On Monday the People’s Bank of China (PBOC) announced yet another measure to stabilise the offshore traded yuan, or CNH, ruling that from January 25 a reserve requirement ratio (RRR) will be imposed on renminbi deposits placed by foreign banks in yuan clearing banks.
A RRR simply sets the minimum amount of customer deposits, expressed as a percentage, that each commercial bank must hold in reserves.
The chart below, courtesy of David Qu and Khoon Goh of ANZ, reveals how the RRR mechanism will work.
ANZ believe that the level – as yet unannounced by the PBOC – is likely be 17.5%, bringing it in line with the RRR imposed on large Chinese banks by the PBOC at present.
Qu and Goh suggest that the PBOC announcement will drain offshore traded yuan from the financial system, tightening liquidity and, as a consequence, short-term borrowing rates.
The chart below is for CNH HIBOR, essentially the rate banks are willing to lend offshore yuan to each other over a set period of time.
Following the PBOC announcement, one-week and one-month CNH borrowing costs rose sharply. Offshore traded yuan, or USD/CNH also fell as a consequence, indicating that the yuan had strengthened against the US dollar.
While Qu and Goh suggest the RRR implementation is aimed at establishing a long-term mechanism for the PBOC to manage CNH liquidity, in the near-term they believe its introduction was designed to curb speculation over further yuan weakness in the period ahead.
“We believe that part of the authorities’ reasoning for introducing it now is to tighten the CNH liquidity and push up CNH interest rates to make it more expensive to short the currency,” wrote the pair.
“Following the depreciation pressure in the early part of the year, the authorities have been seeking to stabilise the RMB via setting stronger and stable fixings, intervening in the offshore market and re-iterating yuan stability.”
“We suspect that the authorities are using the same playbook as the post-August devaluation period in an attempt to stabilise the currency. (Monday’s) measure fits nicely with this playbook, recalling that last year the PBoC introduced margin requirements for onshore forward hedging in a bid to stem speculation via forwards.”
Qu and Goh suggest that while the PBOC may be successful in stabilising the yuan near-term, depreciation pressures are unlikely to go away.
“Ultimately, we still expect the RMB to weaken, given the growth and deflation risks that China is facing,” they wrote.