Picture: REUTERS/KIM KYUNG-HOON
FALLING: A clerk counts 100-yuan banknotes. The currency lost 1.5% to the dollar in onshore trading last week. Picture: REUTERS/KIM KYUNG-HOON

BEIJING — China’s financial system was "largely stable and healthy", the country’s foreign-exchange regulator said at the weekend in an effort to reassure global markets, as investors braced for a possible resumption of last week’s market turmoil.

Attention is likely to focus on China’s central bank and its management of the yuan this week, after the markets regulator appeared to stabilise last week’s stock sell-off by scrapping a controversial "circuit breaker" mechanism and extending a ban on share sales by large shareholders.

The yuan fell 1.5% to 6.59 yuan/$ in onshore trading last week — a sharp move for the carefully managed currency. Traders have largely ignored the central bank’s guidance that they should focus on the yuan’s stability against a basket of 13 currencies rather than volatility against the dollar.

Offshore the yuan fell 1.7% to 6.68 yuan/$, widening the spread between the two rates to a record level. The gap implies that international investors are pricing in further weakening of the onshore rate. Before the People’s Bank of China unexpectedly devalued the currency in August, the two rates traded at virtually the same level.

More recently, the People’s Bank of China has been letting the onshore rate weaken and intervening in the offshore market to limit the gap.

Separately, China’s State Administration of Foreign Exchange (SAFE) has been scrutinising banks that help clients arbitrage between the two — a move that some critics feel is inconsistent with the International Monetary Fund’s recent designation of the yuan as an official reserve currency under its special drawing rights (SDR) regime.

"We seem to be drifting back into a two-tiered (yuan) system and that is worrying," said an investment strategist, who asked not to be named.

"How can you be in the SDR and yet you penalise banks for arbitraging between the two rates? It’s outrageous and wrong. They shouldn’t be in the SDR and doing that. They should be making sure they continue liberalising to unify the two rates."

In a statement at the weekend, SAFE tried to reassure investors. "China’s economic fundamentals are strong," the regulator said. "Foreign exchange reserves are relatively abundant and the financial system is largely stable and healthy."

The People’s Bank of China last week blamed "speculative forces" for the yuan’s recent weakness against the dollar. Last month, China’s foreign exchange reserves fell a record $108bn — a number that reflects rising capital outflows, as well as the cost of intervention.

"Investors should not expect the authorities to keep running down the reserves to keep the (yuan) stable indefinitely against the dollar," Mansoor Mohi-uddin, a market strategist with RBS in Singapore, said at the weekend.

Over the past 12 months, China’s forex reserves have fallen more than $500bn, although many analysts argue this is not a concern, as the country currently holds far more reserves than comparable economies and can afford to let them run down further.

© The Financial Times 2016