The new Chinese regulation for foreign lenders that is helping its currency to rise

PUBLISHED : Monday, 18 January, 2016, 6:35pm
UPDATED : Monday, 27 June, 2016, 11:51am

The yuan strengthened on Monday after China’s central bank said it has asked foreign banks to hold more yuan reserves, in its latest move to drive away currency speculators.

Traders said the People’s Bank of China’s new measure would stabilise the currency but slow down its internationalisation. The PBOC has moved rapidly to prevent the yuan from falling too fast as mounting worries over the country’s economic slowdown has led to a capital outflow and devaluation of the currency, with some analysts predicting the yuan to depreciate by 10 per cent this year after shedding over 5 per cent last year.

The yuan was up in both onshore and offshore markets on Monday. Onshore yuan was trading at 6.5792, up 0.07 per cent, while offshore yuan was stronger by 0.27 per cent at 6.5967. The spread between the two at one point fell to zero on Monday. Offshore yuan was last trading at a discount of 175 basis points, compared with a record high discount of 1,400 basis points on January 7.

READ MORE: Currency crossfire: Yuan borrowing cost down as PBOC tames offshore yuan market in Hong Kong

The PBOC announced on its website that from January 25, all foreign banks in the country would be required to hold yuan reserves. Foreign banks operating in mainland China have so far not been required to maintain a specified reserve requirement like domestic lenders, who have to set aside 17.5 per cent of the deposits as reserves.

“The new measure was intended to prevent financial risk and protect financial stability as well as to strengthen the banks’ liquidity management,” the PBOC said.

Aggressive intervention by the central bank in the Hong Kong yuan market saw offshore yuan gain 1.01 per cent last week, bouncing back from a 1.75 per cent drop the previous week. The currency lost 5.76 per cent for the whole of last year.

The central bank last week stipulated mainland banks could not sell any yuan but only buy the currency. That move dried up the liquidity and sent offshore yuan overnight funding cost zooming to a record 200 per cent last Tuesday. The overnight interest rate has now gone back to 1.77 per cent but the one-week rate remains at a high 11.9 per cent, the two-week rate at 12.74 per cent and the one-month rate at 11.83 per cent.

“The PBOC’s recent intervention in the offshore yuan market may instil some short-term calm, but it is unlikely to change the trajectory of longer-term weakness,” said Heng Koon How, a foreign exchange analyst at Credit Suisse.

“Over the long run, we continue to expect more weakness in both the onshore and offshore yuan,” Heng said, adding Credit Suisse expects onshore yuan to weaken towards 6.80 to the US dollar by the end of this year.

Hong Kong Monetary Authority chief executive Norman Chan Tak-lam on Monday said that since Hong Kong has no reserve ratio requirements, the city would not enforce this rule for lenders here.

Speaking on the sidelines of the Asian Financial Forum, Chan said the new measures may reduce supply of yuan and push up the interest rate for offshore yuan. But he added the volatility in the offshore yuan market since the beginning of the year would not affect Hong Kong’s role as a trading hub for the currency.

“Offshore yuan borrowing cost may have shot up last week. But the market has operated smoothly. It is natural for any central bank to intervene in overseas markets to maintain the stability of their currency. This will not affect Hong Kong’s role as a free market for offshore yuan,” Chan said.

Secretary for Financial Services and the Treasury Chan Ka-keung said the yuan market may be volatile in the short term but that he believes the reforms and measures undertaken by the PBOC would help in a healthy development for the yuan market in the longer term.