China's fight to reverse its currency hemorrhage is about to hit a roadbump. The nation has only itself to blame.
The People's Bank of China plans to encourage lenders to sell more dollar debt offshore to slow a decline in foreign-exchange reserves, people familiar with the matter said on Monday. Chinese banks may find less buying interest offshore than hitherto, however, thanks to the same regulator.
Last week, the central bank told financial institutions in China to balance their external flows of yuan. The directions, given verbally, require lenders to show at the end of every month that the amount of outgoing Chinese currency matches the sum coming in, said people familiar with the matter.
The trouble for bond markets is that much of the money that leaves China comes back, often as investment in the dollar-denominated debt of Chinese companies. That helps explain how, in a year when the yuan dropped more than 6 percent -- its worst performance since the managed peg started to fluctuate -- the country set a record for dollar bond issuance.
The clampdown on remitting dollars and now yuan could choke that demand. This is happening just as the nation's banks want to issue more dollar debt to please regulators, and corporations do the same because they need to.
It seems that China is about to get a practical lesson on the most basic rule of capitalism. Limited demand with more supply can only mean lower prices. In bond terms, that means higher yields, which have the nasty trait of going viral and infecting similar securities.
While trying to avoid a currency crisis, Beijing may be about to create a funding crunch.
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