The People's Bank of China restricts some banks' investments in Stock Connect bonds.


As China's financial markets suffer losses and significant capital outflows, overseas investors are impatient with the slow pace of economic stimulus. The central bank's demands show policymakers see the yuan exchange rate as urgent.

Two informed sources revealed that the People's Bank of China has asked domestic banks to reduce their investments in foreign bonds. This move is the latest effort by China to support the yuan exchange rate.

Sources claim that the directive issued this week demands banks to restrict their investments in foreign bonds under the Bond Connect program, aiming to limit the offshore yuan supply. This action is the latest in a series of measures to control the yuan exchange rate, intended to increase the cost and difficulty of shorting the yuan.

As China's financial markets have suffered losses and significant capital outflows, overseas investors are becoming increasingly impatient with the slow pace of economic stimulus measures. The central bank's latest mandate has heightened expectations among policy makers that the yuan exchange rate is a pressing issue.

At present, any significant monetary easing measures could further exacerbate pressure on the yuan to depreciate and accelerate capital outflow, with the yuan exchange rate being a key challenge in reviving China's economic growth prospects. Ken Cheung, Chief Asian Foreign Exchange Strategist at Mizuho Bank, stated that this guideline "may reduce the outflow of mainland capital through the bond market and increase the cost and difficulty for the offshore market to short the yuan, providing support for the persistently weak yuan against the dollar exchange rate.

The yuan has fallen more than 5% against the dollar this year, touching a ten-month low of 7.3180 yuan per US dollar last week, just a step away from the low during the 2008 global financial crisis. Although the offshore yuan exchange rate has shown signs of stabilization, the spread between onshore and offshore forward points (an indicator measuring the cost of borrowing yuan) has soared to a five-year high, indicating that short-sellers in the offshore yuan market are under pressure.

Another indicator of offshore liquidity, the one-month borrowing cost of yuan in Hong Kong, reached a nearly five-year high earlier this week. Xiaojia Zhi, Chief China Economist at Crédit Agricole, said that although liquidity indicators suggest that the short-selling pressure in the offshore yuan market remains moderate, the rise in this indicator is a warning signal for short sellers in the offshore market to take seriously.

Under the Bond Connect program, which has been in effect for two years, mainland institutional investors can purchase bonds traded in Hong Kong. As of the end of July, mainland institutional investors held approximately 426.98 billion yuan (about 60 billion US dollars) in offshore bonds.

It is currently unclear whether the central bank's requirement refers to the banks' own investments or those held on behalf of clients. However, data shows that overseas bond investments through Bond Connect decreased by 24.6 billion yuan last month.

In addition to the People’s Bank of China's directive to control the size of overseas bond investments, earlier this week, sources from two different institutions mentioned that the People's Bank of China has been urging banks to stop subscribing to transferable certificates of deposit issued by offshore banks, a move aimed at reducing offshore yuan transactions. One source mentioned that restricting the flow of yuan into offshore markets could tighten offshore yuan liquidity, raise financing costs, and strike at short-sellers in the offshore yuan market.

In recent weeks, to maintain the stability of the yuan exchange rate, the People’s Bank of China has, on the one hand, set the yuan trading range above market expectations, and on the other hand, has required state-owned banks to sell dollars and buy yuan in the London and New York markets. A former central bank official noted that although multiple measures have been taken to support the continuously weak exchange rate, they have not achieved the anticipated effect so far.

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Exchange Rate

The exchange rate refers to the price of one currency expressed in another currency, namely, the exchange ratio between two currencies.

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