China’s Central Bank Takes Action to Quell Mounting Inflation Concerns

Officials at the People’s Bank of China (PBOC) announced new measures late Monday night aimed at curtailing growth in the yuan’s value, which has recently surged to its highest level against the dollar in three years.

The decision will require domestic financial institutions to increase the proportion of foreign currencies held as reserves from 5% to 7% by June 15, in the hopes that this will relax demand for onshore-traded renminbi. This particular tool of monetary policymaking has not been exercised by the PBOC since the height of the global financial crisis in 2007.

Although the move is estimated to add just $20 billion in foreign exchange (FX) reserves to the much larger domestic total of around $1 trillion, according to a report by Barron’s, analysts see it as an indication of a broader strategic approach towards governing the country’s currency.

Concerns have been mounting in Beijing over recent months regarding a global surge in commodity prices, hints of slowing domestic growth and a steadily appreciating yuan, with further protective action expected to be announced in the near future.

In addition, a surplus of dollars resulting from extensive spending by the US Federal Reserve has provided further impetus for the yuan’s rally, as policy makers in Washington attempt to rescue a pandemic-ridden American economy. As a result, Chinese banks now face an overabundance of FX reserves, which risks narrowing the scope of regulators to enact emergency measures in the event of rapid inflation.

Following a steady rise in value throughout the past year, the onshore renminbi has recently soared to its highest level since April 2018, trading at 6.38 to the dollar as of Wednesday afternoon.

The stronger Chinese yuan has been riding the wave of the domestic economy’s robust comeback from the covid-19 pandemic, although slower-than-expected 2021 first quarter growth – just 0.6% according to the country’s National Bureau of Statistics – suggests the surge has begun to wane.

Despite a solid trade performance over the past few quarters, “the broad renminbi strength will likely undermine the competitiveness of China’s export sector,” said Ken Cheung, Chief Asian FX Strategist at Mizuho Bank, in comments to the Financial Times.

Furthermore, a global spike in commodity prices has worried PBOC about the prospects of inflation, after the price of raw materials in the country increased by 6.8% for the month of April, year-on-year.

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Currency regulation by Beijing and Washington has played a critical role in the increasingly fraught commercial relationship between the world’s two largest economies, in addition to issues of tariffs, intellectual property theft and the substantial US trade deficit.

Whether or not the Biden administration will attempt to pursue the highly combative approach of former President Trump towards the trade relationship remains to be seen.

On the morning of May 27 Beijing time, the new US Trade Representative Katherine Tai participated in a virtual meeting with Chinese Vice Premier Liu He, marking the opening of trade talks between the two sides during the Biden administration’s tenure. The discussion included “candid, pragmatic and constructive exchanges with an attitude of equality and mutual respect,” according to a statement by the Chinese Commerce Ministry.