China's Central Bank Is Battling Investors at Home Over the Yuan

By Saumya Vaishampayan and Shen Hong Features Dow Jones Newswires

China's central bank is finding that some of the most stubborn yuan skeptics are lurking in its backyard.

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A tug of war between the People's Bank of China and investors in the country's domestic foreign-exchange market has played out almost daily in recent months, with the yuan consistently closing weaker than the level set by the central bank.

While the central bank's support has helped the yuan gain 2.2% against the U.S. dollar this year, after three years of declines, Chinese investors have been focusing in recent weeks on factors that could drag the currency lower in the coming months, traders say.

Many investors expect the Chinese economy to slow in the second half of 2017, as authorities try to cool the country's reliance on debt-fueled growth. That could force Beijing to rely on a cheaper yuan to turbocharge China's sizable export sector. The Federal Reserve, meanwhile, is predicting further U.S. interest-rate increases, which should boost the dollar against the yuan.

And while China has clamped down on capital outflows in recent months, there is still demand for foreign assets from Chinese people as they seek to diversify their wealth. That could exert downward pressure on the yuan.

Conversely, the central bank's chief objective is yuan stability, The Wall Street Journal has reported, as it seeks to keep the economy on an even keel.

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The tension is showing up in how the yuan trades inside China.

China's central bank sets the yuan's value against the dollar 15 minutes before trading starts at 9:30 a.m. each day. The currency is then allowed to trade 2% above and below that so-called fix.

In recent months, the yuan has usually started weakening from the fix once trading starts. On May 18, it closed 0.4% lower: A bigger one-day drop has happened just 10 times since the PBOC devalued the yuan in August 2015.

The downward pressure persisted until the central bank stepped in later that month, market participants say, directing state-owned banks to buy yuan and sell dollars. It also changed the way it calculates the fix by adding a "countercyclical" component that gives it more control over the currency.

The PBOC didn't respond to a request for comment.

The central bank's apparent intervention didn't shift Chinese investors' expectations for long. The yuan closed at a weaker level versus the central bank's fix for most of June. That has continued in July, though to a smaller degree, after another bout of suspected intervention by the central bank late last month. In all, the yuan has closed weaker than the fix on 25 of the past 29 trading days: It weakened 0.1% from the central bank's fix on Monday and 0.02% on Tuesday.

"Once the PBOC stops intervening, there's actually great pressure for the yuan to fall because the weak outlook of our economy and the financial risk we've accumulated are still hanging over our heads," said a Shanghai-based senior currency trader at a midsize local bank.

Chinese exporters, major players in the domestic currency market, appear unconvinced that the yuan will steady.

Deposits of foreign currencies at Chinese banks hit a record of $779 billion in May, according to data from Wind Info going back to 2002, suggesting that many big companies are parking their dollars at banks rather than swapping them into yuan.

The holdouts include companies such as Shenzhen-based Noncam Technology, a gaming-gadgets maker that sells 80% of its products to clients from the U.S. and Europe. Its chief executive, Frank Shen, expects the dollar to rise after the Fed's rate increases, while China may be pressured to devalue the yuan to boost exports.

"Any short-term fluctuations will not alter the longer trend of a stronger dollar," Mr. Shen said. "Everyone expects that the dollar will rise further."

The Chinese central bank's difficulties with the changing expectations of participants in the domestic market are striking in part because its main struggle in the past has been with overseas investors betting against the yuan in offshore markets, where the currency trades more freely.

On several occasions in the past 18 months, the PBOC has squeezed short-term borrowing costs for the yuan in Hong Kong, the main center for offshore yuan trading, making it expensive for investors to bet against the Chinese currency.

The message appears to have hit home with yuan skeptics overseas.

"We know when there's a major selloff in renminbi, the PBOC will intervene," said Edmund Goh, Asian fixed-income investment manager at Aberdeen Asset Management in Singapore, using another name for the yuan. Mr. Goh said he has been slightly overweight the yuan for a while.

"I would not want to bet against the PBOC," he added.

Yifan Xie contributed to this article.

Write to Saumya Vaishampayan at saumya.vaishampayan@wsj.com and Shen Hong at hong.shen@wsj.com

(END) Dow Jones Newswires

July 11, 2017 06:47 ET (10:47 GMT)