China will impose a reserve requirement on offshore renminbi deposits, the central bank said on Monday, in an effort to soak up liquidity and raise the cost of speculating on renminbi depreciation.
The move marks an escalation of efforts by the People’s Bank of China to discourage capital outflow and curb renminbi weakness in both the onshore and offshore markets.
The spread between onshore and offshore renminbi widened to a record early this month before the PBoC intervened in the offshore — or CNH — market in Hong Kong to narrow the gap. The onshore renminbi has fallen 2.7 per cent against the dollar since December.
The overnight CNH borrowing rate jumped to a record 67 per cent last week after the PBoC sold dollars from its foreign exchange reserves to buy renminbi, causing a liquidity squeeze in the CNH money market.
The new reserve requirement will permanently raise CNH interest rates by forcing banks to set aside a portion of CNH deposits at the central bank, where the funds are not available for lending.
“As depreciation pressures have intensified, the offshore market has become an important venue for short-selling the renminbi,” Huili Chang, analyst at China International Capital Corp, wrote on Monday. “This move will push up the cost of offshore renminbi financing and help to restrain speculation.”
Speculators have used CNH as a funding currency to execute a short-term carry trade in which they swap borrowed renminbi for dollars, then repay the loan the following day once CNH has weakened.
While the onshore renminbi market remains tightly controlled, the offshore CNH market has largely operated outside the reach of mainland authorities since its creation in 2010. China’s central bank can exert regulatory influence over the CNH market, however, through rules affecting the onshore correspondent banks that serve as links between the onshore and offshore markets.
In recent weeks, the PBoC has intervened on the CNH by selling dollars in the open market, but the latest move broadens its use of administrative measures to influence the offshore market. The central bank previously suspended certain foreign-exchange transactions by onshore units of foreign banks that were helping clients arbitrage between the onshore and offshore renminbi exchange rates.
The PBoC published rules in December 2014 allowing it to impose a required reserve ratio on correspondent banks, but the ratio had been set at zero.
The central bank will enforce a “normal” reserve requirement on onshore banks that accept renminbi deposits from offshore banks from January 25, it said on Monday, without specifying a number. The current reserve requirement for onshore renminbi deposits is 17.5 per cent for large banks.
The new reserve ratio creates a “counter-cyclical adjustment mechanism for cross-border renminbi liquidity”, the PBoC said, without mentioning the exchange rate.