China to cut FX reserve requirement ratio in latest supportive move

China’s central bank, the People’s Bank of China (PBOC), announced on Friday its intention to reduce the foreign exchange reserve requirement for banks. In a bid to counter the yuan’s declining strength and lend support to a sluggish economic rebound, the PBOC aims to cut the foreign exchange reserve ratio (RRR) by a notable 200 basis points – bringing it down from 6% to 4%. This strategic move, effective September 15, is predicted to liberate a considerable pool of foreign exchange reserves, predominantly in dollars, and thereby provide a boost to the yuan. Initially, the Chinese currency saw an increase of up to 0.5% in response to the news, later stabilizing to remain unchanged in trading.

Expected to have a twofold impact, the RRR reduction is set to make holding dollars more cost-effective for Chinese banks, while simultaneously affording the PBOC greater flexibility in potentially reducing interest rates to stimulate economic activity.

Although this step is anticipated to furnish temporary respite for the yuan, the currency still grapples with ongoing challenges stemming from deteriorating sentiment towards the Asian economy, coupled with disparities in local and U.S. interest rates.

With the yuan experiencing a decline of roughly 5% this year, positioning it as one of the weakest performing Asian currencies, China’s central bank has been employing measures such as robust daily midpoints and interventions in currency markets to thwart further depreciation. Despite these efforts, the outlook remains skewed towards a weaker yuan, particularly if local monetary policies continue to ease to drive growth.

Guided by the PBOC, Chinese banks have already embarked on a path of lowering their yuan deposit rates, an initiative anticipated to enhance local liquidity and pave the way for a less robust yuan in the forthcoming months.

Traders, influenced by uncertainties surrounding the Chinese economy and a less favorable forecast for local interest rates, have generally adopted a cautious stance towards the yuan.