Yuan Onshore Forwards More Bullish Than Offshore for First Time

By Belinda Cao

Sept. 3 (Bloomberg) -- Traders of yuan forward contracts inside China are more bullish than those outside for the first time as overseas investors pared bets on the currency's gains versus the dollar.

One-year yuan non-deliverable forwards contracts, traded between international banks, yesterday declined 1 percent to 6.7490 per dollar in Tokyo, showing traders are betting on a 1.3 percent gain in the Chinese currency in the next 12 months. That compares with 6.7440 per dollar traded in Shanghai for similar- dated contracts, implying a 1.4 percent advance.

The reversal occurred after China reined in the yuan on concerns attempts to curb inflation through currency appreciation were hurting exporters. A smaller difference between forward rates reduces incentives for arbitrage by investors able to trade inside and outside of China, said David Mann, a strategist at Standard Chartered Plc in Hong Kong.

``There's a less obvious one-way bet over the longer term for the yuan,'' Mann said. ``Also the liquidity on the onshore market is rising.''

China had allowed the yuan to rise faster in the first half of 2008 as it sought to curb inflation and trim a record trade surplus with a stronger currency. Forward rates on Jan. 2 showed investors expected the yuan to gain 9 percent versus the dollar in one year's time. The currency strengthened 6.6 percent in the first half, following a 6.9 percent advance for the whole of 2007.

The yuan dropped for a second day against the dollar, sliding along with currencies including the euro and the pound on speculation cheaper crude oil will bolster economic growth in the U.S. China's currency fell 0.12 percent to 6.8476 per dollar as of 12:21 p.m. in Shanghai, from 6.8397 yesterday, according to the China Foreign Exchange Trade System.

Policy Shift

In August, policy makers switched focus to sustaining growth as well as cooling inflation, after expansion in the world's fourth-biggest economy declined for four straight quarters amid a global slowdown. Inflation slowed to 6.3 percent in July, from a 12-year high of 8.7 percent in February.

``The central bank may be satisfied with a gaining pace of 2 to 3 percent in a year,'' said Shi Lei, a Beijing-based analyst at Bank of China Ltd., the country's largest foreign currency trader. ``Overseas opinions are divided on the currency's pace of appreciation.''

China's currency fell 0.05 percent in August, the first monthly loss since May 2006 and closed at 6.8397 a dollar yesterday.

``The gap between the two market prices is at historically low levels now as offshore prices tend to move with those onshore,'' Shi said.

Negative Spread

The yuan's gains have only played a limited role in fighting inflation, said Zhang Xiaojing, director of the institute of economics at the China Academy of Social Sciences. ``The authorities have come to an agreement that they will no longer rely on fast yuan gains to stem inflation,'' he said.

The yuan spread between the two 12-month contracts today was minus 0.03 as of 1:45 p.m. in Shanghai, data compiled by Bloomberg showed. International traders cut bets on the currency's gains yesterday by the most in almost three months, making rates traded offshore weaker than those onshore.

The biggest difference this year between offshore and onshore rates was 0.23 yuan, reached in July. Yuan forwards weren't traded between banks in China until August 2005, when the government scrapped the currency's peg to the dollar.

Forwards are agreements to buy and sell assets at current prices for delivery at a specified time and date. Non- deliverable contracts are used for currencies that can't be freely converted and are settled in dollars.

Domestic Influence

China may need to let domestic banks trade non-deliverable forwards overseas to stress the influence of Chinese institutions in pricing forwards, Tang Liang, a currency trader at the Beijing Branch of Industrial and Commercial Bank of China Ltd., said in an interview.

He said the volume of yuan forwards traded by customers at his bank more than doubled in the first six months of 2008 from a year ago.

The yuan forward market is becoming more like that of the other currencies where it's normal for the onshore market to be more liquid and have more influence in driving markets, according to Mann at Standard Chartered.

``It's returning to normality now as it's abnormal previously for the offshore market to have more influence,'' he said.

To contact the reporter on this story: Belinda Cao in Beijing at lcao4@bloomberg.net