November 18, 2015 / 6:36 AM / in 4 years

REFILE-UPDATE 2-China tightens offshore yuan market to slow outflows, rates rise

(Corrects to add Beijing in dateline)

* Central bank gives ‘window guidance’ from Friday - trade source

* Move will make it more difficult to shift funds offshore

* Offshore borrowing rates rise this week

By Hongmei Zhao and Pete Sweeney

BEIJING/SHANGHAI, Nov 18 (Reuters) - China has moved to restrict trade at offshore yuan clearing banks, sources told Reuters on Wednesday, stepping up capital controls even as Beijing positions its currency for inclusion in the International Monetary Fund’s reserve basket.

The move suggests Chinese regulators still harbor concerns about depreciation pressure, which could put China’s IMF bid at risk, even though capital outflows eased in October.

It marks the latest in a series of steps by the central bank to control the market after a shock devaluation of the yuan in August spurred three months of dramatic capital outflows.

Three sources with direct knowledge of the matter said offshore yuan clearing banks and related offshore participant banks had been instructed by the central bank to suspend trading in bond repos and yuan account financing.

“We received window guidance from the central bank on Friday,” a trader at an offshore yuan clearing bank said. “We have already temporarily suspended trade in account financing and bond repurchases with onshore banks.”

The problem is that different policy goals - the desire to get the yuan into the IMF and the need to support flagging growth - appear to be working at cross purposes.

“I think this action runs contrary to recent forex market reforms, given that the central bank is trying to internationalise the yuan and boost demand for the currency,” said a trader at a foreign commercial bank in Shanghai.

“This action may curb speculation in the currency, but it is a little bit confusing why the central bank would take this move now.”

As the People’s Bank of China (PBOC) lowers domestic interest rates to combat slowing growth, it diminishes the currency’s relative attractiveness versus the dollar, especially as the Federal Reserve is expected to raise its rates soon.

As a result of the latest move, tightening liquidity has pushed the short-term HIBOR rate tracking offshore yuan liquidity in Hong Kong up by 36 basis points to around 4 percent.

While the offshore bond repo market is relatively small, the wider offshore yuan financing market - an umbrella term that describes a cluster of financing mechanisms facilitating cross-border movements of currency - is much larger.

Faxes and calls by Reuters to the PBOC requesting comment were not immediately answered.

RISING PRESSURES

In September, China’s foreign currency regulator started looking into corporate forex purchases. An official said foreign currency demand by some firms and individuals exceeded “the real and rational use” for the currency.

Since then it has also been accused of intervening in onshore and offshore markets, instructing state-owned banks to buy yuan to keep both the onshore yuan and offshore yuan stable at approximately the same level around 6.4 per dollar.

A strong yuan may help mute China’s foreign critics, who often accuse Beijing of suppressing its exchange rate to support its exports, but some believe China will be unable or unwilling to hold the line, expecting the currency to depreciate further as soon as the IMF decision is announced at the end of November.

Chinese central bankers have struggled to put a floor under the exchange rate since the yuan’s August devaluation, which shaved nearly 3 percent off the yuan’s value versus the dollar.

Intervention to stave off panic forced the central bank to drain China’s forex reserves at unprecedented rates, but the trend appeared to be halted in October, when the PBOC and commercial banks bought a net 12.9 billion yuan ($2.02 billion) of foreign exchange.

The yuan eased against the dollar for the first time since 2009 last year, shedding over 2 percent, and is down more than 3 percent so far this year.

Additional reporting by Shanghai Newsroom; Editing by Richard Borsuk and Jacqueline Wong

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