Starting Monday, China's central bank will collect reserve requirements for offshore yuan deposits, or those belonging to foreign financial institutions. What does this mean for the yuan's foreign exchange rate?
Offshore yuan will not be used as freely as they used to be. Foreign banks have to place a portion of their onshore deposits in reserve at the central bank, effective Jan 25th. The People's Bank of China said this required ratio will be raised from its current zero deposit. Analysts say this would soak up around 200 billion yuan, and stem downward pressure on the Chinese yuan, directly in the offshore market.
"Directly reduce the RMB available offshore to bet against more depreciated CNY. The second is the money multiple effect, this would mean an even less currency for the offshore market. The offshore market will become an even smaller market, you can get much less currency to bet against the depreciation," said Chen Jiahe, chief strategist of Cinda Securities.
The market has spoken for itself, after the Central Bank released the new ruling one week ago. Offshore yuan has rapidly converged back from its record lows, shrinking the gap between onshore and offshore rates to a more sustainable level.
"What you have in the offshore market is actually a reducing currency. You have to exclude the daily normal export and import use of the currency. So what is left for the currency speculation is decreased. And also people are very clear about the PBOC's policy, which is a slight depreciation and not a drastic one. So people would not be panic," said Chen.
Chinese currency's forex rate has both the onshore and offshore versions. To internationalize the currency in a step by step manner, the central bank sets the rate for the onshore market every day, but it doesn't intervene the offshore market unless otherwise needed.
Analysts say making the offshore rate stable helps the onshore policy. Although Chinese authorities have won the battle to defend the yuan's rate, the problems are not over.
"On one hand we squash the volatility in the spot market, but at the same time, the volatility in the forward market sort of spurred up. So it is difficult, because market has its own mind. The market is trying to capitalize on the yuan depreciation, which is a derivative theme from Chinese growth slowdown," said Hong Hao, chief china strategist of BOCOM International Holdings.
In a long run, however, experts say it is China's economic well being that will eventually affect the rate.
"The most important job we have to do is to stabilize the economy. Going in 2016, the environment that we are operating in is becoming more complex than before. It requires policy flexibility, communication, and also maybe sometimes we have to make difficult choices," said Hong.
