BEIJING – China is trying to get the yuan under control as it hits three-year highs against the US dollar.

A stronger yuan makes Chinese goods relatively more expensive for foreign buyers and has raised concerns about the competitiveness of Chinese exports – a major contributor to domestic economic growth.

The Chinese currency weakened slightly against the US dollar on Wednesday after the People’s Bank of China set the yuan’s daily midpoint at 6.3773 against the greenback. The move reversed six consecutive trading days of stronger bindings since May 24, according to data from Wind Information.

The PBOC tried to allow the market to play a bigger role in determining the exchange rate of the yuan. But the central bank retains some control through daily mid-term fixings against the dollar, allowing the yuan to rise or fall 2% from that level.

The weaker fix follows the central bank’s announcement on Monday evening that from June 15, financial institutions must increase their foreign currency deposit ratio by 2 percentage points – to 7% from 5% currently. The hike forces banks to keep more of their foreign currency holdings, reducing the amount that could be used to influence exchange rates.

This is the first such increase in 14 years since the previous change in May 2007 – before the financial crisis – economists said. They estimate the move will reduce the amount of currency available for long-term trading by $ 20 billion.

Analysts said the exact dollar amount was less important than the central bank’s message that the yuan would not move in a single direction of continued strengthening against the US dollar.

“This is a strong signal,” said Xu Hongcai, deputy director of the Economic Policy Commission of the China Association of Political Science. This is according to a CNBC translation of his remarks in Mandarin.

He stressed that the size of the adjustment is relatively large and that it represents a form of targeted tightening of monetary policy. The increase in the ratio will limit speculative activity as financial institutions need to keep more money in their reserves, Xu said.

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Chinese authorities are trying to keep economic growth steady as the world tries to recover from the shock of the coronavirus pandemic last year. However, Beijing’s monetary policy has diverged from that of the United States and major developed economies, making mainland Chinese assets more attractive to global investors.

The 10-year Chinese government bond yields around 3.07%, while its US counterpart has a much lower yield of around 1.62%.

The yield spread created a vicious cycle of money flowing into yuan-denominated assets and strengthening the currency, which in turn attracts more foreign capital, Xu said.

Outlook for the yuan

In addition to announcing an increase in the currency deposit rate, Chinese authorities have sent other messages to the public in an attempt to prevent large movements in the yuan.

The yuan could strengthen and weaken, regulators said at a meeting on May 27 attended by Liu Guoqiang, vice governor of the PBOC, and Wang Chunying, deputy director of the national exchange regulator.

The exchange rate cannot be used as a tool, much less as a way to boost exports or offset the impact of rising commodity prices, meeting participants said, according to a reading posted on the central bank’s website.

Separately, a former central bank manager Sheng Songcheng told state-run Xinhua news agency on Sunday that the yuan probably “exceeds” the US dollar and that these gains are not sustainable.

Analysts do not expect major movements in the Chinese currency this year.

China Renaissance predicts that the yuan will hold close to 6.4 against the US dollar this year and next.

Macquarie predicts that the yuan will weaken slightly to 6.55 against the dollar amid rising expectations of a tightening of monetary policy in the United States, a moderate trade surplus and new avenues for Chinese capital to leave the country.

In May, Morgan Stanley analysts lowered their forecast to 6.48 yuan to the dollar by the end of the year, from 6.25 yuan previously. The investment bank did not have an updated analysis to share on Tuesday evening.

The Chinese yuan was trading near 6.386 against the greenback on Wednesday afternoon.


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