 "Yuan soars as China steps up intervention")
China stepped up its defense of the yuan, buying the currency in Hong Kong and sparking a record surge in the city's money-market rates to deter bearish speculators.
The People's Bank of China repeatedly intervened in the offshore market on Tuesday, according to people familiar with the matter, following efforts to talk up the currency from two senior government officials on Monday. The yuan rose as much as 0.7 per cent versus the dollar in Hong Kong, briefly erasing its discount to the onshore rate for the first time since October. The cost to borrow yuan overnight in the city's interbank market surged to 66.82 per cent, more than five times the previous high on Monday, as PBOC purchases reduced supply of the currency.
By intervening in the Hong Kong market, the central bank is trying to curb bets on a rapid depreciation and close the gap between onshore and offshore rates - a condition for entry into the IMF's reserve-currency basket. While efforts to stabilise the exchange rate may ease investor concerns about a hard landing in the nation's economy, a sustained surge in offshore borrowing costs could undermine the ruling Communist Party's plans to make the yuan a key funding currency in international financial markets.
"The problem is that the yuan had become a one-way depreciation bet; this is a situation no policy maker wants to find themselves in and it's no surprise we have seen a step up in intervention - both actual and verbal," said Sue Trinh, head of Asia foreign-exchange strategy at Royal Bank of Canada in Hong Kong. "Whoever is short offshore yuan will be hurt most in the short-term."
The turbulence highlights the challenge for Chinese authorities as they seek to internationalise the yuan while maintaining some control over its value amid an economic slowdown. In Hong Kong, the biggest offshore yuan trading hub, deposits of the currency have dropped 14 per cent from a December 2014 record. Issuance of Dim Sum bonds - yuan-denominated notes sold outside of China - fell 38 per cent last year.
Betting against the yuan will fail and calls for a large depreciation are "ridiculous" as policy makers are determined to ensure the currency's stability, Han Jun, the deputy director of China's office of the central leading group for financial and economic affairs, said Monday in New York. He confirmed that the central bank intervened in the overseas currency market over the last two days to support the exchange rate.
The yuan rose 0.4 per cent in Hong Kong to 6.5842 a dollar at 4:40 pm local time. It traded at a 0.15 per cent discount to the rate in Shanghai, which weakened 0.1 per cent.
The PBOC's intervention was aimed at maintaining a stable currency and preventing speculation and arbitrage, said people familiar with the matter, who asked not to be identified because the move hasn't been made public.
Yuan borrowing costs in Hong Kong posted record jumps across tenors ranging up to a year. The Hong Kong Interbank Offered Rate fixing for one-week loans tripled to 33.79 per cent, while the one-month rate jumped by about seven per centage points to 15.74 per cent.
The increases make "short-selling the currency very expensive overseas," said Eddie Cheung, a Hong Kong-based currency strategist at Standard Chartered Plc.
Companies that need yuan for trade and investment can still get relatively cheap financing in China's onshore market. Interbank lending rates in Shanghai for periods up to a month are all below 3 per cent, the latest fixings show.
While the PBOC is flushing out wagers against the yuan, the currency is likely to keep depreciating over the long term, said Michael Every, head of financial markets research at Rabobank Group in Hong Kong.
The firm's year-end forecast of 7.60 per dollar is the weakest of 41 estimates in a Bloomberg survey. ABN Amro Bank NV, ranked by Bloomberg as the most-accurate yuan forecaster over the last four quarters, cut its prediction to 6.70 last week.
The PBOC also helped support the yuan on Tuesday by keeping its reference rate for the currency little changed for the third day in a row.
Last week's 1.1 per cent depreciation in central bank fixings heightened concern that the Chinese economy is weaker than official data suggest, driving the offshore yuan to a record 2.9 per cent discount to the onshore rate and roiling equity markets from Shanghai to New York.
Investors misunderstood the PBOC's intentions, according to Ma Jun, chief economist at the monetary authority's research bureau. The fixings are based on the previous day's closing price in Shanghai as well as changes in a basket of currencies, he said in comments posted Monday on the central bank's website, adding that downward pressure on the yuan is expected to ease.
Yuan Index
A Bloomberg replica of a yuan index composed of 13 currencies and published by the China Foreign Exchange Trade System fell 0.06 per cent to 100.52, after climbing 0.56 per cent on Monday. It's still down 2.8 per cent from where it was at the end of November, when the International Monetary Fund approved the yuan to be added to its basket of reserve currencies from Oct. 1.
The surge in Hong Kong borrowing costs will probably be temporary because the PBOC seems to have succeeded in efforts to narrow the gap between onshore and offshore rates, said Ryan Lam, Hong Kong-based head of research at Shanghai Commercial Bank Ltd.
"Given that the Chinese have achieved their target of narrowing the convergence between offshore and onshore, we could see the end" of the surge in rates, Lam said. "I don't see this as a start of a crisis, at least for now."
