China Boosts Yuan Support With Warning, Capital Control Tweaks

China's efforts to stabilize its currency, the yuan, have been in the spotlight recently, with the country implementing a series of measures to manage capital flows and maintain exchange rate stability. In this article, we will explore the recent developments in China's capital control tweaks and their impact on the yuan's stability.



The People's Bank of China (PBOC) has been actively managing the yuan's exchange rate, using various tools to maintain stability and prevent excessive volatility. One of the most important tools at the PBOC's disposal is the daily fixing, which sets a reference rate for the yuan's exchange rate against the US dollar. The fixing has evolved over the years, becoming more market-based and transparent, with the PBOC laying out the factors that banks need to consider when submitting prices for the rate.

In addition to the daily fixing, the PBOC has introduced other measures to manage capital flows and stabilize the yuan. One such measure is the foreign exchange reserve requirement ratio, which sets the amount of foreign currency deposits banks need to hold as reserves. By adjusting this ratio, the PBOC can fine-tune liquidity in the banking system and influence the yuan's exchange rate. The PBOC raised the ratio twice in 2021, to 9% by the end of the year, and then cut it three times in 2022 and 2023, to 4%.

Another tool at the PBOC's disposal is shadow interventions, such as state-owned banks selling the dollar versus the yuan in spot trading or engaging in large transactions in the foreign-exchange swap market. These interventions can prop up the yuan when it comes under pressure, helping to maintain stability.



Verbal intervention has also played a role in stabilizing the yuan. Chinese officials have not been averse to talking their currency up or down when needed, with the PBOC's standard line being that the yuan will be kept basically stable at reasonable, equilibrium levels. Stronger verbal intervention has been observed since 2022, with officials pledging to adopt comprehensive measures to support the yuan.

While these measures have been effective in stabilizing the yuan, they also have potential unintended consequences. Capital controls may limit investment opportunities for domestic residents, increase domestic financial market volatility, and lead to a misallocation of resources. Additionally, capital controls may increase the risk of a currency crisis if they are eased too quickly, leading to a sudden outflow of capital and a rapid depreciation of the currency.

In conclusion, China's capital control tweaks have been effective in stabilizing the yuan and maintaining exchange rate stability. However, these measures also have potential unintended consequences that must be carefully managed. As China continues to navigate the challenges of a rapidly changing global economy, it will be important for policymakers to monitor the impact of these measures and adjust them as needed to ensure the long-term stability and prosperity of the Chinese economy.