China Hits Bump on Road to an Internationalized Yuan

China's latest measures to shore up its currency and plug an outflow of capital risk setting back the long-held goal for an internationalized yuan.

The People's Bank of China said Monday that lenders in offshore yuan-trading centers will now have to lock away a share of deposits in its accounts, ending the exemption for foreign institutions in a push to curb speculation against the currency. That followed large-scale intervention in Hong Kong last week that sent yuan borrowing rates in the city soaring to a record as liquidity was temporarily crunched.

China is caught in a dilemma as it pushes toward eventually letting market forces determine the yuan's value, but in the short term clings to old government controls to defend the currency and prevent a capital outflow that could harm stability and dent economic growth. What's not clear is how the heavy-handed state measures will go over in the 20-odd yuan trading hubs that now stretch from Singapore to London to Toronto.

“In the past, the offshore market could work by itself to reflect market opportunities, but now it's a currency controlled by the PBOC,” said Iris Pang, a senior economist for Greater China at Natixis SA in Hong Kong. “Progress is stepping backward.”

Top leaders in Beijing are under increasing pressure to maintain confidence in the currency at the same time they fight off new threats from the second bear market in equities in seven months and contend with the slowest economic growth in a quarter century. The U.S. Federal Reserve made life even tougher by raising its main interest rate from near zero last month for the first time in seven years, pushing the dollar higher.

The PBOC reserves announcement shows outflows are a key concern, said Ding Shuang, chief China economist at Standard Chartered Plc in Hong Kong. Capital has exited for at least 10 straight months through November, while foreign reserves shrank last year for the first time since 1992, falling $513 billion to $3.33 trillion, amid defense of the yuan, also known as the renminbi, or RMB.

“Under capital outflow and exchange rate pressure, China will take a lot of measures in order to slow down capital outflows and depreciation even at the cost of temporarily slowing down RMB internationalization,” Ding said.

Several financial centers have set up yuan trading hubs outside China, a step that would help the world's second-biggest economy integrate further into global markets. The International Monetary Fund also has given its approval for reserve currency status for the yuan, which it will add to its Special Drawing Rights basket in October, alongside the dollar, yen, euro and pound.

More global yuan use dovetails with some of President Xi Jinping's biggest economic policy initiatives, from the “One Belt, One Road” plan to build new trade links to Asia and Europe by land and sea, and the $100 billion China-led Asian Infrastructure Investment Bank, which formally opened in Beijing last weekend with a ceremony led by Xi.

Premier Li Keqiang said in comments posted on a government website late Friday that China can maintain the yuan exchange rate “basically stable at a reasonable and balanced standard,” adding there's “no basis for a continued depreciation.”

Out of 135.7 trillion yuan ($20.6 trillion) of total financial institution deposits in China, foreign-banks account for about 0.9 percent of deposits, Citigroup Inc. analysts wrote Monday. Offshore bank deposits in mainland China amount to about 1.223 trillion yuan, they said.

While the PBOC didn't say what reserve ratios it will apply, assuming the same 17.5 percent rate for domestic banks would mean liquidity in the offshore currency falling by 255 billion yuan, according to Pang. Banks in Hong Kong would have to put away 151 billion yuan, followed by 55 billion yuan in Taiwan, 39 billion yuan in Singapore and 9 billion yuan in London, she estimates.

“The move will raise offshore RMB funding costs and help contain bets against the currency,” China International Capital Corp. analysts Yu Xiangrong and Liang Hong wrote in a note. “The new measure may mark the beginning of a process to reduce the regulatory gaps between markets, which may have negative impacts on the development of the offshore market.”

Bloomberg News

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