China central bank stops offshore lending to support yuan
SHANGHAI (Reuters): China has banned banks in its ground-breaking free trade zones from certain lending activities to ease pressure on the yuan currency in offshore markets, two sources with direct knowledge of the matter said on Thursday.
The move comes as nervous global financial markets wait to see how much further China will allow the yuan to fall, after it weakened against the dollar for nine straight weeks, reviving memories of its jolting devaluation in 2015.
The restrictions, announced by the Shanghai branch of the People’s Bank of China (PBOC) on Thursday morning, have closed off channels used to deposit and lend yuan offshore through the trade zones as the currency plumbs 15-month lows, the sources said.
They prevent commercial banks from using some interbank accounts to deposit or lend yuan offshore through free trade zone schemes, the people said.
The notice to banks said the measures followed significant recent volatility in the offshore yuan CNH=D3, and are effective Aug. 16.
The move was aimed at tightening offshore yuan liquidity and making it more expensive to short the Chinese currency, traders said.
Bets on further losses in the yuan had jumped to an all-time high in late July as it continued to skid, according to a Reuters poll[ASIA/FXP], but investors have grown slightly more cautious this month after the PBOC tightened rules on trading currency forwards.
The yuan has been pressured by worries about the escalating Sino-U.S. trade war and signs of slowing in China’s economy. Rising U.S. interest rates are also giving a sustained boost to the dollar against most emerging market currencies.
The Shanghai branch of the PBOC did not immediately respond to a Reuters query on the matter.
Analysts and traders said that the value of offshore yuan loans and deposits affected by the new restrictions is unclear.
But Qi Gao, Asia FX strategist at Scotiabank in Singapore, said that “the signal is very clear, because if they prevent this (channel) it will push up … offshore yuan funding costs.”
He compared the PBOC’s action to the recent moves by the Hong Kong Monetary Authority to push up Hong Kong dollar borrowing rates by reducing banking system liquidity, which in turn supports the Hong Kong dollar.
“The mechanism and the impact is similar, pushing up funding costs to defend the CNH exchange rate,” he said.
The offshore yuan CNH=D3 has fallen more than 10 percent from late-March highs, while its onshore counterpart CNY=CFXS has fallen nearly 10 percent over the same period.
Several traders said news of the restrictions drove the offshore yuan higher on Thursday, as market participants rushed to purchase one-year forwards. One year dollar/yuan forwards in the offshore market CNH1Y= jumped to 820 points, the highest since June 29.
However, onshore liquidity remained ample, with onshore forwards for the same tenor CNY1Y=CFXS staying in negative territory.
The restriction on offshore yuan deposits and lending applies to some Free Trade Accounting Unit (FTU) businesses, though it is not meant to affect cross-border capital flows that reflect real demand, according to the notice.
FTU businesses were introduced through financial reforms in the Pilot Free Trade Zone in Shanghai, and are managed by Chinese banks separately from their ordinary domestic accounts.
The zones have been touted as landmarks for China, serving as test-beds for financial reforms and its goal of further opening up the economy.
The restrictions introduced on Thursday are the latest in a series of moves by the PBOC to support the yuan, which has lost about 5.7 percent against the dollar so far this year.
While there have been no indications of the central bank stepping into the market directly, it has sought to manage market expectations about the yuan.
In late July, traders reported seeing large state-run Chinese banks swapping large amounts of dollars for yuan in currency forwards, tempering depreciation expectations by containing the price of yuan in the forwards market.
State-run banks are widely believed to often act on behalf of the PBOC in the market.
The PBOC has also required banks to keep reserves equivalent to 20 percent of their clients’ foreign exchange forwards positions from August 6, and said it would take counter-cyclical measures to keep foreign exchange markets stable.
Such moves are seen as likely to give support to the yuan in the near term, but market watchers say trade tensions between the U.S. and China will continue to weigh on the onshore and offshore yuan.
“Without a trade deal achieved between the U.S. and China, such kinds of measures can only slow the yuan depreciation, but cannot turn the direction (around),” Gao said.