Exclusive-China asks banks to limit some Connect bond outflows – sources

SHANGHAI/BEIJING (Reuters) -China’s central bank has asked some domestic banks to scale back their outward investments through the Bond Connect scheme, two sources with direct knowledge of the matter said, adding to several recent measures aimed at propping up the Chinese yuan.

The window guidance from the People’s Bank of China (PBOC)seems to be aimed at containing yuan flows into Hong Kong, and limiting the supply of yuan in offshore markets, the sources said.

It is the latest in a raft of recent efforts to stem the yuan’s slide and comes as China’s financial markets suffer losses and heavy outflows.

The guidance “could reduce mainland capital flowing out through the bond market,” said Ken Cheung, chief Asian FX strategist at Mizuho Bank. “And it could also drive offshore yuan yields higher to support the renminbi.”

The southbound leg of the two-year-old Bond Connect scheme allows mainland institutional investors to purchase bonds traded in Hong Kong.

“Restricting yuan from flowing to offshore market could tighten offshore yuan liquidity to raise the financing cost,” said one of the sources, who reckons the central bank’s move is a strike against foreign yuan bears.

Both sources spoke on condition of anonymity as they were not authorised to talk to the media. The PBOC declined to comment on the content of the window guidance.

The directive is the latest in a volley of measures China has taken to defend a currency that’s been beaten down by a weak economy and capital outflows. The currency, which is down about 5% against the dollar this year, hit a 10-month low of 7.3498 per dollar last week; it has since firmed to trade at 7.2865 on Friday.

Several measures have been aimed at raising the cost of shorting the yuan offshore.

China’s state-owned banks have taken steps to squeeze yuan this week by mopping up cash from the market, other sources told Reuters earlier this week. They started lending less to their peers, and then they were seen actively trading sell/buy swaps in the forwards market to absorb offshore yuan.

Increased yuan bill sales by China’s central bank in Hong Kong this week also helped tighten liquidity in the offshore market to help stabilise the yuan, a former central banker said.

The cost of staying short yuan, measured by short-term swaps, has shot up to 5.55%, levels last seen two years ago.

The PBOC has also been nudging banks to stop subscribing to Negotiable Certificates of Deposit (NCDs) issued by offshore banks, another step aimed at curtailing the amount of yuan in Hong Kong markets.

(Reporting by Beijing and Shanghai Newsroom. Writing by Vidya RanganathanEditing by Shri Navaratnam)