China Raises Banks' Dollar Reserve Requirement to 6% to Slow the Yuan's Rally

China's central bank will raise the foreign-exchange reserve requirement ratio by two percentage points to 6 percent, effective November 15, to slow the yuan's rally.

The People's Bank of China announced the move on Tuesday, November 3 in Beijing, which was Monday night in the United States. The foreign-exchange reserve requirement ratio, or FX RRR, is the share of foreign-currency deposits banks must hold as reserves at the central bank.

The ratio rises from 4 percent. The bank said the decision was "aimed at strengthening the management of foreign exchange liquidity in financial institutions." That wording is the bank's own, published on its website.

The mechanical effect is a drain on dollars. Banks will have to lock up an additional 2 percent of their foreign-currency deposits with the central bank. Less dollar liquidity stays available for lending and trading at home.

Reuters calculated the size of that drain from official foreign-exchange deposit data. The adjustment withdraws an extra 24 billion dollars from the financial system, the wire said. That is a calculation, not a central bank figure.

A tool turned the other way

This is the same tool, pointed in the opposite direction. In September 2023 the bank lowered the FX RRR from 6 percent to 4 percent. That cut, effective September 15, 2023, was meant to stem the yuan's rapid losses and capital outflows.

Then, Beijing wanted more dollars circulating to support a weakening currency. Now it wants fewer dollars circulating to cool a strengthening one. The ratio itself is back exactly where it stood before the 2023 cut.

The backdrop explains the turn. The yuan has gained more than 5 percent against the dollar this year. It has reached its strongest level since 2022 and become one of Asia's best-performing currencies.

Reuters tied that strength to robust exports and big trade surpluses. Heavy corporate conversion of foreign currency into yuan added to it. Onshore yuan closed Monday at 6.6458 per dollar, a four-year high, Chinese reporting said.

The yuan weakened on the news

The currency moved the way the bank intended, at least at first. The onshore yuan weakened as much as 0.37 percent to 6.6728 per dollar after the announcement. That was its weakest level since October 23.

The move put the yuan on course for its biggest one-day drop since May 15. The offshore yuan followed the same weakening trend.

A second signal pointed the same way. The bank lowered its daily midpoint for a second straight day on Tuesday, to 6.7150 per dollar. That was 661 pips weaker than a Reuters estimate, the largest weak-side deviation since September 10.

Analysts see a signal more than a wall

"The PBOC is responding to strong market-driven yuan appreciation," said Marco Sun, chief financial market analyst at MUFG (China). By absorbing dollar liquidity, he said, the bank aims to reduce appreciation momentum. It also aims to prevent "excessive one-way expectations."

Zhaopeng Xing, senior China strategist at ANZ, put more weight on the message than the mechanics. The move likely carries "greater symbolic significance," he said. Heavier corporate settlement into yuan created excess supply over demand, he added.

On that reading, the higher ratio alone would not ease the oversupply. Zhiwei Zhang, chief economist at Pinpoint Asset Management, heard the same message. The bank "has sent a clear message" that it is concerned about fast appreciation, he said.

A moderate appreciation may be tolerated, Zhang added. But the speed of the rise in October likely raised concerns. Market participants, Reuters reported, do not expect the move to reverse the yuan's upward trend.

Deputy Governor Zou Lan restated the official line the same day in Hong Kong. "China has promoted high-level opening-up and insisted that the market play a decisive role in the formation of the exchange rate," he told a financial forum.

What remains unknown

What remains unknown starts with the price. The yuan weakened on the announcement, but traders may resume buying it well before the November 15 effective date. A one-day drop does not settle the direction.

Whether the bank follows with more tools is also open. The midpoint can be set weaker again, and other macro-prudential measures exist. Nothing in the announcement commits the bank to any of them.

The deepest unknown is intent. ANZ reads the move as mainly symbolic, a warning against one-way bets. MUFG reads a mechanical drain on dollar liquidity. Both readings cannot be fully right.

What to watch next

What to watch next is the yuan's trading into November 15. A renewed climb toward Monday's close would test whether the warning worked. A hold near the weaker levels would suggest it did.

Watch the daily midpoint settings as well. A run of weak-side fixings would confirm a deliberate campaign to slow the pace. A return to stronger fixings would soften that reading.

Finally, watch for further macro-prudential steps before the effective date. Another move would show the bank wants mechanics, not just symbolism. Silence would leave the signal to do the work alone.