Chinese yuan set for biggest daily drop in six months after PBOC tightens FX reserves

China's yuan weakened on Tuesday and was on track for its biggest one-day decline against the US dollar in six months after the country's central bank announced a move to tighten foreign exchange liquidity, signalling concerns over the currency's rapid appreciation.

People's Bank of China (PBOC) said on Tuesday it would raise the foreign exchange reserve requirement ratio (RRR) for financial institutions by 2 percentage points to 6% from 4%, effective November 15.

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Traders and analysts told Reuters the move is expected to tighten dollar liquidity in the domestic market and moderate the pace of yuan appreciation.

The Chinese currency gained 0.74% against the dollar in October, taking its year-to-date appreciation to around 5%, supported by robust exports, trade surpluses and persistent corporate demand for yuan conversion.

The rapid strengthening of the currency has raised concerns among policymakers about its potential impact on China's export competitiveness.

Following the announcement, the onshore yuan weakened to 6.6728 per dollar, its lowest level since October 23. It was last trading at 6.6702 per dollar at 0253 GMT.

Reuters reported that if the yuan holds on to its losses until the end of Tuesday's trading session, it would mark a decline of 0.33% against the dollar, its steepest single-day fall since May 15.

The offshore yuan also weakened, trading at 6.6677 per dollar, down around 0.29% during Asian trading hours.

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The PBOC's decision comes ahead of a seasonal period that typically supports the yuan. Chinese exporters generally convert a larger proportion of their foreign currency earnings into yuan towards the end of the year and ahead of the Lunar New Year.

These conversions are driven by accounting and administrative requirements, as well as seasonal cash requirements for employee bonuses and holiday-related expenses. The resulting increase in yuan demand typically supports the currency in December and January.

PBOC signals caution over Yuan appreciation
The central bank also signalled its preference for a more measured pace of currency appreciation through its daily reference rate.

Before markets opened on Tuesday, the PBOC set the yuan's midpoint rate at 6.7150 per dollar for the second consecutive day. The fixing was 661 pips weaker than a Reuters estimate, marking the largest deviation towards the weaker side since September 10.

Although the central bank has gradually strengthened its daily yuan guidance this year, the fixings have remained weaker than market expectations, suggesting policymakers are seeking to manage the pace of appreciation.

Zhiwei Zhang, chief economist at Pinpoint Asset Management, said the PBOC's move reflected concerns about the yuan's rapid strengthening in October. He noted that China, given its heavy dependence on exports, may tolerate moderate currency appreciation but could be uncomfortable with a faster pace of gains.

Meanwhile, the US dollar wavered alongside oil prices in global markets on Tuesday as investors assessed the possibility of a diplomatic breakthrough between the United States and Iran.

(Disclaimer: This article is based on inputs from agencies. These do not represent the views of The Economic Times.)