China's yuan slides sharply after PBOC raises FX reserve requirement

what happened

According to Reuters, the yuan weakened on Tuesday and was heading for its largest one-day drop against the dollar in six months. The People's Bank of China said it will raise the foreign exchange reserve requirement ratio by 2 percentage points, to 6% from 4%, starting November 15. Traders and analysts expect the step to tighten dollar liquidity and cool the currency's rally.

The yuan had gained 0.74% against the dollar in October, bringing its year-to-date rise to about 5%. Strong exports, trade surpluses and steady conversion of export earnings into yuan had supported it. Zhiwei Zhang, chief economist at Pinpoint Asset Management, said: "A moderate appreciation may be tolerated, but the speed in October likely raised concerns in the policy circle." The onshore rate dropped to 6.6728 per dollar at its weakest point, and the offshore yuan also fell.

The PBOC also set its daily midpoint weaker than expected, at 6.7150 per dollar, 661 pips below the Reuters estimate. Market watchers see this as an effort to slow the currency's appreciation. Meanwhile, the dollar and oil moved within a narrow range on hopes for a diplomatic breakthrough between the US and Iran.

why it matters

The higher reserve requirement effectively reduces dollar liquidity in the banking system and slows the yuan's gains. Seasonal FX conversion by exporters, which typically supports the yuan in December and January, may partly offset the effect, but how durable the move will be remains unclear.

market impact

Yuan: tighter dollar liquidity and a softer fixing add pressure on the currency

• ▼Yuan pressure down — tighter dollar liquidity slows the currency's gains

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