June 2, 2017 2:01 am JST

China's support bolsters yuan to 7-month high -- at a cost

Market manipulation annoys investors, weakens push toward international currency

YUSHO CHO, Nikkei staff writer

China is taking steps to control the yuan, including a new rate fixing formula announced May 26.

SHANGHAI -- The yuan appreciated to a seven-month high Thursday, showing that China's desperate measures to prop up its currency are working. But those market interventions have tightened liquidity in Hong Kong, grating investors.

In Shanghai, the yuan posted its fourth straight advance against the greenback, trading at 6.8061 per dollar as of 4:30 p.m. local time. Traders who used to buy the U.S. currency in anticipation of yuan depreciation have all but disappeared, said one person at an international bank's dealing room.

Back in January, the yuan weakened all the way to 6.9557 per dollar. But the Chinese currency has rebounded more than 2% since then, staging one of the sharpest comebacks since the People's Bank of China engaged in a series of reference rate cuts in August 2015.

The PBOC announced it was revising its reference rate formula May 26, fueling the yuan's buying spree. The central bank currently fixes the yuan based on the previous day's closing rate, but now will price in other factors as well in a way designed to curb volatility.

Yet authorities have revealed no details of that mechanism, prompting speculation that the yuan will be more at the mercy of the central bank's discretion. Beijing is clearly retreating from its goal of transforming the yuan into an international currency whose value is determined by market forces. But traders are still snapping up the yuan because the PBOC has shown its determination to prevent the currency's depreciation, a source at a major bank said.

That determination also affects the Hong Kong offshore yuan market. The overnight Hong Kong Interbank Offer Rate for the yuan jumped for the second day in a row Thursday to reach 42.8%, the highest since January. Chinese state-owned banks reportedly have purchased so much of the yuan that funding supplies have become more limited, creating an environment ripe for higher rates.

Several market players have a hunch about the central bank's intent. By pumping up short-term rates and procurement costs, hedge funds and other overseas speculators will find it more challenging to expand short positions against the yuan.

State authorities also are taking these defensive steps ahead of the two-day U.S. Federal Open Market Committee meeting starting June 13. If the Fed decides to raise policy rates, the spread compared with China would shrink, which may lead traders to dump the yuan again.

China repeatedly tightened capital controls through the end of last year, but pressures for yuan depreciation and capital flight remain, and the state is running out of options. Beijing also is countering U.S. President Donald Trump's claims that the yuan is undervalued.

While those in the market express understanding of the PBOC's intentions, they are sharply critical of the seemingly arbitrary means the bank will use to set the yuan. "It will be problematic to expand transactions if predictions are difficult," a representative of a major bank said.

"The yuan had been gradually moving toward a heavier focus on the market, but the new mechanisms have dimmed the prospects of it becoming an international currency," a source at an investment bank said. 

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