How will the central bank respond to the tide of foreign exchange settlement and appreciation wave?

Key Points

❖ Renminbi Exchange Rate Appreciation: How Do the Central Bank’s Attitudes and Toolbox Shape Up? By the end of 2025, the RMB exchange rate will break 7 against the US dollar driven by market forces. Although the accumulated foreign exchange settlement pressure earlier might trigger a positive cycle of “exchange rate appreciation → higher settlement volume,” the central bank has explicitly stated that it does not seek to gain competitive advantage through devaluation, nor does it want to allow a unilateral appreciation trend or herd behavior. Maintaining a “two-way floating” remains the policy tone.

❖ Reflecting on the experience of 2020-2021, the People’s Bank of China (PBOC) has a rich toolbox including expectations guidance, countercyclical factor adjustments, forward foreign exchange sale risk reserves, foreign exchange deposit reserves, and macroprudential parameters for cross-border financing. These operations are precise and restrained enough to handle overheating scenarios. For the issuance of central bank bills in September and December 2025, these are more tactical moves to respond to the phase strengthening of the US dollar or to guide corporate foreign exchange settlement, rather than deliberate efforts to promote RMB appreciation.

❖ What stage is the current foreign exchange settlement at? Despite trade surplus bringing significant settlement pressure, the current settlement mainly remains in the first stage of “commercial banks acting as agents for clients,” and has not yet entered the second stage of “central bank stabilizing the exchange rate to release base money.” Data shows that by December 2025, bank net settlement hits a new high, but the central bank’s foreign exchange reserves have not increased; instead, they have decreased, with high levels of M0 and M1. This indicates funds are accumulating within the banking system, not being converted into base money through central bank expansion, but rather foreign exchange deposits have been converted into RMB deposits, increasing statutory reserves and effectively consuming excess reserves, posing challenges to bank liability stability.

❖ How does the central bank respond to the settlement surge? Since 2017, the foreign exchange reserve balance has maintained narrow fluctuations, mainly reflecting proactive foreign exchange buy-sell activities by commercial banks with the central bank, indicating a diminished reliance on direct intervention via foreign exchange reserves to control the exchange rate. This approach aims to avoid being labeled a “currency manipulator” and to preserve monetary policy independence, preventing exchange rate stabilization from passively interfering with domestic liquidity. Given current pressures on bank liabilities and settlement trends, the central bank prefers to use active liquidity management tools such as MLF, MDS, government bond operations, and macroprudential measures like countercyclical factors and foreign exchange deposit reserve ratios, rather than passively expanding the balance sheet to buy foreign exchange.

❖ How does the exchange rate appreciation affect bond markets? Historically, RMB appreciation often coincides with rising interest rates, but in non-unilateral trends, domestic policies and fundamentals are the main drivers. For example, in 2021, despite RMB strengthening, the central bank maintained easing policies due to domestic structural transformation pressures, resulting in a bond bull market. Although the central bank has not yet allowed banks to settle foreign exchange, which might increase friction costs, as long as domestic fundamentals remain under pressure, it is likely to maintain a protective stance. RMB appreciation does not necessarily imply negative impacts on the bond market; interest rates will still be primarily driven by domestic factors, remaining at favorable low levels.

Main Text:

By the end of 2025, driven by market forces, the RMB/USD exchange rate will break 7. This is mainly because since May 2025, the China-US trade situation has eased, the US dollar index has weakened somewhat, and the RMB has appreciated against the dollar. Looking ahead, China’s large-scale market and complete industrial chain, accelerated integration of technological and industrial innovation, vigorous development of new growth drivers, continuous release of domestic demand potential, and smoother domestic-international dual circulation, combined with a long-term positive macroeconomic outlook, suggest steady RMB appreciation. Meanwhile, over the past three years, due to large trade surpluses and relatively low overall settlement volume, there has been significant foreign exchange settlement pressure. Under current RMB appreciation expectations, the settlement surge has begun, and the short-term surge in RMB demand can easily create a positive feedback loop of “exchange rate appreciation → higher settlement volume → further appreciation.” Will the RMB accelerate its appreciation further?

1. How Will the Central Bank Respond to RMB Appreciation?

1.1 What Is the Central Bank’s Attitude?

Some investors believe China might intervene due to export pressures, but export pressure alone does not justify the central bank’s “guidance of depreciation.” “China is a responsible major country; there is no need or intention to devalue the currency to gain a competitive edge in international trade.”

— Vice Governor Zou Lan, January 15, 2026

This reflects China’s consistent stance on the relationship between foreign exchange and exports.

“China does not seek to gain international competitive advantage through currency devaluation.”

— Vice Governor Zou Lan, July 14, 2025

The central bank will not intervene solely because of export concerns, but that does not mean it will allow the RMB to appreciate unrestrainedly. Currently, the main reason for intervention is to prevent unilateral trends and herd behavior, guiding the exchange rate to fluctuate in both directions.

“External circumstances remain complex and severe. The magnitude and pace of interest rate adjustments by major economies are uncertain, geopolitical shocks may persist, and these could cause some volatility in the exchange rate. The RMB exchange rate is expected to continue to fluctuate within a two-way band and remain flexible.”

— Vice Governor Zou Lan, January 15, 2026

“From the external environment, this year global economic growth is expected to be moderate, and major developed economies may continue to cut interest rates, which will help maintain the stability of China’s foreign exchange market. Of course, uncertainties and unpredictable factors still exist in international financial markets and geopolitics. We will continue to strengthen cross-border capital flow monitoring, enhance foreign exchange market resilience, improve macroprudential and expectation management, and maintain the steady operation of the foreign exchange market, keeping the RMB exchange rate basically stable within a reasonable range.”

— Deputy Director Li Bin, January 15, 2026

It is clear that a two-way floating remains the current policy tone. Given the RMB appreciation pressure, what tools does the central bank have, and what past experiences can be drawn upon?

1.2 What tools does the central bank use to intervene in RMB appreciation?

Overall, the central bank’s measures include expectation guidance, countercyclical factor adjustments, forward foreign exchange sale risk reserves, foreign exchange deposit reserves, and macroprudential parameters for cross-border financing.

During 2020-2021, facing the misalignment of domestic and international economic cycles after the pandemic shock, the RMB experienced a sharp shift from depreciation pressure to rapid appreciation. The central bank’s policy adjustments became flexible and precise, shifting from initial “expanding inflows” to later “preventing overheating,” with restrained and targeted use of tools.

1.2.1 2020: From “Facilitating Inflows” to “Returning to Neutral” Policy

In early 2020, the pandemic caused global financial turmoil. To facilitate cross-border financing and attract foreign investment to counter shocks, the PBOC and SAFE raised the macroprudential parameter for cross-border financing from 1 to 1.25 on March 11. This aimed to increase the cap for cross-border financing for enterprises and financial institutions, encouraging foreign inflows, which helped supplement liquidity and stabilize expectations amid RMB pressure.

However, in the second half of 2020, as China’s supply chain recovered first, RMB entered a strong appreciation cycle. The central bank then activated countercyclical tools to “correct” this trend. On October 12, it lowered the foreign exchange risk reserve ratio for forward sales from 20% to 0, significantly reducing the cost for enterprises to hedge forward, encouraging market-based demand for foreign exchange, and easing the unilateral appreciation trend.

By the end of 2020, appreciation pressure persisted, prompting further tightening of cross-border financing. On December 11, the central bank and SAFE adjusted the macroprudential parameter for cross-border financing back from 1.25 to 1, constraining the upper limit of cross-border financing, aiming to guide banks to adjust their foreign exchange asset-liability structure market-orientedly and curb procyclical capital inflows. Meanwhile, in December, the foreign exchange self-discipline mechanism intensified “risk-neutral” work, using macroprudential soft constraints to guide market participants to focus on “hedging value, not appreciation,” reducing speculative forex trading.

1.2.2 2021: Deploying “Heavyweight” Tools to Deeply Reabsorb Foreign Exchange Liquidity

In 2021, despite RMB’s overall strength and some volatility, the central bank upgraded its tools to better manage foreign exchange supply-demand and market expectations.

Early in the year, the central bank continued its “broad easing, strict control” macroprudential approach. On January 5, it increased the macroprudential adjustment coefficient for outbound loans by domestic enterprises from 0.3 to 0.5, supporting enterprises to “go global” and balancing cross-border capital flows. Just two days later, on January 7, it lowered the macroprudential parameter for cross-border financing from 1.25 to 1, returning to pre-pandemic levels, further restricting procyclical capital inflows.

Mid-2021, as RMB remained strong, the central bank activated a more powerful quantity tool—the foreign exchange deposit reserve ratio. On June 15, it raised the reserve ratio for foreign exchange deposits by commercial banks from 5% to 7% for the first time since 2007, directly locking in USD liquidity within banks and reducing foreign exchange supply.

However, the strong export-driven settlement volume continued to surge in the second half. To address this, regulators emphasized expectation management, reaffirming at the November 19 self-discipline meeting that financial institutions “must not assist enterprises in forex speculation, nor speculate themselves,” reinforcing risk neutrality. At year-end, the central bank again sharply increased the foreign exchange deposit reserve ratio by 2 percentage points from 7% to 9%.

This series of measures—reabsorbing USD liquidity, curbing unilateral appreciation expectations, and short-term settlement impulses—sent a clear policy signal: the central bank does not want a sustained unilateral trend and aims to maintain exchange rate stability at a reasonable and balanced level.

1.2.3 Other Tools for Exchange Rate Regulation

Besides these, the central bank can also guide market expectations through the countercyclical factor. Introduced in May 2017, the countercyclical adjustment factor is a macroprudential tool embedded in the RMB midpoint pricing model, designed to counteract procyclical market sentiment. When forming the daily RMB/USD midpoint, the quoting banks can adjust the previous close based on the countercyclical factor. When there are expectations of unilateral depreciation or appreciation, or deviations from fundamentals, the factor can buffer the impact. It is used flexibly: when depreciation pressure is high, a positive factor can boost RMB; when appreciation pressure is high, the factor can be reduced or temporarily halted to make the midpoint more market-driven.

In practice, during 2017, when RMB depreciated rapidly against the dollar, the central bank used the countercyclical factor to keep the midpoint slightly stronger than the market, stabilizing the RMB. In early 2018, when RMB began to appreciate rapidly, the central bank judged market expectations had become rational and adjusted the factor to neutral (almost inactive). Later, during RMB depreciation in late 2018 and pressure in late 2022, the countercyclical factor was partially reactivated to curb depreciation expectations.

Additionally, when the US dollar index strengthens or shows clear upward expectations, the central bank often issues central bank bills offshore to absorb RMB liquidity, raising the cost for speculators to short the RMB.

Some investors interpret the issuance of central bank bills in September and December 2025 as deliberate signals of RMB appreciation guidance. However, we believe that the September issuance was likely due to the phase strengthening of the US dollar (strong US economic data, increased volatility in Japan and Europe), as a response to offshore RMB depreciation pressure. The December issuance was relatively small and may have aimed at encouraging firms to settle foreign exchange to release accumulated foreign currency, but it is far from a deliberate effort to promote RMB appreciation.

1.3 Does the Surge in Foreign Exchange Settlement Mean the Central Bank Is Buying FX for Banks?

Since 2017, the foreign exchange reserve balance has generally fluctuated narrowly, indirectly confirming that the central bank’s FX intervention has shifted from quantity-based control to price-based control. The changes in foreign exchange reserves mainly reflect the proactive foreign exchange buy-sell behavior of commercial banks with the central bank, a market-driven activity. Since 2017, the reserve balance has remained within a narrow range of 21 to 22 trillion RMB, indicating that the central bank has largely ceased direct intervention through foreign exchange reserve operations to control the exchange rate.

Reducing the use of FX reserves aims to lower direct liquidity shocks to the market and avoid signaling overly strong policy intentions. Changes in FX reserves directly correspond to the injection or withdrawal of base money, a quantity-based monetary policy tool with significant influence and potential for market misinterpretation as a policy signal, which could cause volatility. The “quiet” trend after 2017 reflects a mature policy approach: avoiding passive interference with monetary policy independence under exchange rate stabilization. Under normal market conditions, the central bank prefers to use tools like the countercyclical factor, foreign exchange deposit reserve ratio, or offshore operations by large state banks, rather than directly using FX reserves.

Furthermore, avoiding the label of a “currency manipulator” is also an important consideration for maintaining stable FX reserve levels.

This strategic restraint not only avoids “copying others’ tricks” but also demonstrates to international markets the commitment to a market-oriented RMB exchange rate formation mechanism.

Specifically, from January 2017 to December 2020, the moderate decline in FX reserves was mainly due to external uncertainties causing capital flow pressures and the central bank’s shift in liquidity injection methods. During this period, trade frictions and global risk appetite fluctuations increased foreign exchange demand and reduced settlement willingness, leading to capital outflows or insufficient inflows. Meanwhile, the central bank shifted focus to actively injecting liquidity via tools like MLF, reducing reliance on passive FX reserve operations, resulting in a slight contraction of FX reserves without significant change.

From January 2021 to March 2024, the rebound in FX reserves was driven by strong trade surpluses and commercial banks’ foreign exchange reserve conversions. Post-pandemic export resilience and record-high trade surpluses provided solid foreign exchange supply. Additionally, some banks converted FX reserves into RMB, increasing “foreign assets—foreign exchange” on the central bank’s balance sheet, while “foreign assets—others” decreased.

From April 2024 to January 2026, the decline in FX reserves may be due to hedging banks’ selling pressure and moderate stabilization of the RMB. Market expectations of depreciation and capital flow disturbances at times still exist, and the central bank’s efforts to stabilize the exchange rate and manage cross-border flows may involve passive FX reserve consumption.

Does the central bank’s foreign exchange settlement activity affect banks’ settlement?

Settlement generally involves two stages: commercial banks acting as agents for clients’ settlement and the central bank settling with commercial banks. These stages have very different impacts on bank liquidity. The first stage involves banks responding to clients’ expectations of RMB appreciation, increasing foreign exchange assets on their balance sheets and converting foreign currency deposits into RMB deposits. Since the statutory reserve ratio for RMB deposits (about 9%) is much higher than that for foreign exchange deposits (4%), this process effectively consumes banks’ excess reserves, causing a temporary tightening of bank capital.

The second stage occurs when banks, for regulatory or risk management reasons, settle with the central bank at a stable rate, with the central bank’s foreign exchange reserves increasing and providing base money, leading to overall liquidity expansion.

Current data suggests that settlement still mainly remains in the first stage, with the central bank’s foreign exchange reserves still decreasing, while M0 and M1 have grown significantly. Although December’s net settlement was at a historical high, FX reserves did not increase substantially, indicating that the second stage of “central bank stabilizing” has not occurred on a large scale. From the monetary supply perspective, M2 performed better seasonally in December, and M0 and M1 remained high, reflecting that a large portion of settlement funds have been converted into cash, demand deposits, or held in money market funds, remaining within the banking system and market. This divergence of “high settlement” and “low FX reserves” confirms that funds are mainly accumulating at the bank level, not yet being converted into base money via central bank expansion.

In the first stage, banks may face liquidity pressure, which could be one reason for the central bank’s increased liquidity injection in January. Since settlement funds are mainly in the “agent” stage, the conversion of foreign exchange deposits into RMB deposits increases statutory reserve requirements, squeezing excess reserves and challenging bank liability stability.

Additionally, historically, the central bank’s FX reserve changes do not necessarily correlate directly with liquidity conditions, as monetary policy adjustments and macroprudential tools provide ample means to maintain reasonable liquidity levels.

2 How Will RMB Appreciation Affect Funds and Bond Markets?

Historical review shows that the relationship between exchange rate and interest rates mainly features the following characteristics:

First, interest rates and exchange rates are essentially two sides of the same coin—fundamentals and policy factors—domestically and internationally. Usually, RMB appreciation coincides with rising interest rates, and vice versa. Before 2014, due to weak marketization of the RMB/USD midpoint and expectations of unilateral RMB appreciation, the correlation was weak; but after the “August 11” reform, their trends generally aligned. Typically, improving economic fundamentals and tightening monetary policy push interest rates higher and support RMB appreciation; conversely, during economic downturns, RMB tends to depreciate and interest rates fall.

Second, exchange rate fluctuations can constrain monetary policy, indirectly affecting the pace of interest rate adjustments. While major countries prioritize internal balance, rapid unilateral exchange rate changes can influence monetary policy operations. For example, during the Fed’s rate hike cycle from December 2015 to January 2019, amid intensified US-China trade frictions and RMB depreciation pressures in 2018, the Fed continued to raise rates, but China’s monetary policy remained relatively stable, with only reserve requirement ratio cuts, and no rate cuts in 2018.

Regarding the current, does RMB appreciation necessarily imply pressure on the domestic bond market? Does RMB appreciation influence monetary policy?

We believe not necessarily—2021 is a good example.

Benefiting from China’s early recovery from the pandemic, rapid export growth, and strong settlement willingness, RMB appreciated in 2021. However, due to peak domestic fundamentals in the first half, structural transformation pressures, declining momentum in real estate and infrastructure, rising commodity prices increasing operational costs for downstream firms, and other factors, monetary policy gradually turned easing, with consecutive RRR cuts in July and December, maintaining stable liquidity. Meanwhile, declining old growth drivers increased asset shortage pressures, creating a bond bull market.

Therefore, in a non-unilateral exchange rate environment, domestic policy and fundamentals remain the main drivers of interest rates. Although settlement volume increased and the central bank’s systemic support for banks’ settlement is unlikely, as long as domestic fundamentals remain under pressure and the central bank maintains a protective stance, overall liquidity and bond markets are unlikely to be adversely affected. Interest rates will still be primarily driven by domestic factors, remaining at favorable low levels.