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Exclusive: China central bank bars some offshore lending in latest move to support yuan

By Winni Zhou, Zheng Li and Andrew Galbraith
FILE PHOTO: A China yuan note is seen in this illustration photo May 31, 2017. REUTERS/Thomas White/Illustration/File Photo

By Winni Zhou, Zheng Li and Andrew Galbraith

SHANGHAI (Reuters) - China has banned banks in its ground-breaking free trade zones from certain lending activities to ease pressure on the yuan currency in offshore markets, two sources with direct knowledge of the matter said on Thursday.

The move comes as nervous global financial markets wait to see how much further China will allow the yuan to fall, after it weakened against the dollar for nine straight weeks, reviving memories of its jolting devaluation in 2015.

The restrictions, announced by the Shanghai branch of the People's Bank of China (PBOC) on Thursday morning, have closed off channels used to deposit and lend yuan offshore through the trade zones as the currency plumbs 15-month lows, the sources said.

They prevent commercial banks from using some interbank accounts to deposit or lend yuan offshore through free trade zone schemes, the people said.

The notice to banks said the measures followed significant recent volatility in the offshore yuan , and are effective Aug. 16.

The move was aimed at tightening offshore yuan liquidity and making it more expensive to short the Chinese currency, traders said.

Bets on further losses in the yuan had jumped to an all-time high in late July as it continued to skid, according to a Reuters poll[ASIA/FXP], but investors have grown slightly more cautious this month after the PBOC tightened rules on trading currency forwards.

The yuan has been pressured by worries about the escalating Sino-U.S. trade war and signs of slowing in China's economy. Rising U.S. interest rates are also giving a sustained boost to the dollar against most emerging market currencies.

The Shanghai branch of the PBOC did not immediately respond to a Reuters query on the matter.

Analysts and traders said that the value of offshore yuan loans and deposits affected by the new restrictions is unclear.

But Qi Gao, Asia FX strategist at Scotiabank in Singapore, said that "the signal is very clear, because if they prevent this (channel) it will push up ... offshore yuan funding costs."

He compared the PBOC's action to the recent moves by the Hong Kong Monetary Authority to push up Hong Kong dollar borrowing rates by reducing banking system liquidity, which in turn supports the Hong Kong dollar.

"The mechanism and the impact is similar, pushing up funding costs to defend the CNH exchange rate," he said.

LINE IN THE SAND?

The offshore yuan has fallen more than 10 percent from late-March highs, while its onshore counterpart has fallen nearly 10 percent over the same period.

Several traders said news of the restrictions drove the offshore yuan higher on Thursday, as market participants rushed to purchase one-year forwards. One year dollar/yuan forwards in the offshore market jumped to 820 points, the highest since June 29.

However, onshore liquidity remained ample, with onshore forwards for the same tenor staying in negative territory.

As of 0914 GMT Thursday, the offshore yuan