China Sends Warning on Yuan Rally by Cutting Cost to Short

(Bloomberg) -- China’s policy makers are pushing back against a surge in the yuan by lifting rules that made betting against the currency expensive.

Effective Monday, financial institutions will no longer need to set aside cash when buying foreign exchange for clients through currency forwards, the official Financial News reported, citing a People’s Bank of China notice. Previously, banks had to hold 20 percent of sales at zero interest for a year -- a rule imposed in October 2015 as the authorities struggled to contain the fallout from the yuan’s devaluation. The central bank has also removed a reserve requirement on yuan deposited onshore by overseas financial institutions, the newspaper reported.

The news drove the currency lower, with the yuan falling 0.54 percent to 6.5240 per dollar as of 6:09 p.m. in Shanghai, and down 0.5 percent in Hong Kong. The PBOC emailed a statement which cited the head of its financial research institute as confirming the easing of the rules, although it didn’t specify the timing. It’s necessary to be more neutral on foreign-exchange policy because the yuan is at a reasonable level, the market is more rational and cross-border flows are more balanced, Sun Guofeng was cited as saying in the emailed statement. The currency market will better serve the real economy as a result, he added.

“This is a clear positive step of stepping back on capital controls,” said Eddie Cheung, a strategist at Standard Chartered Plc in Hong Kong. “It can be argued that the recent yuan appreciation was too fast. The yuan may be a bit more rangebound in the near term than one-way as markets digest the impact of the move.”

The lifting of the restrictions is a signal that the government is growing uncomfortable with the pace of gains in the yuan, which has jumped more than 2 percent in the last two weeks. The move may also be a prelude to allowing greater two-way flexibility in a currency still strongly influenced by state directives, capital controls and a daily fixing rate.

The rolling back of measures also shows how far sentiment has shifted in the currency, which started 2017 under severe pressure after its worst annual loss in more than two decades. Since then, a slumping dollar, abating outflows, a change to the fixing mechanism and bets the government wants a strong yuan before next month’s Communist Party congress helped send buying momentum in the currency to the highest level in 12 years.

The amount of foreign exchange China banks sold to clients with forwards shrank to 51.2 billion yuan ($7.9 billion) in July from a peak of 497.4 billion yuan in August 2015, according to data released by the State Administration of Foreign Exchange.

While the step suggests policy makers have become more confident in the yuan’s outlook, it also shows how they continue to pull levers to guide the nation’s financial markets.

"As for the near-term CNY outlook, while assessing market pressures helps, interpreting policy intention is probably even more important," MK Tang, an analyst at Goldman Sachs Group Inc., wrote in a report.

Separately, the PBOC has been reducing its short foreign currency forward positions this year. A total of $5.4 billion -- or 90 percent of outstanding positions -- will mature this month. The current pile of $6 billion as of July is down from a peak of $45.3 billion in January.

"The fact that the PBOC didn’t roll over its forward positions shows the central bank’s confidence in yuan strength," said Iris Pang, Hong Kong-based economist at ING Bank NV. "After the currency’s gains so far this year, the PBOC no longer needs to keep these forward positions."

--With assistance from Helen Sun

To contact Bloomberg News staff for this story: Justina Lee in Hong Kong at jlee1489@bloomberg.net, Tian Chen in Beijing at tchen259@bloomberg.net.

To contact the editors responsible for this story: Richard Frost at rfrost4@bloomberg.net, Sarah McDonald, Robin Ganguly

With assistance from Justina Lee, Tian Chen