The People’s Bank of China (PBoC) lowered the foreign exchange risk reserve ratio for forward foreign exchange sales from 20% to 0%, effective from October 12, following a surge in onshore Yuan last Friday. Onshore Yuan rallied to a 17-month high of 6.69 against USD on Friday, as China’s onshore market returned after a week-long holiday. Both onshore and offshore yuan pared back some earlier gains after markets opened on Monday, with both weakening by around 0.40% against USD.
The foreign exchange risk reserve ratio was introduced in 2015 (Figure 1), and was part of the PBoC’s toolbox for macro-prudential policy. This tool has been through several adjustments, especially following excessive movements in Yuan. The ratio was last adjusted in August 2018, from 0% to 20%, which helped to stem further losses in Yuan.
Both onshore and offshore Yuan have risen sharply against USD since May, gaining by 5.1% and 6.1% respectively. We think there are several factors at play. While the decline of USD is an important reason, the currency outlook for Yuan is also shaped by its domestic situation. For China, the domestic recovery is sufficiently good into 2021 that we now no longer forecast official interest rate cuts, which keeps the interest rate spread wide against USD. The policy move by the PBoC is seen having a limited impact on Yuan, as we believe portfolio allocation into China still remains a key theme in helping a further recovery of CNY going forward.