Chinese yuan.
