Slowing down the yuan
The flood of foreign capital into the mainland has led the authorities to attempt to put the brakes on the mainland's speeding currency
Derivatives traders are scaling back bets that the yuan will appreciate, as record capital inflows prompt mainland authorities to investigate possible fraud relating to export data and to require banks to boost their holdings of foreign exchange.
In a sign that traders see less value in the yuan, cross-currency swaps show they are willing to pay the most in a month to exchange payments denominated in yuan for those based in US dollars. The yuan has fallen 0.3 per cent to 6.1488 per dollar from a 19-year high on May 9.
China's currency regulator is investigating trade deals after a 93 per cent jump in exports to Hong Kong in March and US$197 billion of inflows to the mainland in the first quarter sparked concern that companies may have exaggerated shipments in order to transfer cash from abroad. Lenders on the mainland need to buy about US$57 billion to comply with new loan-to-deposit ratios for overseas currencies, Bank of America said.
David Loevinger, a former senior co-ordinator for China affairs at the United States Treasury who joined the investment manager TCW in Los Angeles last year, said: "While unlikely to reverse fundamental appreciation pressures, these measures are clearly meant to slow the pace of appreciation. In the short term, we are going to see more volatility."
The People's Bank of China weakened its daily reference rate for the yuan by 0.3 per cent since announcing a record fixing a week ago. The central bank allows the spot rate to diverge a maximum of 1 per cent from the fixing, which was lowered 0.04 per cent yesterday to 6.2096 per dollar.
Non-deliverable forwards due in a year traded at 6.2300 in Hong Kong, 1.3 per cent weaker than the exchange rate.
The State Administration of Foreign Exchange said on May 5 that it would send notices to companies whose goods and capital flows do not match, as well as those importing large sums of cash. The regulator also required Chinese lenders to limit foreign-currency loans to 75 per cent of deposits by the end of June.
Banks were sent into "knee-jerk" purchases of dollars for preparation to fulfil the new requirements, said Liu Dongliang, a senior analyst at China Merchants Bank in Shenzhen.
"There's not yet been any details on whether banks' offshore yuan holdings are counted as their positions, so there's still some uncertainty in the market," he said.
Banks need to buy about US$57 billion to meet the requirements, including about US$20 billion in the coming month, said Claudio Piron, Bank of America's Singapore-based head of emerging Asia foreign-exchange and fixed-income strategy.
The yuan fell 0.2 per cent in Shanghai the day after SAFE's announcement, the most this year. It rebounded 0.6 per cent in the following three days as Premier Li Keqiang pledged to come up with a plan this year that would allow investment capital to move more freely in and out of the country.
The validity of export data and a surge of capital flows into the economy have been questioned by economists at financial institutions including Bank of America and Nomura.
Shipments to Hong Kong increased 69 per cent year on year in the first four months of this year, including a 93 per cent jump in March that was the biggest in 18 years.
The mainland's customs administration said last month that officials were investigating possible fraud relating to the export data. Falsifying trade declarations "does exist, but is definitely not mainstream", it said.
Yuan positions at Chinese financial institutions stemming from foreign-exchange transactions, a gauge of capital inflows, surged by 294.4 billion yuan (HK$368.2 billion) last month.
The first-quarter increase of 1.22 trillion yuan was more than four times the rise a year earlier.
The one-year cross-currency swap has increased 0.41 percentage points this month, heading for the biggest increase since August. It reached 3.03 per cent in November, the highest closing level since the contracts began trading in 2010.
Three-month implied volatility for the yuan, a measure of expected moves in the exchange rate used to price options, is climbing at the fastest pace among Asian currencies in percentage terms this quarter.
The measure jumped to a seven-month high of 2 per cent yesterday, from 1.3 per cent at the end of March.