China rushes to pull back the yuan from a three-year high

  • The Chinese yuan has strengthened to three-year highs against the U.S. dollar, spurring concerns about the competitiveness of Chinese exports.
  • The People's Bank of China made a rare announcement Monday that financial institutions will need to increase the ratio of their foreign exchange deposits.
  • On Wednesday, the central bank set the yuan's midpoint fix weaker against the U.S. dollar, reversing six straight trading days of stronger fixings.

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BEIJING — China is trying to rein in the yuan as it surges to three-year highs against the U.S. dollar.

A stronger yuan makes Chinese goods relatively more expensive to buyers overseas, and has spurred concerns about the competitiveness of Chinese exports — a major contributor to national economic growth.

The Chinese currency traded slightly weaker against the U.S. dollar Wednesday after the People's Bank of China set the yuan's daily midpoint at 6.3773 versus the greenback. The move reversed six straight trading days of stronger fixings since May 24, according to data from Wind Information.

The PBOC has tried to allow the market to play a greater role in determining the yuan's exchange rate. But the central bank retains some control through daily midpoint fixings against the dollar, allowing the yuan to move 2% higher or lower from that level.

The weaker fix followed the central bank's announcement late Monday that beginning June 15, financial institutions must increase the ratio of their foreign exchange deposits by 2 percentage points — to 7% from 5% currently. The hike forces banks to retain more of their foreign currency holdings, reducing the amount that could be used to influence foreign exchange rates.

It is the first such hike in 14 years since the previous change in May 2007 — before the financial crisis — economists pointed out. They estimate the move will reduce the amount of foreign currency available for long-term trading by $20 billion.

Analysts said the exact dollar amount is less significant than the central bank's message that the yuan will not move in a single direction of continued strengthening against the U.S. dollar.

"It's a strong signal," said Xu Hongcai, deputy director of the Economics Policy Commission at the China Association of Policy Science. That's according to a CNBC translation of his Mandarin-language remarks.

He pointed out the size of the adjustment is relatively large, and said it represents a form of targeted monetary policy tightening. The ratio increase will limit speculative activity since financial institutions need to keep more money in their reserves, Xu said.

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Chinese authorities are trying to keep the economy growing steadily as the world attempts to recover from the shock of the coronavirus pandemic last year. However, Beijing's monetary policy has diverged from that of the U.S. and major developed economies, making mainland Chinese assets more attractive to global investors.

The Chinese 10-year government bond yields about 3.07%, while its U.S. counterpart has a far lower yield of around 1.62%.

The gap in yield has created a vicious cycle of money flowing into yuan-denominated assets and strengthening the currency, which in turn then attracts more foreign capital, Xu said.

Outlook for the yuan

In addition to announcing an increase in the foreign exchange deposit ratio, Chinese authorities have sent other messages to the public in an attempt to prevent large moves in the yuan.

The yuan may strengthen, and it may weaken, regulators said at a meeting on May 27 attended by Liu Guoqiang, a PBOC vice governor, and Wang Chunying, deputy director of the national foreign exchange regulator.

The exchange rate cannot be used as a tool, much less as a way to stimulate exports or offset the impact of rising commodity prices, meeting attendees said, according to a readout posted on the central bank's website.

Separately, a former central bank director, Sheng Songcheng, told state news agency Xinhua on Sunday that the yuan is likely "overshooting" the U.S. dollar and that these gains are not sustainable.

Analysts don't expect major moves in the Chinese currency this year.

China Renaissance forecasts the yuan will hold near 6.4 against the U.S. dollar this year and next.

Macquarie anticipates the yuan will weaken slightly to 6.55 versus the dollar due to growing expectations of tighter monetary policy in the U.S., a moderating trade surplus and new channels for Chinese capital to leave the country.

In May, Morgan Stanley analysts adjusted their forecast weaker to 6.48 yuan per dollar by the end of this year, versus 6.25 yuan previously. The investment bank did not have updated analysis to share as of late Tuesday.

The Chinese yuan traded near 6.386 versus the greenback as of Wednesday afternoon.

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