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China’s central bank tries to ease yuan’s downward pressure by asking big banks to adjust dollar purchases

China’s central bank has issued an informal directive to some of the country’s largest lenders, asking them to refrain from immediately squaring their foreign exchange positions in the market, and to run open positions for a while in order to alleviate downside pressure on the yuan, according to two sources with knowledge of the matter.

What is the directive and why is it issued?

As part of this informal “window guidance”, banks have been asked not to square their positions in the inter-bank foreign exchange markets after any U.S. dollar sales to clients, until their spot foreign exchange position hits a certain level, the sources said. Most banks are allowed to run a net short or long foreign currency position in spot dollar-yuan markets, within defined limits.

The move would effectively mean some of the heavy dollar purchases by companies would be absorbed by banks and sit on their books for a while, thus partially reducing downward pressure on the sliding yuan.

The directive came from a meeting the People’s Bank of China (PBOC) held with a few commercial banks earlier this week, the sources said. Banks were also told that companies requiring to purchase $50 million or more will need to seek the central bank’s approval.

China’s central bank tries to ease yuan’s downward pressure by asking big banks

The PBOC did not immediately respond to Reuters request for comment.

How is the yuan performing against the dollar?

China’s yuan has lost more than 5% against the dollar so far this year to trade 7.2735 per dollar on Thursday, becoming one of Asia’s worst performing currencies for 2023. The yuan has been under pressure from a slowing domestic economy, rising trade tensions with the United States, and a stronger greenback.

The PBOC has been trying to stabilize the exchange rate by setting a firmer midpoint for the daily trading band, injecting liquidity into the banking system, and cracking down on speculative activities. However, some analysts believe that the central bank may allow more depreciation of the yuan in the coming months, as it could help boost exports and offset some of the impact of U.S. tariffs.

What are the implications of the directive for the market?

The directive could have a short-term impact on easing the yuan’s depreciation, as it would reduce the supply of dollars in the market and increase the demand for yuan. However, it could also create some risks for the banks, as they would have to bear the exchange rate fluctuations and potential losses on their open positions.

Some market participants also expressed doubts about the effectiveness of the directive, as it could be easily circumvented by other channels of dollar purchases, such as offshore markets or derivatives. Moreover, it could also signal that the PBOC is running out of options to defend the yuan, and that it may resort to more drastic measures in the future, such as capital controls or intervention.

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