China to reuse 2017 currency fixing method to control yuan's fall

The Chinese government is reportedly planning to re-introduce an old yuan fixing method to control the weakening currency. It claimed that the method could reflect the supply and demand in the market better. It could also minimize the possible “herd effect” and guide market actors to focus on the important points of macroeconomics.

An inside source told Reuters that the Chinese government had asked a number of local banks in 2017 to adjust their yuan quotes which would be used by the People's Bank of China (PBOC) to set the daily reference rate. This method introduced a bias called the “counter-cyclical factor” that improved the value of the yuan against other currencies.

The Chinese authorities asked 14 banks that had worked with them in the past to manage the yuan fixing rate on Tuesday. These banks are important members of the China FX Market Self-Regulatory Framework. The intervention reportedly will be effective in the next few days.

The Chinese government expects the action will “strengthen the two-way floating nature of the yuan.” Throughout 2022, the yuan has lost 11 percent of its value against the U.S. dollar.

China abandoned the method when the yuan saw a significant value increase in 2020. The country's government decided to let the yuan’s movement be dictated by the market instead.

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Other measures to protect yuan

This year, the yuan is facing pressure from the economic slowdown in China due to the government’s tight pandemic policies. There are also outflows of foreign portfolio investment which further pressurized the Chinese currency.

The PBOC trimmed the country’s interest rates in August, an opposite move from other major economies that hiked their interest rates to battle inflation. It led to a more significant plunge of the yuan against other currencies.

Starting in September, the Chinese government has taken several measures to support the yuan. It implemented firm mid-point rate fixings, sent verbal warnings to a number of financial institutions, and reigned in major easing efforts. On Tuesday, the yuan closed in a stronger position against the market projection.

The Chinese central bank also has also begun to lower the number of minimum reserves that a foreign exchange financial firm needs to hold, which increases the cost of shorting the yuan. It also reinstated risk-reserve requirements for currencies obtained using forward contracts.

U.S. dollar’s newfound strength

The U.S. dollar recently reached its two-decade highs against other major currencies. Earlier this week, the U.K. pound sterling reached its lowest point against the greenback. A few weeks ago, the euro reached parity against the currency for the first time in twenty years.

This newfound strength came after the Federal Reserve introduced significant interest rate hikes to maintain inflation at a two-percent rate. The Fed said there would be a higher hike by the end of 2022, which may prolong the dollar’s strong position in the global economy.

Reports said that the situation was beneficial to U.S. importers and travelers as their purchasing power increased. A number of parties, however, will be hurt in the long run, including multinational companies, emerging economies and U.S. tourism.