How does China fight back against the strong dollar?

How does China fight back against the strong dollar?
How does China fight back against the strong dollar?

As the US tightened monetary policy and Europe’s energy crisis deepened, the value of the dollar rose and other currencies depreciated. The yuan was no exception, hitting a two-year low after the dollar’s last rally in late August.

In response to the strong US currency, the People’s Bank of China decided to reduce the foreign exchange reserves of financial institutions from September 15, 2022 by 2%. Thus, the ratio will be reduced from the current 8% to 6%, it is clear from a statement published on the website of the central bank and quoted by the Xinhua agency.

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Despite the People’s Bank of China’s actions, international financial institutions, including Goldman Sachs Group, still expect the Chinese currency to fall to 7 yuan to the dollar. The forecasts are based on new COVID restrictions in the country’s major cities and the crisis in the property sector, which are hitting the economy of the world’s second largest economy, reports Bloomberg.

“The People’s Bank of China has clearly signaled that it will protect the yuan’s exchange rate,” said Zhang Juwei, chief economist at Pinpoint Asset Management. “This action shows that the central bank will not tolerate a sharp depreciation of the yuan against the US dollar,” he added.

The yuan limited its depreciation after the decision, but still remains low. At the time of writing, the offshore yuan was trading at 6.9403 per dollar, after falling to a two-year low of 6.93 per dollar in early August, MarketWatch data showed.

“The central bank’s decision shows the institution’s stance to slow down the pace of yuan depreciation, but is unlikely to reverse course,” said Mizuho Bank’s Ken Chun. “The action was somewhat expected after the series of yuan fixings, the impact of which was not great,” he adds.

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The last time the People’s Bank of China cut its foreign exchange reserve ratio was in April. Then the yuan lost more than 4% of its value after the series of lockdowns in Shanghai.

Financial institutions in China estimate foreign currency deposits at $953.6 billion as of July. For comparison, in February, deposits in foreign currency amounted to a record 1.1 trillion. dollar.

The decision by the People’s Bank of China to reduce the size of the deposits in question is likely to add $20 billion of foreign currency to the market, which is not much, said Xin Zhaopeng, senior strategist at Australia&New Zealand Banking Group. He does not expect a further reduction in foreign exchange reserves.

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