Summary of the report

On April 25, the central bank decided to lower the required reserve ratio for foreign exchange deposits of financial institutions from 9% to 8% from May 15 this year.

first,What is the required reserve ratio for foreign exchange deposits? According to the regulations on the Administration of Foreign Exchange Deposit reserves of Financial institutions, financial institutions are required to deposit a certain proportion of their foreign exchange deposits with the central bank. "this proportion" is the required reserve ratio for foreign exchange deposits, which is determined by the central bank. Similar to RMB Statutory deposit reserve ratio. The central bank does not directly hold foreign exchange deposit reserves, but deposits them in a special account of foreign exchange reserve deposits opened by the central bank with Chinese-funded commercial banks in China.

Second,This is the first time that the central bank has lowered the required reserve ratio for foreign exchange deposits. An important background is the rapid depreciation of the RMB exchange rate recently. We understand that the driving factors include: (1) the export itself has a gradual deceleration trend this year, which will lead to the convergence of the current account foreign exchange surplus and the contraction pressure on the domestic foreign exchange supply. Under the background of epidemic prevention and control from March to April, the constraints of land logistics, port manpower and other factors may aggravate the impact of exports and foreign exchange settlement in the short term. (2) the interest rate gap between China and the United States has narrowed significantly since February, which may logically lead to some foreign capital outflow. There is also shrinking pressure on the foreign exchange surplus between capital and financial accounts, which increases the depreciation pressure on the exchange rate in the short term. (3) the domestic epidemic situation has not been fully controlled in April, which will affect the risk premium factors in the short term.

Third,The reduction in the required reserve ratio for foreign exchange deposits will support the RMB exchange rate from two levels: (1) releasing more foreign currency supply and affecting the supply and demand of foreign currency in the interbank foreign exchange market, according to the current estimate of US $1.05 trillion in foreign exchange deposits, an one-point reduction in the required reserve ratio would release about $10.5 billion in supply. (2) relax the liquidity constraints of banks' foreign exchange loans, encourage banks to increase the amount of foreign exchange loans, increase the supply of foreign exchange in the physical sector, and further increase the supply of foreign currency in the interbank foreign exchange market through foreign exchange settlement, thus affecting the exchange rate of RMB.

FourthMore importantly, the central bank's move sends a signal that the policy wants to stabilize the RMB exchange rate, which has a certain coordinate significance for the short cycle of the current round of exchange rates. In March 2020, the central bank lowered the macro-prudential adjustment parameters of full-caliber cross-border financing to encourage cross-border financing and increase capital inflows to stabilize the exchange rate and broad credit. From historical experience, the annual rise and depreciation of the RMB since 2005 has never exceeded 7%. This is because the RMB itself fluctuates in both directions around the value center; second, the central bank will also try its best to maintain the basic stability of the RMB at a reasonable equilibrium level, so as to avoid the disturbance of foreign exchange between residents and enterprises. If there is still a large depreciation pressure on the exchange rate, theoretically, the tools that can be further used include: strengthening the expected management to release the stable exchange rate signal; strengthening the macro-prudential management of cross-border capital flows; adjusting the foreign exchange risk reserve ratio; using the counter-cyclical factor; further adjusting the foreign exchange deposit reserve ratio; increasing the scale of offshore central bill issuance, and so on.

FifthFrom the empirical data, there is a certain correlation between the exchange rate and the stock market: first, the exchange rate depreciation trend usually points to the stage of slowing down real growth, corresponding to the expected adjustment of enterprise profits; second, under the exchange rate depreciation trend, there are exchange losses on foreign capital holding RMB assets, and foreign capital inflows will slow down. If the exchange rate stabilizes later, it will also be a positive message for the stock market.

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On April 25, the central bank decided to lower the required reserve ratio for foreign exchange deposits of financial institutions from 9% to 8% from May 15 this year.

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%.

What is the required reserve ratio for foreign exchange deposits? According to the regulations on the Administration of Foreign Exchange Deposit reserves of Financial institutions, financial institutions are required to deposit a certain proportion of their foreign exchange deposits with the central bank. "this proportion" is the required reserve ratio for foreign exchange deposits, which is determined by the central bank. Similar to RMB Statutory deposit reserve ratio. The central bank does not directly hold foreign exchange deposit reserves, but deposits them in a special account of foreign exchange reserve deposits opened by the central bank with Chinese-funded commercial banks in China.

The regulations on the Administration of Foreign Exchange Deposit reserves of Financial institutions points out that foreign exchange deposit reserves are deposits deposited by financial institutions with a certain proportion of their foreign exchange deposits with the people's Bank of China in accordance with the regulations. The required reserve ratio of foreign exchange deposits is the ratio of the foreign exchange deposit reserves deposited by financial institutions with the people's Bank of China to their absorption of foreign exchange deposits.

The foreign exchange deposit reserves of financial institutions shall be deposited in the special foreign exchange reserve deposit account opened by the people's Bank of China with Chinese-funded commercial banks in China.

Reserves for foreign exchange deposits are deposited in US dollars and Hong Kong dollars in the original currency, and foreign exchange deposits in other currencies are converted into US dollars. The conversion rate between various currencies shall be calculated according to the monthly conversion rate of various currencies to the US dollar published by the State Administration of Foreign Exchange.

This is the first time that the central bank has lowered the required reserve ratio for foreign exchange deposits. An important background is the rapid depreciation of the RMB exchange rate recently. We understand that the driving factors include: (1) the export itself has a gradual deceleration trend this year, which will lead to the convergence of the current account foreign exchange surplus and the contraction pressure on the domestic foreign exchange supply. Under the background of epidemic prevention and control from March to April, the constraints of land logistics, port manpower and other factors may aggravate the impact of exports and foreign exchange settlement in the short term. (2) the interest rate gap between China and the United States has narrowed significantly since February, which may logically lead to some foreign capital outflow. There is also shrinking pressure on the foreign exchange surplus between capital and financial accounts, which increases the depreciation pressure on the exchange rate in the short term. (3) the domestic epidemic situation has not been fully controlled in April, which will affect the risk premium factors in the short term.

The central bank made four adjustments to the required reserve ratio of foreign exchange deposits from 2005 to 2021, all of which were raised, basically against the background of appreciation pressure on the RMB exchange rate.

The downgrade is the first time in history and mainly points to the recent rapid devaluation of the RMB exchange rate.

The reduction in the required reserve ratio for foreign exchange deposits will support the RMB exchange rate from two levels: (1) releasing more foreign currency supply and affecting the supply and demand of foreign currency in the interbank foreign exchange market, according to the current estimate of US $1.05 trillion in foreign exchange deposits, an one-point reduction in the required reserve ratio would release about $10.5 billion in supply. (2) relax the liquidity constraints of banks' foreign exchange loans, encourage banks to increase the amount of foreign exchange loans, increase the supply of foreign exchange in the physical sector, and further increase the supply of foreign currency in the interbank foreign exchange market through foreign exchange settlement, thus affecting the exchange rate of RMB.

Similar to the impact of the central bank's reduction of RMB Statutory deposit reserve ratio on the RMB capital interest rate, the central bank's reduction of the required reserve ratio for foreign exchange deposits will have an impact on the RMB exchange rate in two aspects.

First, it can directly release previously frozen foreign exchange funds and increase the supply of foreign currency in the interbank foreign exchange market. In March 2022, the balance of foreign exchange deposits of financial institutions was $1.05 trillion, and an one-point cut in the required reserve ratio would release about $10.5 billion.

Second, it can relax the liquidity constraints of foreign currency loans of banks, increase the ability of foreign currency loans of banks, increase the availability of foreign currency loans of trading enterprises, and increase the supply of foreign currency in the physical sector. The supply of foreign currency in the physical sector will eventually be transferred to the banking sector through bank settlement of foreign exchange.

More importantly, the central bank's move sends a signal that the policy wants to stabilize the RMB exchange rate, which has a certain coordinate significance for the short cycle of the current round of exchange rates. In March 2020, the central bank lowered the macro-prudential adjustment parameters of full-caliber cross-border financing to encourage cross-border financing and increase capital inflows to stabilize the exchange rate and broad credit. From the perspective of historical experience, the annual rise and depreciation of the RMB since 2005 has never exceeded 7%. This is because the RMB itself fluctuates in both directions around the value center; second, the central bank will also try its best to maintain the basic stability of the RMB at a reasonable equilibrium level, so as to avoid the disturbance of foreign exchange between residents and enterprises. If there is still a large depreciation pressure on the exchange rate, theoretically, the tools that can be further used include: strengthening the expected management to release the stable exchange rate signal; strengthening the macro-prudential management of cross-border capital flows; adjusting the foreign exchange risk reserve ratio; using the counter-cyclical factor; further adjusting the foreign exchange deposit reserve ratio; increasing the scale of offshore central bill issuance, and so on.

Similar to the previous 23 measures issued by the central bank, it is more important for the central bank to cut the required reserve ratio for foreign exchange deposits, that is, to control the depreciation pace of the RMB exchange rate and create a window for stable domestic growth for as long as possible.

In addition to the foreign exchange deposit reserve ratio, theoretically, the tools that the central bank can use are: strengthening the macro-prudential management of cross-border capital flows and strengthening the monitoring of capital flows; continue to increase the supply of foreign currency and reduce the supply of RMB, such as increasing the scale of central bank note issuance in the offshore market; affecting the willingness of enterprises and residents to settle and sell foreign exchange by adjusting the foreign exchange risk reserve ratio; restart counter-cyclical factors and strengthen expectation management.

From the empirical data, there is a certain correlation between the exchange rate and the stock market: first, the exchange rate depreciation trend usually points to the stage of slowing down real growth, corresponding to the expected adjustment of enterprise profits; second, under the exchange rate depreciation trend, there are exchange losses on foreign capital holding RMB assets, and foreign capital inflows will slow down. If the exchange rate stabilizes later, it will also be a positive message for the stock market.

Core hypothetical risk:The macro environment is higher than expected; the liquidity environment is higher than expected.