In order to enhance the ability of financial institutions to use foreign exchange funds, the people's Bank of China has decided to lower the foreign exchange deposit reserve ratio of financial institutions by 1 percentage point from May 15, 2022, that is, from the current 9% to 8%. Our comments are as follows:

Policy logic: intervene in the continuous devaluation of RMB in order to maintain the stable expectation of capital market.The recent depreciation of the RMB is only second to that of the "811" exchange rate reform period in 2015. For the exchange rate, once a sustained depreciation expectation is formed, the RMB exchange rate is likely to enter the self-strengthening stage, and the pressure of periodic devaluation should not be underestimated, which also has a certain negative impact on RMB-denominated assets.

With the rapid depreciation of the RMB exchange rate, the Shanghai Composite Index has also fallen below the important mark of 3000 points. We believe that the reduction of foreign exchange deposit margin by the people's Bank of China at this time will release US dollar liquidity, affect the pace of RMB depreciation, and then maintain the expected stability of the domestic capital market.

It may have policy effect: affect the rhythm of RMB exchange rate depreciation, but it may be difficult to change the release of phased depreciation pressure of RMB.In total, the people's Bank of China has only adjusted the required reserve ratio for foreign exchange deposits five times in history, with the exception of this reduction, the other four times have been raised. From past experience, similar policy interventions can affect the pace of exchange rate movements, but fail to change the stage trend of exchange rates. In principle, lowering the required reserve ratio for foreign exchange deposits contributes to the release of domestic dollar liquidity. But the impact of a reduction in the foreign exchange reserve ratio on dollar liquidity at a time when the Fed is about to shrink its schedule is a drop in the bucket, and there is a good chance that the abundance of dollar liquidity will not return to last year's levels.

We prefer the exchange rate of Q2 RMB to depreciate slightly to 6.8-7.0.The analytical framework of RMB exchange rate: the dollar index is β and the export competitiveness is α. Looking forward to the coming months, it may be a high probability that the dollar index will continue to rise in the next 1-2 months against the background of accelerated tightening of dollar liquidity. With the resumption of overseas production and the outbreak of domestic epidemics, the share of Q2 exports may decline slightly. Assuming that the Q2 dollar index is in the range of 100-102 and China's export share is 15%, the RMB exchange rate is likely to fall in the range of 6.8-7.0. If a phased exchange rate depreciation does occur, then there may still be a net outflow of foreign capital, which will still have a negative impact on RMB-denominated assets.

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一、How to understand the reduction of the required reserve ratio for foreign exchange deposits?

In order to enhance the ability of financial institutions to use foreign exchange funds, the people's Bank of China has decided to lower the foreign exchange deposit reserve ratio of financial institutions by 1 percentage point from May 15, 2022, that is, from the current 9% to 8%. Our comments are as follows:

The current foreign exchange deposit reserve system was formed at the end of 2004, and its principle is similar to RMB deposit reserve, which requires commercial banks to pay reserves to the people's Bank of China according to a certain proportion of the scale of foreign exchange deposits (deposits). Therefore, when the required reserve ratio of foreign exchange deposits is lowered, the supply of negotiable foreign exchange in the market increases, and the depreciation trend of RMB may moderate.

In total, the people's Bank of China has adjusted the required reserve ratio of foreign exchange deposits only five times in history, except for this reduction, the other four times have been raised. In response to the gradual release of appreciation pressure after the exchange rate reform in July 2005, foreign exchange deposit reserves were increased by 1 percentage point in September 2006 and May 2007 respectively. Since then, the required reserve ratio for foreign exchange deposits has remained unchanged at 5%. Until last year, due to the strong performance of China's economic exports and the sharp increase in RMB appreciation pressure, the people's Bank of China once again resumed its policy of raising the required reserve ratio for foreign exchange deposits, raising the required reserve ratio for foreign exchange deposits twice in June and December in order to ease the pressure on RMB appreciation. In other words, the previous policy objective of the people's Bank of China to adjust the required reserve ratio for foreign exchange deposits is to alleviate the appreciation trend of the RMB. However, from past experience, similar policy interventions will periodically affect the exchange rate trend in the short term, but can not 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 continued appreciation of the RMB in the medium term until China's economic fundamentals weakened periodically.

We believe that this operation of the people's Bank of China will help to alleviate the risks in the domestic capital market. Since April 19, the RMB has depreciated continuously and by a large extent, with a cumulative depreciation of nearly 2.8% in five trading days, and there has also been a significant adjustment in the entire domestic capital market.

Judging from the history of recent years, the recent depreciation of RMB is only second to that of the "811" exchange rate reform period in 2015. For the exchange rate, once a sustained depreciation expectation is formed, the RMB exchange rate is likely to enter the self-strengthening stage, and the pressure of periodic devaluation should not be underestimated, which also has a certain negative impact on RMB-denominated assets. With the rapid depreciation of the RMB exchange rate, the Shanghai Composite Index has also fallen below the important mark of 3000 points. We believe that the reduction of foreign exchange deposit margin by the people's Bank of China at this time can release foreign exchange liquidity, affect the pace of RMB depreciation, and then maintain the stability of the domestic capital market.

二、It may affect the rhythm of RMB exchange rate depreciation, but it may be difficult to change the release of phased depreciation pressure of RMB.

Judging from our indicator of the adequacy of domestic dollar liquidity and the basis point of the implied spread between foreign exchange swaps and 10-year US Treasury bonds, the recent abundance of domestic US dollar liquidity has fallen rapidly with the tightening of monetary policy in overseas economies. Lowering the required reserve ratio for foreign exchange deposits is conducive to the release of domestic foreign exchange liquidity.

But the impact of a reduction in the foreign exchange reserve ratio on dollar liquidity at a time when the Fed is about to shrink its schedule is a drop in the bucket, and there is a good chance that the abundance of dollar liquidity will not return to last year's levels. In other words, the abnormal phenomenon caused by the abundant liquidity of US dollars in 2021: the US dollar index with high long-term correlation deviates from the exchange rate of the US dollar against the RMB, while the appreciation of the US dollar index while the RMB exchange rate is still strong will not reappear. The RMB exchange rate will return to the stage dominated by fundamentals.

In the recent report "RMB Exchange rate Analysis Framework and Prospect", we once again discussed the framework of RMB exchange rate: the US dollar index is β and the export competitiveness is α. In other words, the above two factors should be dominated by the RMB exchange rate in the medium and long term.Looking forward to the next few months, we prefer the exchange rate of Q2 RMB to depreciate slightly to 6.8-7.0.Against the backdrop of accelerated tightening of dollar liquidity, it is likely that the dollar index will continue to rise in the next 1-2 months. With the resumption of overseas production and the outbreak of domestic epidemics, the share of Q2 exports may decline slightly. The disruption of overseas production after the epidemic has increased China's export share from 13.1% in 2019 to 15.2% in 2021. With the resumption of overseas production and the outbreak of the domestic epidemic, China's export share may drop slightly to less than 15%. Assuming that the Q2 dollar index is in the range of 100-102 and China's export share is 15%, the RMB exchange rate is likely to fall in the range of 6.8-7.0. If a phased exchange rate depreciation does occur, then there may still be a net outflow of foreign capital, which will still have a negative impact on RMB-denominated assets.

Risk hint

(1) exports exceeded expectations

(2) the Fed's monetary policy exceeded expectations.

(3) the monetary policy of the people's Bank of China exceeded expectations.