Date
22 July 2017
The People's Bank of China has issued new rules on calculating the reserve requirement ratio for onshore banks ahead of an imminent increase in US interest rates. Photo: CNSA
The People's Bank of China has issued new rules on calculating the reserve requirement ratio for onshore banks ahead of an imminent increase in US interest rates. Photo: CNSA

How Hong Kong is bracing for yuan volatility

Pressure is building on the Chinese yuan as the Fed increasingly moves toward another interest rate hike.

The Chinese central bank issued new rules on calculating the reserve requirement ratio (RRR) for onshore banks ahead of the imminent increase.

The new policy, which takes effect on July 15, calculates RRR based on the arithmetic average of banks’ daily outstanding deposits.

For overseas lenders with yuan funds in domestic banks, RRR will be calculated on the average of their daily outstanding deposits in the previous quarter.

The move shows the central bank is keen to avoid distortions in the real picture.

It will tighten liquidity management onshore and avert frequent fluctuations in cross-border capital flows.

The authorities are determined to manage yuan liquidity and stabilize exchange rate expectations.

The market has been relatively calm amid a weakening yuan and there have been no signs of impending panic.

The People’s Bank of China is ready to step in if the yuan encounters further depreciation pressure.

Investors should not be overly pessimistic.

Those who think the yuan will weaken further have been hedging their risks including issuing fake invoices to accumulate US dollars offshore, buying bitcoin or shorting Hong Kong stocks.

The Hong Kong market has a close correlation with the yuan-dollar exchange rate.

Meanwhile, the weaker yuan has bought some time for mainland manufacturers but also triggered capital outflows.

Encouraging first-quarter data provided some support amid signs the economy is still consolidating.

Yuan movement largely depends on the sustainability of a strong US dollar.

Some believe the rally is short-lived and, therefore, the yuan is unlikely to post sharp declines.

By contrast, some investors are betting heavily on yuan depreciation.

The price of bitcoin surged to its highest in nearly two years last week on the back of a rapid increase in trading, with 95 percent of activity in mainland exchanges.

Regulators are checking oil re-export deals to prevent companies from moving capital offshore illegally.

In recent weeks, yuan trading of NDFs (non-deliverable forwards) has surged to a five-month high, regardless of a stable price gap with the spot rate.

Many foreign investors are using NDFs to bet on yuan depreciation.

The Hong Kong market has fared reasonably well, bolstered by expectations of a smooth launch for Shenzhen-Hong Kong Stock Connect and the potential inclusion of A shares in MSCI.

However, some foreign investors are trying to dump Hong Kong stocks given the close link with the yuan movement.

It’s critical for the Chinese central bank to manage market expectations on where the yuan is going.

Hong Kong’s offshore yuan market is already a battlefield for global speculators trying to hedge the yuan.

Beijing is expected to ask Hong Kong regulators to be vigilant against abnormal capital flows and to watch out for signs of major currency speculation.

This article appeared in the Hong Kong Economic Journal on June 6.

Translation by Julie Zhu

[Chinese version 中文版]

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JZ/DY/RA

Senior investment banker

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