The People’s Bank of China (PBoC) has removed the 20% reserve requirement for financial institutions wanting to trade USD/CNY forwards in the interbank FX market, effective September 11 2017. This demonstrates PBoC’s confidence in the renminbi, and furthers China’s currency liberalization efforts.

The move comes as the pressure of capital outflow has been released over the past few months. Data from PBoC show that in August 2017 China’s FX reserve has increased for seven consecutive months, and now stands at US$3.09 trillion.

“On a medium-term basis, the removal of the FX forwards reserve requirements is in line with the recent pledges by the authorities to liberalize the currency and increase flexibility,” says Christy Tan, head of markets strategy/research for Asia at National Australia Bank.

According to a research report by Bank of America Merrill Lynch, the renminbi reserve requirement still remains for custodian banks, BoC Hong Kong, BoC Macau, as well as the parent banks of other clearing banks. But the reserve requirement is lifted for participating banks and clearing banks (other than BoC Hong Kong and BoC Macau).

“The relaxation suggests that PBoC is still trying to stabilize the renminbi exchange. In practice, it can lower the cost to corporates when purchasing renminbi forwards,” notes Qilin Li, managing director and chief macro analyst at Lianxun Securities.

While the removal of the reserve requirement makes renminbi forwards less costly, it is not likely that the USD will appreciate at this point given that the overall flow position has shifted in favour of the renminbi, according to Tan.

The 20% reserve requirement was announced on September 2 2015, and came into effect on October 1 2015. It was introduced after a sharp depreciation of the renminbi following the introduction of the renminbi exchange fixing mechanism in August 2015.

In early June 2017, China Foreign Exchange Trading System confirmed that it would adjust the renminbi fixing formula by adding a counter-cyclical factor. In the 2016 annual report issued in early July this year, PBoC also highlighted that it would further enhance the renminbi exchange mechanism with a two-way fluctuation.