A recent RMB rally has come to a halt following the announcement by the People’s Bank of China (PBoC) that it will raise the foreign exchange reserve ratio for financial institutions (Figure 1).
On 31 May, PBoC announced that the reserve ratio for total foreign exchange deposits will be increased to 7% from 5%, with effect from 15 June, forcing lenders to hold more foreign currency. This effectively curbs their ability to purchase RMB onshore.
Despite Covid-19, China has continued to record a large trade surplus (Figure 2). The country’s exports have remained resilient, fueled by the global surge in online shopping and demand for medical products, and more recently by the economic recovery in several Western countries as they successfully roll out vaccination programmes. This has led to the accumulation of a large stockpile of foreign currency in the Chinese financial system.
For the first five months of 2021, China posted a trade surplus of US$203.4 billion, representing a surge of 70% compared to the same period a year ago. This comes as the country’s GDP growth continues to outpace most major economies due to its early success in reining in the coronavirus, which in turn boosted capital inflows and market confidence in the RMB.
The central bank’s latest move indicates that it is becoming increasingly concerned about the sharp appreciation of the RMB. Over the past 12 months, the currency has strengthened nearly 10% against the U.S. dollar, reaching its strongest level in three years at the end of May.
Sign up for the latest news & offers.