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China Tries to  Keep the Yuan Desirable

The offshore yuan, an ostensibly free-floating version of the Chinese currency, strengthened in Hong Kong trading but the reason had little to do with market action and came after China boosted its efforts to make shorting the currency prohibitively expensive.

The People's Bank of China (PBOC) said it will require reserve ratios on yuan deposited on the mainland by foreign financial institutions beginning January 25th. The bank did not say what the ratio level would be, but according to Bloomberg, it would be the same as that applied to domestic institutions, 17.5 percent for major lenders.

The move will force institutions to keep a much greater amount of cash idle as backing for financial or speculative endeavors, reducing the funds available for, among other uses, shorting the yuan in Hong Kong trading.  The central bank did not specify how the new reserve requirements will be applied to the yuan deposits of overseas institutions.

Last week Chinese authorities reportedly drained the Hong Kong yuan market of liquidity, driving the overnight rate to over 60%. The purpose was to make it extremely costly to fund or initiate short positions in the yuan. The Hong Kong interbank offered rate for one-week money climbed 370 basis points to 11.9 percent on Monday. The one-month rate rose 251 basis points to 11.84 percent, on January 12th it had touched an all-time high of 15.74 percent.

The off-shore yuan (CNH) rose as high as 6.5739 in early Asian trading after appreciating 1.05 percent last week.  The CNH has fallen 6.57 percent to date against the U.S. currency from its 52 week high since the Chinese authorities began its surprise devaluation in August.

The official or on-shore yuan (CNY) is traded in Shanghai and is managed by the PBOC through its daily fixing level. The CNY is permitted to vary 2 percent on either side of the fix which is set by the central bank each day.  The yuan is quoted in terms of the number of yuan per USD, hence the higher the dollar/yuan rate the weaker the yuan and vice versa. 

The PBOC has also promised the International Monetary Fund as part of the deal including the yuan in its SDR basket, to keep the values of its two currencies in line. The spread between the CNY and CNH had widened to a record2.9 percent on January 7th in the aftermath of the official devaluation of the CNY. 

Premier Li Keqiang on Friday said that the nation wants a “stable” exchange rate and has no intention of stimulating exports through competitive currency devaluation, according to a Bloomberg news story.

 The People's Bank of China announced recently that the yuan will be measured against a basket of currencies rather than strictly versus the U.S. Dollar. The appreciation of the dollar over the past year and a half has dragged the value of the yuan higher making Chinese exports increasingly expensive and costing mainland manufacturers’ sales.  It was to correct this appreciation move that the PBOC began its summer devaluation.

The recent move to restrict yuan supplies in the offshore market through regulatory changes has come about because the alternative, direct intervention in the off-shore market to support the CNY by buying the currency and selling dollars, is becoming increasingly expensive. China's foreign-exchange reserves, the largest in the world, fell by a record $108 billion in December alone.

As Chinese economic growth slows and global GDP follows suit, markets have been willing to speculate that the government will be forced to devalue the yuan to remain export competitive. The combination of a falling yuan, declining resource demand from China and higher U.S. rates for the first time in nine years have played havoc with emerging markets equities and currencies.

The yuan devaluation has also spurred a massive capital flight from China as foreign firms attempt to get their funds out of the mainland before large losses in the yuan reduce profitability.  A total of $508 billion of capital left China in the August-November period according to a Bloomberg News story and estimate that includes funds held in dollars by exporters and domestic recipients of direct investment recipients.

Joseph Trevisani

Chief Market Strategist

WorldWideMarkets Online Trading

 

Charts: Bloomberg

CNY

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CNH

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