China's central bank Photo: VCG

China's central bank announced on Thursday that it would raise foreign exchange reserve requirements for financial institutions in mid-December, in an apparent move intended to offset the yuan's sustained strength. 

The People's Bank of China (PBC) said that the forex reserve requirement ratio will be lifted to 9 percent from the current 7 percent, effective December 15.

The previous hike in the forex reserve requirement was in mid-June, when the central bank raised the ratio by 2 percentage points from 5 percent.

The raise in the forex reserve requirement ratio is seen as curbing demand for the sale of dollars in exchange for yuan, thus reducing the upward pressure on the yuan.

The offshore yuan weakened against the US dollar instantly after the PBC announcement. As of 9:05 pm (Beijing time) on Thursday, the offshore yuan had retreated almost 350 basis points, weakening beyond the 6.38 level.

The yuan's daily official exchange rate was set at 6.3498 per US dollar on Thursday, an advance of 179 basis points from the prior day, indicating sustained yuan strength despite recent PBC moves to funnel liquidity into the economy.

The daily fixing's move beyond 6.35 echoed a similar trend over the previous day when the yuan's onshore and offshore exchange rates against the dollar both strengthened beyond the 6.35 level, hitting the highest levels since May 2018.

The yuan's strength against the dollar contrasted with the apparent weakness of a basket of currencies including the euro, the Australian dollar and the yen this year. 

More strikingly, the yuan's rise against the US dollar wasn't interrupted by the central bank's announcement on Monday that a 50 basis-point universal cut in the reserve requirement ratio for financial institutions will be effective from December 15. That decision will release 1.2 trillion yuan ($189 billion) in long-term liquidity into the economy, according to the central bank.

The move followed a similar broad-based cut in July, when a reduction of 0.5 percentage points in the reserve requirement ratio was applied to financial institutions, a move that was envisioned to release long-term capital of about 1 trillion yuan.

Additionally, the central bank cut the relending rate to support rural and small enterprises by 25 basis points, effective on Tuesday, according to the Securities Times, another adjustment of relending facility rates after the PBC cut the interest rates by 25 basis points in July 2020.

Overseas funds' risk-on buying of yuan-denominated assets was considered to have partly underpinned the strong yuan.

Net capital inflows into the Chinese mainland stock market through the northbound link between the Hong Kong and mainland bourses reached 21.66 billion yuan, the third time that the daily net purchase reading topped 20 billion yuan, according to Chinese financial news site cls.cn.

Also, between December and early in the new year, when the Chinese Spring Festival falls, exporters tend to sell the dollar in exchange for the yuan, and that might be propping up the Chinese currency, media reports said.

A stronger yuan, arguably a drag on Chinese exports, was seen as being offset by the country's unrivalled export strength as the coronavirus and its mutations - the Delta and Omicron variants - remain a big concern for the global economy at large, analysts said.