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China aims to cool yuan's surge by reducing cost of shorting

From Monday, financial institutions no longer need to set aside cash when buying forex for clients through currency forwards

Beijing

CHINA'S policymakers have acted to restrain a rally in the yuan by removing rules that made betting against the currency expensive.

Financial institutions will no longer need to set aside cash when purchasing foreign exchange for clients through currency forwards, effective from Monday, according to a statement from the People's Bank of China (PBOC) on Saturday.

Banks previously had to hold 20 per cent of sales on some foreign exchange forward contracts, a move imposed two years ago when the currency slumped towards seven yuan per US dollar.

The yuan surged about 1.6 per cent on Friday when the currency traded for the first time this month following National Day holidays. While the move was partly a catch-up with the offshore exchange rate, which continued trading during much of the holiday period, there is little doubt that gains in the yuan have been accelerating. Last quarter was the currency's best in 12 years.

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The step by the central bank is likely to prompt bullish traders to pare back optimism, at least for now. Back in September 2017, when the PBOC similarly cut the cost to zero following sharp gains, the yuan slumped about 2.5 per cent in the next three weeks. The move also shows how the PBOC continues to pull on levers to influence the currency, undermining the yuan's potential as a haven.

The PBOC will continue to maintain flexibility in the yuan exchange rate and stabilise market expectations, according to Saturday's statement. Officials will also keep the yuan basically stable at a reasonable equilibrium level, it said.

The yuan is the top performer among Asian peers in the past three months, climbing about 4.5 per cent against the dollar. It closed on Friday at about 6.69 per dollar, its strongest level since April 2019.

A recovering economy, a hefty yield premium in sovereign debt over Treasuries and the prospect of a US presidential victory by Democrat nominee Joe Biden are all providing tailwinds.

How far the authorities will go to limit the currency's strength remains to seen. The more influential signal will be seen on Monday, when the PBOC sets its daily currency reference rate, according to Khoon Goh, head of Asia research at Australia and New Zealand Banking Group in Singapore.

The reserve requirements are typically removed when there is no longer any concern about currency weakness, he said. "The fixings will be a more important clue as to whether the authorities deem recent strength to be too much," he said. BLOOMBERG

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