Offshore Yuan drops as China steps back from market intervention

After gaining for a while on government's intervention, offshore Yuan fell for three sessions in a row. The Chinese government seems to be moving back from supporting the weakening currency Yuan and restricting capital outflow.

Maybe the government is watching the free-float trading in currency. However, these supportive measures would give short-term gains of controlling capital outflow, but in the long-term it would be detrimental to the goal of internationalizing Yuan, observe market analysts.

Chinese currency Yuan is witnessing volatile trading in the mainland and offshore forex markets. After gaining last week, Yuan fell continuously for three days this week. The three-session drop was 0.34 percent and Yuan closed at 6.3778 a dollar. This was the major drop since August.

The intervention of China-backed funds and banks to prevent the further drop of Yuan is aimed at checking the capital outflow while maintaining a stable level for the recently devalued currency.

The Chinese currency offshore Yuan in Hong Kong eased 0.15 percent to 6.4658 on Wednesday. People's Bank of China (PBOC) has set daily reference rate at 6.3632.

Market sources attribute the reasons for the latest drop to Chinese central bank's limiting its role of intervention in the market.

The State Administration of Foreign Exchange has ordered financial institutions in Shanghai and Guangdong to step up checks in currency business.

Analysts feel that this is nothing but imposing a 20 percent currency reserve for institutions' currency forward sales. These 20 percent deposits have zero percent interest. The government has also imposed restrictions on fluctuations of Yuan to two percent on either side.

The offshore Yuan eased on Tuesday to 6.49 against the US dollar in Hong Kong trading. The continuous fall for three sessions indicates the weakening confidence of investors on Yuan.

Analysts feel that Yuan is likely to fall further and may continue to weaken by another three to seven percent in next one or two years.

Last week, the offshore Yuan rose in Hong Kong foreign exchange (forex) market. This was mainly aided by the involvement and support of Chinese government. The foreign exchange regulator The State Administration of Foreign Exchange has taken measures to prevent the capital outflow. Hong Kong is the main offshore forex center for the Chinese renminbi (RMB) center.

Forext analysts observe that reason behind minimizing the intervention of Chinese government may be to watch the measures on free-float Yuan effective to what extent?

Moreover, there's drop in forex reserves as well. The onshore market for Yuan has been stabilized for the moment. Supporting Yuan in global markets is putting more pressure on forex reserves of China.

The dragon country spent about Yuan 600 bn (GBP85bn) in August alone to support the falling the currency. China's forex reserves fell GBP83bn. It's estimated that Chinese government is holding about 10 percent of shares in the domestic stock markets.

Experts feel that these supporting measures would give short-term benefits. But, in the long-run, it'll work against the country's objective of internationalizing Yuan.