Yuan depreciation raises investment risks
Recent losses against the US dollar seen as a warning shot to squeeze out mounting speculative flows into the currency
The risks of investing in China's tightly managed currency have rocketed in the last two weeks, with a sudden state-mandated depreciation of the yuan acting as a stern reminder that Beijing will not tolerate aggressive speculation on the currency.
Market participants are in no doubt that the yuan's late February loss against the US dollar - including the biggest one week slide since at least 2007 - is a warning shot designed to squeeze out mounting speculative flows into the currency that analysts at Deutsche Bank reckon currently stand at US$500 billion.
"That's not what the [People's Bank of China] wants," Bernard Poignant, a member of the European Parliament and adviser to the Bank of China, told the South China Morning Post.
Poignant, formerly a banker with BNP and the Royal Bank of Scotland, said the offshore yuan market was "full of speculators" who should be squeezed out.
"I have a very dismal view on the [offshore yuan] market. It has been driven by speculation," he said.
"Investors were waiting for a foreign exchange rate increase and in addition to the interest rate [change]," Poignant said.
"Anyone investing in assets denominated in renminbi during the past four years, thanks to the revaluation … should have a 7 per cent return on average a year. That was a regular driver, but is it a good driver for the future?"
A steady appreciation of more than 30 per cent in the value of the yuan since its peg to the US dollar was officially broken in 2005 - and a steady 2 per cent to 3 per cent annual gain against the greenback in the last few years - has fostered the belief among many investors that the yuan is a one-way bet being engineered by Beijing.
The PBOC sets the daily reference point around which the yuan is allowed to trade, but the authorities say they want markets to play a greater role in setting its value.
They also say investors should anticipate greater two-way movement as the currency trades closer to its fair value.
That is a particular issue for domestic buyers of massively popular wealth management products - structured savings vehicles sold through banks that pay rates of interest two or three times above that of bank deposits.
Many mainland corporations have borrowed foreign currency at about 3 per cent in the offshore bond and loan market. That money has then been swapped in yuan and used to buy wealth management products from mainland banks which yielded between 6 and 10 per cent, according to Credit Suisse.
A sudden fall in the value of the yuan means foreign currency loans get more expensive to repay, putting fresh stress on corporate balance sheets that are already suffering as China's economic growth slows and external demand for the country's exports wilts.
As Beijing pushes ahead with the internationalisation of its currency, different yuan centres have been springing up across the globe to satisfy demand from investors keen to gets their hands on the yuan.
It begs the question: are the recent moves by China's central bank going to drive investors away?
Rongrong Huo, head of yuan business at HSBC Europe, said: "All we want to do is have a scheme that allows institutional investors to tap into China's onshore market, without any constraints.
"Ultimately, the onshore market and the offshore market will converge. China is definitely going that way."