As China's official exchange rate breaks 7 yuan... Forward exchange risk reserve ratio raised to 20% (Comprehensive)

[Image source=Reuters Yonhap News]

[Asia Economy Beijing=Special Correspondent Kim Hyunjung] The People's Bank of China, the central bank of China, has raised the risk reserve ratio for forward foreign exchange contracts from 0% to 20%. This move is interpreted as a measure to defend against the continued depreciation of the yuan against the dollar.

On the 26th, the Foreign Exchange Trading Center under the People's Bank of China announced the yuan's central parity rate against the dollar at 7.0298 yuan, up 0.0378 yuan (0.54%) from the previous trading day. This is the first time since July 7, 2020, that the yuan's official exchange rate has exceeded 7 yuan per dollar.

The People's Bank of China also announced on the same day that it would raise the risk reserve ratio for forward foreign exchange contracts from 0% to 20%, effective from the 28th of this month. The foreign exchange risk reserve is the amount that Chinese banks must deposit interest-free with the People's Bank of China for one year when conducting forward foreign exchange transactions. For example, if a bank enters into a forward contract worth 10 billion dollars, it must deposit 2 billion dollars as a reserve with the central bank. When the ratio is raised, the cost burden of foreign exchange transactions increases, allowing an indication of the currency authority's response direction regarding foreign exchange.

The history of this system is not long. It was introduced at the end of August 2015 to cope with downward pressure on the yuan and was initially set at 20%. Then, as the depreciation pressure eased, the ratio was lowered back to 0% on September 8, 2017, about two years later. Subsequently, on August 6, 2018, amid concerns about yuan depreciation, it was raised again to 20%, and then lowered to 0% on October 12, 2020. This is the fifth adjustment in history.

This measure is considered the second exchange rate stabilization action following the reduction of the foreign currency reserve requirement ratio by 2 percentage points from 8% to 6% on the 5th. Guan Tao, Chief Economist at Bank of China Securities, explained, "Based on previous experience, raising the foreign exchange risk reserve ratio is an important and effective macroprudential measure to address exchange rates," adding, "This adjustment will help stabilize the yuan exchange rate by curbing demand for forward foreign exchange purchases."