Beijing's decision on Monday to impose reserve requirements on currency forward trading is expected to stabilise the yuan by pushing up the cost of selling the currency but may not be able to prevent its depreciation in the long run.
Banks will be required to submit 20 per cent of the sales of currency forward trading to the People's Bank of China as a reserve requirement from October 15.
The PBOC will conduct monthly checks on banks' reserve requirement pools, according to a document issued to banks and financial institutions yesterday.
Forward markets
The central bank said the move was “to improve the prudent management framework over the macro economy, prevent major financial risks, and promote steady operation of the financial institutions”.
“This forward reserve measure is likely to rein in the forward curve and help stabilise (the yuan),” said Heng Koon-how, a strategist with Credit Suisse. “It is not surprising given that (the yuan) has been extremely weak in the forward markets since the August 11 devaluation.”
The forwards have been pricing in a substantial depreciation in the yuan. The one-year US dollar-yuan forward had traded to a high of 6.75 last week, before retreating to 6.60 this week alongside a much more stable spot.
Heng said the forward reserve measure supported his view that the dollar-yuan spot would be relatively stable at 6.40 this month.
But longer-term concern over real effective exchange rate overvaluation remained. A fair bit was now contingent on how third-quarter gross domestic product shaped up on the mainland, he said. If it turned out to be weaker than expected, then the risk of more yuan weakness would be needed over the long run to adjust for the overvalued REER.
Tommy Wang, the managing director of treasuries and markets at DBS, said: “It is more of a short-term measure to rein in rising speculation as investors have been betting on (yuan) devaluation in the past two weeks.”
Depreciation agenda
The central bank could use its foreign exchange reserves to defend the currency, while the latest move would ease some pressure on the reserves. However, Wang said it was unlikely to remain in place long and might not influence the yuan's value in the long run as too much intervention in the market would go against Beijing's goal of internationalising the yuan.
Andrew Fung, an executive director of Hang Seng Bank, said the move was also meant to reduce interbank settlement risks, as forward contracts involved credit exposure and risk grew as trade became hot.
“Also, by increasing the cost of buying onshore dollar forwards, the incentive of doing arbitrage between onshore and offshore prices is lessened,” Fung said. “The market interprets this a signal of the PBOC's determination to hold yuan at the current level at least for the time being, without a further depreciation agenda.”
Adam Xu, a mutual fund manager in Shanghai, said the move had little to do with the stock market. “It seems the government feels a more urgent need to defend the currency before the national parade [tomorrow],” he said.
Spot yuan closed at 6.363 to the dollar on Monday.
The value of yuan forward transactions in July was US$51.1 billion, according to the State Administration of Foreign Exchange, compared with US$698 billion in the spot market.
To read more from the Geo Eco section, click here .