Hong Kong Yuan Trade Tightens
 
Intervention by Beijing suspected as the cost for banks to borrow climbs above 5.5%
The most vibrant market for yuan trading outside mainland China has turned into a key battleground for Beijing to defend the Chinese currency.
Suspected intervention by Chinese banks in what is known as the offshore market in Hong Kong has led to a surge in the cost for banks in the territory to borrow yuan from one another. Investors and analysts believe the intervention—which they say likely has come at the behest of China's central bank—is aimed at thwarting bets against the Chinese currency, also known as the renminbi.
On Monday, the overnight interbank yuan borrowing rate in Hong Kong reached 5.5155%, its highest since Feb. 19. The rate breached 5% on Thursday, ending a nearly two-month stretch of relative calm, and has since remained at levels that traders characterized as
elevated.
Suspected heavy yuan buying by Chinese banks has helped squeeze a market that China had tried to foster just a few years ago as it looked to promote the yuan as a major international trading currency. It comes on top of other re-
cent measures from Beijing intended to support the currency, such as tightening restrictions on money flowing out of the mainland.
"It's pretty obvious that renminbi intemationalization has taken a back seat" to defending the currency, an exec-utive at one of China's top four state banks operating in Hong Kong said.
"The stated views and analyses are not true," the People's Bank of China said when asked for comment. It didn't elaborate. President Xi Jinping said last week that yuan liberalization would be carried out in an orderly way and China would continue to encourage the yuan's use abroad.
Yuan-related trading has been falling in Hong Kong since Beijing first put a squeeze on the market earlier this year, according to the latest data. Deposits denominated in the Chinese currency have dropped to 667.1 billion yuan ($99.9 billion) in July from a peak of just over 1 trillion yuan in December 2014,
according to the Hong Kong Monetary Authority. Yuan-bond issuance has dropped to $6.3 billion this year from $16.2 billion a year earlier, according to Dealogic.
The declining interest in using the yuan for trading and capital-raising has come as Beijing's priorities have shifted, with the Chinese economy losing steam after years of breathtaking growth—and steady yuan appreciation. Beijing first allowed the yuan to be bought and sold outside the mainland in 2010, in Hong Kong, still the world's major center for offshore trading in the currency.
Now, a more urgent task for China is to prevent the currency from falling too much and potentially further erod-ing investors' confidence in the economy.
Since early this year, China's central bank has been trying to let some air out of the yuan while trying to make sure that the descent doesn't become so fast as to trigger
excessive capital outflows. That strategy often risks getting derailed by investors who use the offshore market in Hong Kong, where the currency can be traded freely, to wager against the yuan. (In the mainland, the yuan is allowed to swing only 2% above or below the level set by the central bank each day.)
The more that bearish bets pile up on the yuan offshore, the more difficult it is for the central bank to control its descent These bets typically are enacted by traders who borrow the yuan overnight, and ex-change it for dollars, exchang-ing the money back the following day after the yuan has dropped—a practice known as short selling. A rise in overnight borrowing costs makes this a less-profitable trade.
Following a surprise weakening of the yuan's official rate by the central bank in early January, investors piled on bets against the currency in Hong Kong's market, causing a widening divergence between the yuan traded there and its mainland peer. Chinese authorities at the time responded by drastically tightening yuan liquidity in Hong Kong,    by   ordering   local
branches of Chinese state-owned banks to buy up the currency, sending the overnight yuan-borrowing cost to a record 66.8%.
Then, as now, downward pressure on the yuan—and upward pressure on the dollar— was exacerbated by expecta-tions the Federal Reserve soon might raise interest rates in the U.S.
This time around, many investors saw similar tactics from Beijing as bearish yuan wagers in Hong Kong rose ahead of a Group of 20 eco-
nomic summit in China last week. Some investors placed the bets in belief that China would have fewer incentives to hold the yuan steady after the high-level gathering, which Beijing had hoped would showcase the country's economic might.
"We see consistent interest in shorting" the yuan offshore, said Ben Sy, head of fbced income, currencies and commodities at J.P. Morgan Chase & Co.'s private bank in Asia. Mr. Sy said clients had started to inquire about putting on
such bets last month when the dollar was trading at 6.63 yuan in Hong Kong. The dollar was trading at 6.6913 yuan late Monday in the offshore market, down 0.1% from late Friday. "People are still looking for opportunities to put a bearish trade on," he said.
Such negative sentiment has resulted in the squeeze of yuan funds in Hong Kong's market in recent sessions, as many say Beijing is again putting those short sellers on alert.
"lt doesn't look normal to me," said Iris Pang, senior economist for Greater China at investment bank Natbris, part of France's Groupe BPCE. Tm more convinced [this is] intervention."
Despite growing depreciation pressure, many investors expect the Chinese central bank to try to prevent rapid weakening of the yuan—already the worst-performing currency in Asia this year— ahead of the yuan's forthcoming inclusion in the International Monetary Fund's official reserve-currency basket, scheduled for Oct. 1.
The PBOC's overarching goal is to "prevent any big eruptions," said Sean Chang, head of Asian debt investment at Baring Asset Management (Asia) Ltd.
—Carol Chan contributed to this article.