China to raise FX RRR to slow pace of yuan gains

China's central bank announced on Tuesday that it will increase the foreign exchange reserve requirement ratio (RRR) by 2 percentage points, raising it to 6% from 4%. The People's Bank of China (PBOC) stated that this move, effective November 15, aims to tighten dollar liquidity conditions and slow the recent gains in the value of the yuan. The adjustment is expected to withdraw an additional $24 billion from the financial system, according to Reuters calculations based on official FX deposit data.

The PBOC's decision to raise the RRR comes in response to strong market-driven appreciation of the yuan. According to Marco Sun, chief financial market analyst at MUFG (China), the central bank is attempting to absorb some of the available US dollar liquidity in the banking system to reduce the momentum behind yuan appreciation and prevent the development of excessive one-way expectations in the market.

This move marks a policy reversal for the PBOC, as it had previously lowered the FX RRR in September 2023 to curb the rapid decline of the yuan's value and associated capital outflows. The yuan has gained over 5% against the dollar so far in 2023, becoming one of the top-performing Asian currencies. Its strength has been driven by robust exports, massive trade surpluses, and significant corporate foreign exchange conversions.