In order to improve the ability of financial institutions to use foreign exchange funds, the People’s Bank of China has decided to reduce the foreign exchange deposit reserve ratio of financial institutions by 1 percentage point from May 15, 2022, that is, the foreign exchange deposit reserve ratio will be lowered from the current 9% to 8%. . Our review is as follows:

Policy logic: intervene in the continuous devaluation of the RMB to maintain the stable expectations of the capital market. The recent depreciation of the renminbi is second only to the 2015 “811” exchange rate reform period. For the exchange rate, once a continuous depreciation expectation is formed, the RMB exchange rate may enter a self-reinforcing stage, and the pressure of periodic depreciation should not be underestimated, and it will also have a certain negative impact on RMB-denominated assets.

With the rapid depreciation of the RMB exchange rate, the Shanghai Composite Index also fell below the important threshold of 3,000 points. We believe that the People’s Bank of China’s reduction of foreign exchange deposit margins at this time will release US dollar liquidity, affect the pace of RMB depreciation, and maintain the policy logic of stable domestic capital market expectations.

Possible policy effect: It affects the depreciation rhythm of the RMB exchange rate, but it may be difficult to change the release of the staged depreciation pressure of the RMB. The People’s Bank of China has only adjusted the foreign exchange deposit reserve ratio five times in total in history. From past experience, similar policy interventions can affect the rhythm of the exchange rate trend, but fail to change the phase trend of the exchange rate. In principle, lowering the foreign exchange deposit reserve ratio will help to release domestic dollar liquidity. However, when the Federal Reserve is about to shrink its balance sheet, the impact of the reduction of the foreign exchange reserve ratio on the liquidity of the US dollar is not enough, and the sufficient liquidity of the US dollar is unlikely to return to last year’s level.

We tend to depreciate the RMB exchange rate slightly to 6.8-7.0 in Q2. The analytical framework of the RMB exchange rate: the US dollar index is β, and the export competitiveness is α. Looking forward to the next few months, against the backdrop of the accelerated tightening of US dollar liquidity, it is likely that the US dollar index will continue to rise in the next 1-2 months. With the recovery of overseas production and the sudden outbreak of the domestic epidemic, the Q2 export share may drop slightly. Assuming that the Q2 US dollar index is in the range of 100-102 and China’s export share is 15%, the RMB exchange rate may fall in the range of 6.8-7.0. If a staged exchange rate depreciation does occur, foreign capital may still have a net outflow, which will still have a certain negative impact on RMB-denominated assets.

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1. How to understand the reduction of foreign exchange deposit reserve ratio?

In order to improve the ability of financial institutions to use foreign exchange funds, the People’s Bank of China has decided to reduce the foreign exchange deposit reserve ratio of financial institutions by 1 percentage point from May 15, 2022, that is, the foreign exchange deposit reserve ratio will be lowered from the current 9% to 8%. . Our review is as follows:

The current foreign exchange deposit reserve system was formed at the end of 2004, and its principle is similar to that of the RMB deposit reserve, which requires commercial banks to pay reserves to the People’s Bank of China in accordance with a certain proportion of the scale of foreign exchange deposits (deposits). Therefore, when the foreign exchange deposit reserve ratio is lowered, the supply of tradable foreign exchange in the market increases, and the depreciation trend of the RMB may ease.

The People’s Bank of China has only adjusted the foreign exchange deposit reserve ratio five times in total. In response to the gradual release of the appreciation pressure after the exchange rate reform in July 2005, the foreign exchange deposit reserves were raised by 1 percentage point in September 2006 and May 2007 respectively. Since then, the foreign exchange deposit reserve ratio has remained unchanged at 5%. Until last year, due to the strong export performance of my country’s economy, the pressure of RMB appreciation increased sharply, the People’s Bank of China restarted the policy of raising the foreign exchange deposit reserve ratio again, and raised the foreign exchange deposit reserve ratio twice in June and December to ease the appreciation pressure of the RMB. . That is to say, the previous policy objective of the People’s Bank of China to adjust the foreign exchange deposit reserve ratio was mainly to ease the appreciation trend of the RMB. However, from the past experience, similar policy interventions will affect the exchange rate trend periodically in the short term, but cannot change the medium-term trend of the exchange rate. The previous four policies of raising foreign exchange deposit reserves could not change the trend of RMB’s continued appreciation in the medium term until the fundamentals of my country’s economy weakened periodically.

We believe that the PBOC’s operation will help alleviate domestic capital market risks. Starting from April 19, the RMB began to depreciate continuously, and the magnitude was relatively large. The cumulative depreciation in five trading days was close to 2.8%, and the entire domestic capital market also experienced significant adjustments.

Judging from the history of recent years, the recent depreciation of the RMB is second only to the “811” exchange rate reform period in 2015. For the exchange rate, once a continuous depreciation expectation is formed, the RMB exchange rate may enter a self-reinforcing stage, and the pressure of periodic depreciation should not be underestimated, and it will also have a certain negative impact on RMB-denominated assets. With the rapid depreciation of the RMB exchange rate, the Shanghai Composite Index also fell below the important threshold of 3,000 points. We believe that the People’s Bank of China’s reduction of foreign exchange deposit margins at this time can release foreign exchange liquidity, affect the pace of RMB depreciation, and maintain the stability of the domestic capital market.

2. It may affect the rhythm of the depreciation of the RMB exchange rate, but it may be difficult to change the release of the pressure on the periodic depreciation of the RMB

Judging from our indicators of the adequacy of domestic dollar liquidity, the basis point of the implied spread of foreign exchange swaps and the spread between China and the United States 10-year Treasury bond, with the tightening of monetary policies in overseas economies, the recent increase in domestic dollar liquidity has Abundance fell rapidly. Lowering the foreign exchange deposit reserve ratio will help to release domestic foreign exchange liquidity.

However, when the Federal Reserve is about to shrink its balance sheet, the impact of the reduction of the foreign exchange reserve ratio on the liquidity of the US dollar is not enough, and the sufficient liquidity of the US dollar is unlikely to return to last year’s level. That is to say, in 2021, the abnormal phenomenon caused by the abundant liquidity of the domestic US dollar: the US dollar index, which has a high long-term trend correlation, deviates from the US dollar-RMB exchange rate. While the US dollar index appreciates, the RMB exchange rate is still strong and there is a high probability that it will not reproduce. . The RMB exchange rate will return to a stage dominated by fundamentals.

In the recent report “Analysis Framework and Prospects of RMB Exchange Rate”, we once again discussed the framework of RMB exchange rate: the US dollar index is β, and the export competitiveness is α. That is to say, the above two factors should be the dominance of the RMB exchange rate in the medium and long term. Looking forward to the next few months, we tend to depreciate the RMB exchange rate slightly to 6.8-7.0 in Q2. In the context of the accelerated tightening of US dollar liquidity, the US dollar index will continue to rise in the next 1-2 months or has a high probability. With the recovery of overseas production and the sudden outbreak of the domestic epidemic, the Q2 export share may drop slightly. The blockage of overseas production after the epidemic has increased China’s export share from 13.1% in 2019 to 15.2% in 2021. With the recovery of overseas production and the sudden outbreak of domestic epidemics, China’s export share may drop slightly to below 15%. Assuming that the Q2 US dollar index is in the range of 100-102 and China’s export share is 15%, the RMB exchange rate may fall in the range of 6.8-7.0. If a staged exchange rate depreciation does occur, foreign capital may still have a net outflow, which will still have a certain negative impact on RMB-denominated assets.

risk warning

(1) Exports exceeded expectations

(2) The Federal Reserve’s monetary policy exceeded expectations

(3) The monetary policy of the People’s Bank of China exceeded expectations

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