深夜的经济学|Late night economics: what did the People’s Bank of China do to the offshore RMB market?

The background:

China has two currency rates. One is onshore, which trades within a narrow band dictated by a central bank daily rate (the yuan is allowed to rise and fall by 2% of this fixed rate). The other is offshore, where the yuan floats freely and serves as an indicator of what markets think about the Chinese economy.

Since last August, when the PBoC declared a change to how it fixes daily yuan rates, which they say reflects market value, the yuan was expectedly devalued. But it was depreciating at much quicker pace than people had anticipated.

Caixin’s details on the change:
The new method, which officials said better reflects market value, links the daily rate to the currency’s closing price for the previous trading session. The fixing is a reference the central bank provides to interbank forex market traders based on the perceived value of the yuan. It is a mid-point from which daily spot trading prices for the yuan are allowed to deviate by 2 percent in either direction.

Dreading further depreciation of the yuan, those with offshore yuan holdings started selling. Then you had speculators who sought profit from the weakening yuan by short-selling their yuan holdings, and the gap between onshore and offshore yuan widened to a record. (Besides the fact that offshore is free floated and onshore isn’t, the fact that capital can’t come out freely from mainland once in, has contributed to the widening gap).

Details on short-selling CNH (offshore RMB in Hong Kong):
Known as “carry trading,” it has become popular practice for speculators to swap borrowed offshore yuan for dollars, then rebuy RMB when it has depreciated, pay off the loan and keep the remainder. Only made possible since August when the RMB started depreciating.

All this had led offshore RMB to become significantly more devalued than onshore RMB, with the gap widening to over 1,300 basis points (in November it was about 300).

What the PBoC has done is to stop short-sellers by raising the interest rate at which they can borrow CNH. It has done so by selling its massive foreign exchange reserves and buying up offshore RMB through state-owned banks in Hong Kong. Hibor (Hong Kong Inter-bank Offered Rate) went to record highs of 66.8% on January 12.

The RMB has now stabilized at 6.58 against the dollar.

But the move has not been without costs. Countering short-selling in such a manner reduced FOREX reserves, which last year shrank for the first time by 500 billion USD to 3.3 trillion. At a time when, Chinese companies are still saddled with 1.53 trillion dollars in foreign debt, most of which are also short-term.

But as China’s economic transition continues (as well as the ups&downs of the stock market), the expectation is further depreciation, and that means more intervention of that nature is likely.

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