A New Perspective On China’s FX RRR Hike 1
The apparent catalyst for last week’s plunge in the USDCNY rate was the Chinese government’s decision to increase the reserve requirement ratio (RRR) for domestic banks’ foreign exchange (FX) deposits. This effectively reduces the amount of USDs available in the Chinese economy, and was ostensibly done to halt the CNY’s continued strength vs the Dollar. Is this too simplistic?
What is curious though, is that this hike in the RRR for FX comes on the back of last Monday’s (6 Dec) announcement of an easing in the RRR for domestic bank reserves. In other words, less supply of FX, but more CNY liquidity within China.
Why would the Chinese government create scarcity for USDs just as global Dollar funding conditions are tightening (as demonstrated by the broadly stronger USD)?
Moreover, why do so when domestic companies are facing the prospect of being locked out of global Dollar funding markets due to uncertainty over Evergrande’s contagion?
The argument that the Chinese want to weaken the CNY only makes sense on the superficial level of wanting to boost exports. If you really think about it, a weaker CNY would do more harm than good, firstly by increasing debt servicing costs; and secondly by making it more expensive for Chinese companies to obtain the USDs they need to engage in international trade.
Ultimately, tighter Dollar conditions never bode well for economic growth, not just in China, but for the whole world. One only has to look at how sharply the USD rallies during times of crisis (e.g. 2008-2010 & 1Q 2020) to understand this.
Consequently, making the argument that the Chinese government wants to engineer a USD shortage in its own economy to weaken the CNY is the same as saying that the Chinese want to shoot themselves in the proverbial foot, twice.
While only the government officials who made the decision can tell us the truth of why they did it, it would be fair to think that they wouldn’t want to act against the best interests of their economy. And the best interests of their economy lie in continued access to Dollars at rates that are as low as possible.
In other words, they need to keep markets as calm about Evergrande and the wider property sector’s woes as possible – which they are, and have been, trying to do. The moment their narrative of “the risks can be effectively managed” fails, Dollar funding costs for Chinese companies will spike, and liquidity will dry up. More importantly, should this occur, the Chinese government will have to act to manage a disorderly rush by foreign investors and Chinese companies to obtain Dollars.
To be continued…
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