The Battle for the Yuan: How China's Big Mama Hurt Speculators

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What Tools Does China Have to Fix Economy?
  • PBOC tackled yuan speculators over December and January
  • Officials warn that short bets on the yuan will fail

Chinese officials are using military analogies to describe the People’s Bank of China’s bruising attack on speculators who were betting against the nation’s currency.

Take Wang Yong, an academic at the PBOC’s training school. He urged policy makers to gird for a "tough battle" and the government to stock up on grain, oil and gold as they fight to keep the yuan stable. Or Mei Xinyu, a researcher at the Ministry of Commerce, who wrote in a commentary on the front page of the overseas edition of the People’s Daily that billionaire investor George Soros’s "war" against China won’t succeed.

For traders in Hong Kong at the sharp end of the PBOC’s recent actions to prop up the currency, that kind of language fits the mood.

QuickTake The People's Currency

"I can’t forget the date," said Ryan Lam, the Hong Kong-based head of research at Shanghai Commercial Bank Ltd. "January 12, 2016."

That was day two of a multi-pronged assault when the PBOC swept into Hong Kong’s money markets to hoover up yuan and shove interbank rates to record highs, forcing losses on speculators who were betting the currency would weaken. The message: take on Yang Ma as the PBOC is sometimes dubbed -- loosely translated as Big Mama -- at your peril.

"They wanted to say, ‘who’s the boss here,’" said Frederic Neumann, co-head of Asian economic research at HSBC Holdings Plc in Hong Kong.

While the PBOC’s actions dealt a blow to yuan bears, there’s a fair way to go before it kills them off. Twelve-month non-deliverable forwards for the yuan trade 4.6 percent weaker than the spot rate, a gap that’s narrowed from a seven-year high of 5.4 percent on Jan. 6. It averaged 3.4 percent in the fourth quarter and was 1 percent on Aug. 10, the day before a surprise devaluation.

The events early this year were just the latest in a series of sudden changes to China’s exchange-rate regime that have roiled global markets in recent months. August’s devaluation was followed in December by a decision to measure the yuan’s value against a basket of currencies, rather than just the U.S. dollar. Resulting yuan weakness in January fueled fears more was to come.

The pace of developments shocked investors and prompted policy makers from Vietnam to Washington to chide the PBOC for not communicating the changes clearly enough. Adding to a sense of panic: China’s economy is growing at its slowest pace since 1990, an estimated $1 trillion in capital flowed out last year, and stock markets in Shanghai and Shenzhen are in the midst of a renewed sell-off that has erased about $2 trillion in market value this year alone.

At the PBOC, preparation for the January push started toward the end of last year, when officials noticed unusual trading patterns in the yuan, according to people familiar with the plans. The central bank suspected that some were deliberately making a quick profit off the state’s back by arbitraging the difference between the value of the yuan traded in Shanghai and its value in Hong Kong, the people said, declining to be named as the deliberations are private.

Arbitrage Assault

That’s because China effectively has two exchange rates -- an onshore one tightly controlled by the government through a daily reference rate, and another offshore that’s traded more freely in Hong Kong and other centers. Offshore trading is meant to be part of a gradual process of eventually freeing up the yuan to the outside world.

In December, the PBOC curbed the arbitrage trades by temporarily suspending a select clutch of foreign banks, including DBS Group Holdings Ltd. and Standard Chartered Plc, from some foreign-exchange business in China, people with knowledge of the matter said at the time. Standard Chartered appealed for the ban to be shortened, said one of the people, who asked not to be identified because they’re not authorized to speak on the matter. DBS’s ban is shorter than three months, another person said.

As 2016 got underway, the PBOC stepped up its intelligence-gathering by asking Chinese banks and state-owned companies in Hong Kong to provide details on who was placing short-sell orders on the yuan. It was part of a deliberate, staged process to tackle speculators, according to people familiar with the matter. At the same time, the PBOC continued to defend the yuan in Hong Kong by selling dollars every time it fell to a certain level.

But it wasn’t always a smooth process. 

On Jan. 6, the PBOC shook markets when it set the yuan’s daily reference rate against the dollar at the weakest level since April 2011. The currency tumbled in Hong Kong the most since the day after the surprise devaluation in August and both exchange rates slumped to their weakest levels since at least March 2011 as markets interpreted the move as another deliberate shift. 

Those who had been betting against the yuan were being proved right.

The PBOC followed up with another nudge weaker at its fixing on Jan. 7, then stepped in to support the currency. The next day, policy makers brought the streak to an end, halting an eight-day run of weaker reference rates in a bid to restore some calm.

Back in Beijing, central bank officials were vexed by a surge in short selling and decided to act, according to the people with knowledge of those plans.

Pincer Move

The following Monday, the PBOC deployed a strategy that would hammer traders caught on the wrong side. First, officials told Chinese banks in Hong Kong to stop lending yuan offshore unless necessary in a move to suck liquidity out of the system. Then, the PBOC went in hard by buying yuan in Hong Kong and sparking a record surge in the city’s money-market rates in the Chinese currency to deter bearish speculators. 

On Jan. 11, the overnight Hong Kong Interbank Offered Rate surged 939 basis points to 13.4 percent.

“Chinese banks were absent from the market since Jan. 11, driving the interest rate to an unbelievable level," said Lam. "The market went into panic mode."

The next day, panic turned into mayhem. The cost to borrow yuan overnight in the city’s interbank market surged to 66.82 percent, almost five times the previous high.

Strong Words

The actions were accompanied by jawboning. In New York, Han Jun, the deputy director of China’s office of the central leading group for financial and economic affairs, told reporters on Jan. 11 that betting against the yuan will fail and described calls for a large depreciation as “ridiculous.”

“It is pure imagination that the Chinese yuan will act like a wild horse without any rein,” said Han.

By then, China had the market back in control, steadying the yuan in both onshore and offshore markets.

Inside the PBOC, officials were viewing their actions as a success and vowed to do it again if needed, according to people familiar with the matter. For good measure, state mouthpieces Xinhua News Agency and the People’s Daily followed up with commentary warning speculators that they haven’t done their homework and will fail if they take on the PBOC again.

The monetary authority has steadied its daily fixing in recent weeks, while the Hong Kong interbank rate has fallen back to the weakest level since mid-2013.

Yu Yongding, a former adviser to the PBOC, said that although the scale of the move on speculators was a surprise, he has "no complaints."

Aggressive Steps

As the dust settles, some argue the aggressive steps in Hong Kong ran contrary to a stated aim after winning reserve status at the International Monetary Fund to make the yuan a global currency.

"Investors may read these actions as an indication of despair, that the situation may be worse than what appears on the surface," said Alicia Garcia Herrero, Asia Pacific economist at Natixis SA in Hong Kong. "This is specially the case for measures that go against the spirit of China’s strategic goals."

Still, given that China is enforcing stricter capital controls on its own citizens to stem an outflow linked to expectations of currency weakness, the move to tackle foreign speculators is consistent with those steps, said London-based Stephen Jen, co-founder of SLJ Macro Partners LLP in London and a former IMF economist.

"Beijing has tightened capital controls further with regards to what the residents are doing," said Jen. "They would have to be tough with foreigners as well, right?"

— With assistance by Enda Curran, and Steven Yang

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