China's Yuan Gains Support as US Tariffs Loom

The Chinese yuan has inched higher against the dollar, finding support from the People's Bank of China (PBOC) as US tariffs on Chinese goods loom. The PBOC has been actively guiding the currency firmer through its daily fixing, aiming to maintain stability in the face of potential trade tensions.



The PBOC has been setting firmer-than-expected midpoint fixings since mid-November 2023, with the yuan trading within the 2% band around the fixing. This has helped to keep the currency steady, despite concerns about the potential impact of US tariffs on Chinese exports and the broader economy.

Market participants and analysts expect the PBOC to continue using various tools to maintain currency stability as the US implements additional tariffs on Chinese goods. Some of the tools the central bank might employ include:

1. Counter-cyclical factor in the fixing formula: The PBOC may reintroduce the counter-cyclical factor in the fixing formulas used by commercial banks to calculate and contribute to the daily reference rate. This factor was used in the past to avoid a fixing that the central bank deemed excessively weak. By reintroducing this factor, the PBOC can guide the fixing rate to be stronger than market expectations, providing support to the yuan.
2. Foreign exchange reserve requirement ratio: The PBOC can adjust the foreign exchange reserve requirement ratio to fine-tune liquidity in the banking system. A cut in the ratio will ease the supply of foreign currency, thus propping up the yuan. The PBOC has used this tool in the past, reducing the ratio from 9% in 2021 to 4% in 2022 and 2023.
3. State-owned banks' intervention: The PBOC can instruct state-owned banks to sell dollars and buy yuan in the spot market, which is seen as a form of shadow intervention. This can help stabilize the yuan and prevent it from depreciating too rapidly.
4. Verbal intervention: PBOC officials can make public statements to bolster the yuan, emphasizing the central bank's commitment to maintaining currency stability. For example, PBOC Governor Pan Gongsheng has repeatedly stated that the central bank will use interest rates and the reserve requirement ratio to keep ample liquidity in the market.
5. Outright open market reverse repo facility: The PBOC can use this new monetary policy tool to inject funds into the market by purchasing securities from commercial banks. This can help maintain reasonable and ample liquidity in the banking system, supporting the yuan.

While the PBOC's interventions have helped maintain currency stability in the short term, the long-term implications for China's currency and economy are complex and multifaceted. Prolonged currency depreciation could have significant negative consequences, but a stable yuan is also crucial for maintaining economic growth and international trade. As the US implements additional tariffs on Chinese goods, the PBOC will need to balance the need for currency stability with other economic objectives, such as supporting growth and preventing capital flight.