Priya PatelTLDR:
- China’s state banks sold dollars in the foreign exchange market to prevent the rapid decline of the yuan after stock markets in Shanghai and Hong Kong fell.
- The aim was to tighten liquidity in the offshore foreign exchange market and stabilize the yuan.
China’s big state banks took action to support the yuan on Monday by selling US dollars in the foreign exchange market. This move came as stock markets in Shanghai and Hong Kong experienced significant declines. The banks aimed to tighten liquidity in the offshore foreign exchange market to prevent the yuan from depreciating too rapidly. The Hang Seng Index in Hong Kong fell by about 2.3%, while the Shanghai Composite Index experienced its biggest one-day fall since April 2022, dropping 2.7%. By actively selling dollars onshore, state banks also aimed to prevent rapid declines in the yuan. This move is seen as a policy signal to stabilize the currency and counter negative market sentiment on equities. China’s economy is facing signs of a slowdown, and overseas funds have sold roughly $1.6 billion in Chinese equities so far this year. The offshore yuan tomorrow-next forwards rose to a two-month high, reflecting tighter liquidity conditions. State banks also curtailed lending in the offshore market, tightening offshore yuan liquidity and increasing the cost of shorting the currency. In addition to these actions, the People’s Bank of China (PBOC) decided to keep benchmark lending rates unchanged in their monthly fixing. The PBOC has limited scope for monetary easing amid downward pressure on the yuan and has held its medium-term lending facility rate steady. Policymakers remain concerned about the yuan and are hesitant to cut rates, as it could lead to additional depreciation pressure. However, when the yuan regains some ground, rate cuts are expected, with a forecast of 20 basis points in reductions by the end of the second quarter. Market watchers also expect the PBOC to increase liquidity injections before the upcoming Lunar New Year holidays. The central bank may employ methods such as reverse repos in open market operations and could reduce banks’ reserve requirement ratio (RRR).
