China’s covert strategy to manage its currency is exposing domestic banks to potential multi-billion-dollar losses, while providing hedge funds and other investors with lucrative profits, according to a report by Bloomberg.
At the core of this strategy are foreign-exchange swaps, which Chinese state-run banks have increasingly relied on to stabilise the yuan amid heavy selling pressure. There port cites unnamed insider as confirming that these swaps have allowed Chinese banks to accumulate short positions against the US dollar, totaling more than $100bn since last year.
The trades though, have led to distortions in the swap market, creating near risk-free returns of up to 6% for traders on the opposite side of the deals. While these returns have decreased recently, estimates suggest Chinese banks have faced paper losses ranging from $5bn to $16bn during the yuan’s sharp decline earlier this year.
This approach marks a shift in China’s currency management, a strategy adopted after a troubled 2015 devaluation that forced the government to spend $650bn in foreign reserves. By using state banks instead of direct central bank intervention, China has managed to support the yuan without depleting its reserves, avoiding scrutiny from international markets.
The report quotes Brad Setser, a senior fellow at the Council on Foreign Relations, saying that: “The benefit of using state banks for indirect intervention is clear. It hides the government’s role and avoids the public and international scrutiny associated with direct action by the People’s Bank of China (PBOC).”
While this tactic has shielded China’s reserves, it has also opened up opportunities for global investors, with roreign banks, hedge funds, and even offshore Chinese entities capitalising on the market inefficiencies created by these swaps. Leveraging these trades has enabled them to amplify profits, attracting multinational corporations and financial institutions alike.
The PBOC and China’s National Financial Regulatory Administration have declined to comment on the matter.
