China Steps In to Support Yuan By Boosting Cost to Short

(Bloomberg) -- China stepped in to try to cushion the yuan after a record string of weekly losses saw the currency closing in on the key milestone of 7 per dollar.

The People's Bank of China will impose a reserve requirement of 20 percent on some trading of foreign-exchange forward contracts, according to a statement on Friday evening. That will effectively make it more expensive to short the yuan, and is a tactic that the central bank used to stabilize the currency in the aftermath of its shock devaluation in 2015.

The change is aimed at preventing macro financial risks as the foreign-exchange market shows signs of volatility amid recent trade frictions, and shouldn't be interpreted as a capital control, according to the PBOC. The yuan surged in offshore trading and U.S. stock-index futures turned higher after the news, though the moves pared after China detailed how it plans to retaliate against U.S. tariff proposals.

Read more about those tariff plans here.

While a weaker yuan benefits the exporters that are being walloped by tariffs, analysts had identified the level of 7 per dollar as a point where officials may seek to arrest declines, to counteract the mounting risk of capital outflows. China burned through foreign reserves propping up its currency after the devaluation almost three years ago spurred a rush to take money out of the country.

“This move shows the PBOC is getting increasingly concerned with the yuan's depreciation, which has been too quick and could lead to a chain reaction, triggering capital flight," said Xia Le, Banco Bilbao Vizcaya Argentaria SA's chief Asia economist in Hong Kong. "The PBOC will use more measures to reverse the market's overly bearish expectations on the yuan."

For a roundup of analyst views on the PBOC's move, click here.

Xia said he expects the yuan will remain basically stable against a basket of currencies in the near term, though "its long-term fate hinges on the trade war." The yuan is one of the world's worst performers against the dollar in the past three months, slumping 7 percent on the trade frictions, local easing measures, and concern about a slowing economy.

The onshore currency tumbled as low as 6.8965 per dollar Friday before suddenly paring the move ahead of the official close, when traders said they saw at least one large bank aggressively selling dollars. The offshore yuan reversed losses after the PBOC's statement, climbing 0.53 percent to 6.8451.

“Investors are focusing on two trades –- shorting the yuan and China's rates –- and they will keep pushing the yuan weaker until the People's Bank of China steps in to intervene heavily,” said Zhou Hao, senior emerging market economist at Commerzbank AG in Singapore, on Friday before the PBOC announcement. “If the yuan breaches 7 per dollar, the currency will likely tumble much faster and send shock waves across markets, hurting stocks as well.”

The Asian nation's equity market, one of the worst performing globally this year, has now lost its place as the world's second-biggest to Japan, data compiled by Bloomberg show.

China introduced a 20 percent reserve requirement on forwards as yuan volatility exploded after the 2015 devaluation, and removed it in September 2017.

There are signs of momentum-chasing moves in the foreign-exchange market that may lead to herd behavior, due to reasons including trade frictions and moves in other global currencies, the PBOC said in a followup Q&A on Friday.

The imposition of reserve requirements is "obviously not a form of capital control," because it doesn't limit the volume of contracts that companies can use and deal-by-deal approvals are not required for such transactions, the PBOC said. The measure is part of the macro-prudential policy framework, and is transparent, the central bank said.

“This means PBOC has shifted its foreign exchange policy to stabilizing depreciation risk from staying neutral,” said Ken Cheung, a currency strategist at Mizuho Bank Ltd. “It shows the PBOC is aware of capital outflow pressures brought by depreciation. It will support the yuan.”

--With assistance from Winnie Zhu, Ryan Lovdahl and Benjamin Purvis.

To contact the reporter on this story: Tian Chen in Hong Kong at tchen259@bloomberg.net

To contact the editors responsible for this story: Sarah McDonald at smcdonald23@bloomberg.net, Malcolm Scott

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