China to raise FX reserve requirement to slow yuan’s rally

BEIJING, Nov 3 (Reuters) - China is raising the amount of foreign currency that financial institutions must hold as reserves, in one of the strongest moves to slow the pace of a long rally in the yuan, setting the currency on course for its sharpest one-day drop in six months.

The People’s Bank of China (PBOC) said in a statement on Tuesday it would raise the foreign exchange reserve requirement ratio (RRR) by 2 percentage points to 6% from 4%, effective on November 15.

The adjustment would result in an extra $24 billion being withdrawn from the financial system, according to a Reuters calculation based on official FX deposit data.

The decision to raise the ratio is "aimed at strengthening the management of foreign exchange liquidity in financial institutions," the PBOC said.

The onshore yuan weakened as much as 0.37% against the dollar to a low of 6.6728 per dollar, the weakest level since October 23, following the announcement. And it looked set for the biggest one-day drop since May 15.

Its offshore counterpart also followed the weakening trend.

"The PBOC is responding to strong market-driven yuan appreciation," said Marco Sun, chief financial market analyst at MUFG (China).

"By absorbing part of the available US dollar liquidity in the banking system, it is attempting to reduce the momentum behind yuan appreciation and prevent the market from developing excessive one-way expectations."

The yuan has gained more than 5% against the dollar so far this year, reaching its strongest level since 2022 and becoming one of Asia’s best-performing currencies. Its strength has been underpinned by robust exports, big trade surpluses and heavy corporate FX conversion.

Tuesday’s FX RRR hike would be a policy reversal of the PBOC’s decision in September 2023 to lower the FX RRR, which was a move to stem the yuan’s rapid losses and capital outflows.

However, market participants do not expect the move to reverse the yuan’s upward trend.

Zhaopeng Xing, senior China strategist at ANZ, said the move was likely to "carry greater symbolic significance" for the market.

Corporates’ heavier FX settlement into yuan had "resulted in the current imbalance conditions of excess supply over demand," Xing said.

He added that the increase in the FX RRR would not be enough to ease the oversupply.

Separately, the PBOC lowered its midpoint rate for a second day in a row on Tuesday to 6.7150 per dollar, 661 pips weaker than a Reuters estimate — its largest weak-side deviation since September 10.

The central bank has been gradually strengthening its daily yuan official guidance this year, but at levels weaker than market expectations, suggesting it is seeking to manage the pace of appreciation, market watchers said.

Meanwhile, PBOC Deputy Governor Zou Lan reiterated the central bank’s stance on the currency.

"China has promoted high-level opening-up and insisted that the market play a decisive role in the formation of the exchange rate," Zou told a financial forum in Hong Kong on Tuesday.