China’s central bank announced on Friday that it will lower the reserve requirement ratio (RRR) for foreign exchange deposits by 2 percentage points, effective from Sept. 15, in a move to ease the appreciation pressure on the yuan.
What is the RRR and why does it matter?
The RRR is the proportion of deposits that banks must hold as reserves at the central bank. It affects the amount of money that banks can lend out and the interest rates they charge. A lower RRR means more money available for lending and lower borrowing costs.
The RRR for foreign exchange deposits was 5% before the cut, which means that banks had to keep 5% of their foreign currency deposits as reserves and could lend out the rest. The cut will release about $20 billion of liquidity into the banking system.
China has a large amount of foreign exchange deposits, mainly due to its huge trade surplus and capital inflows. As of July, China’s foreign exchange deposits stood at $1.02 trillion, up 24.2% year-on-year. These deposits are mostly denominated in US dollars, which means that they are affected by the exchange rate movements between the yuan and the dollar.
How does the RRR cut affect the yuan?
The RRR cut is seen as a way to ease the appreciation pressure on the yuan, which has been rising against the dollar since last year. The yuan has gained more than 10% against the dollar since May 2020, reaching a three-year high of 6.3526 per dollar on Aug. 4.
A stronger yuan makes Chinese exports more expensive and less competitive in global markets, which could hurt China’s economic growth and trade balance. It also attracts more capital inflows, which could increase the risk of asset bubbles and financial instability.
By lowering the RRR for foreign exchange deposits, the central bank reduces the demand for foreign currency and increases the supply of yuan in the market, which could weaken the yuan’s exchange rate. The move also signals that the central bank is not comfortable with the yuan’s rapid appreciation and may intervene to prevent further rises.
What are the implications for the global economy?
The RRR cut is expected to have a limited impact on the global economy, as it is a targeted and moderate measure that does not change China’s overall monetary policy stance. The central bank said that it will maintain a prudent monetary policy and keep the yuan exchange rate basically stable at an adaptive and equilibrium level.
However, some analysts warn that the RRR cut could increase the uncertainty and volatility in the global financial markets, as it reflects China’s concerns over its economic outlook and external environment. The move could also trigger a chain reaction from other emerging markets that are facing similar currency pressures and may follow suit to ease their monetary conditions.
The RRR cut also comes amid rising tensions between China and the US over trade, technology, human rights, and security issues. The US has accused China of manipulating its currency to gain an unfair trade advantage and has imposed tariffs and sanctions on Chinese goods and entities. The RRR cut could exacerbate the trade frictions and worsen the bilateral relations between the world’s two largest economies.
