HONG KONG (Reuters Breakingviews) - China’s bruised offshore currency market is scarred for life. As the yuan nears 7 per dollar, its weakest since 2008, officials are attacking short-sellers exploiting opportunities in overseas derivatives trade. The People’s Republic is trying to manage what are, in effect, two currencies: that’s an unsustainable plan.
Beijing wants to promote the renminbi - the currency’s official name - as an alternative to the greenback to reduce forex risk for its companies and buffer U.S. monetary policy. Yet regulators routinely swat market forces to stem trends they deem excessive. Since many bets are placed in the offshore “CNH” market – as opposed to the onshore CNY - that is where officials often slap hardest.
Having one currency offering different exchange rates, in markets separated by capital account controls, means pricing differences can’t be easily ironed out. When Beijing reinstituted a reserve requirement in August, making it expensive to short onshore, speculation simply shifted to Hong Kong. In theory, bears could push the CNH above the psychologically important 7 per dollar level in advance of the CNY. If they do, the onshore market might follow it. That could set off capital flight, sabotaging attempts to stimulate domestic investment.
Whereas the CNH spot rate has obediently tracked the CNY this year, the spread between onshore and offshore derivatives began diverging sharply in July. By early October, the three-month CNH forward contract was nearly 600 points softer than spot, whereas the same contract onshore was 17 points stronger. The spread remains over 100 points wide.
People’s Bank of China Vice Governor Pan Gongsheng warned late last month that the central bank is back on the warpath against short sellers. That means Chinese state banks will come off the benches to bully offshore derivatives traders; the PBOC is already draining CNH liquidity via targeted bill issues.
But one speculator’s short position is another investor’s hedge. Every time China’s financial firepower demolishes a CNH short position, enthusiasm for holding yuan offshore takes a hit. There’s little point to an overseas currency market if Beijing can’t afford to let it act like one.
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