BKEAY Bank East Asia Ltd (PK)

BEIJING—Having had it easy for a few months, the Chinese central bank is now coming under renewed pressure to steady the yuan and prevent money from leaving China's shores.

The culprit is the dollar.

The greenback's weakness in the past two months had given the People's Bank of China some breathing room to stabilize the yuan, reducing the Chinese appetite for foreign assets along the way.

But since the end of April, the yuan has depreciated 0.6% against the dollar, eroding the 1% gain the Chinese currency made over the previous two months.

The yuan's renewed weakness puts the PBOC back in a familiar juggling act: Its mandate to support growth requires it to pump credit into the economy, which tends to weaken the yuan. But it must make sure it doesn't weaken the currency so much that it worsens the flood of money exiting China.

Some economists and officials within China, including those at the government think tank China Academy of Social Sciences, have urged the central bank to let the market steer the yuan lower as China's slowdown deepens. But for officials at the People's Bank a bigger worry, at least for now, is the potential for ordinary Chinese to exchange their yuan assets for foreign currencies and take them out of the country.

The central bank is also wary of causing the kind of market gyrations that have twice in the past year resulted from its exchange-rate maneuvering. Most recently, in early January, an unexpected move by the People's Bank to guide the yuan sharply weaker against the dollar triggered a global market selloff.

The central bank "wants yuan stability in order to minimize the shocks to the weak economic momentum," said Chi Lo, China economist at BNP Paribas Investment Partners, the asset-management arm of the Paris-based bank.

To do that, it is trying to shift investors' focus on the yuan's movements against the dollar to its value against a broader group of currencies.

When the dollar declines, the central bank can keep the yuan largely flat or even slightly stronger against the greenback, while it still weakens against the basket of 13 currencies. But when the dollar advances, the central bank needs to guide the yuan weaker against it to safeguard the economy and keep the yuan stable against the basket.

The upshot: It can choose to keep the yuan stable either against the dollar or the basket. But weakening the yuan against the dollar could again exacerbate capital outflows and cause a return of bets against the Chinese currency, forcing the central bank again to dip into China's massive but dwindling foreign-exchange reserves to defend the currency.

In Hong Kong, where the yuan can be bought and sold freely, wagers against it have increased in the past few days among both hedge-fund investors and companies, according to analysts and traders. Prompting the bets, aside from the dollar's renewed strength, is growing investor concern over the rapid buildup of debt in China's economy and rising defaults.

Last month, even though banks reined in some lending, the country's overall credit still surged 17% year over year, thanks to a record 1 trillion yuan ($154 billion) in bond sales by various levels of government.

Meanwhile, more Chinese companies are defaulting on bank loans and bond payments. Analyst Francis Cheung at brokerage CLSA estimates that dud loans in China now represent as much as 19% of banks' total loans. That is well above the official nonperforming loan ratio of 1.6%.

Kenix Lai, a senior market analyst at the Bank of East Asia in Hong Kong, said the bank's corporate clients have been buying dollars and selling yuan lately as depreciation pressure on the Chinese currency has increased. The yuan that is traded in Hong Kong is now a tad cheaper than its more tightly controlled cousin traded in the mainland.

In recent months, the pace of outflows has moderated significantly, partly due to the dollar's softness and partly as Chinese authorities have stepped up controls over companies and on individuals seeking to take money out of the country

For instance, Greenland Holding Group, a large Chinese developer, has recently been told by Chinese authorities to limit its investments overseas, people close to the company said. The Shanghai-based firm had been encouraged to make such investments in the past, the people said.

A spokeswoman for the company said it doesn't want to comment on regulators' control on capital flows. Greenland "remains interested in a diversity of good investment opportunities overseas," the spokeswoman said in a statement.

Wang Tao, China economist at UBS Group AG, estimated that a net of $28 billion in funds left China last month, down from an estimated monthly average of $50 billion in the previous two months and more than $100 billion in January and December.

Even if the dollar continues to strengthen, the central bank has built a certain cushion against a dramatic fall of the yuan by letting it depreciate against the currency basket by more than 3% in the past two months.

Ms. Wang of UBS revised her year-end forecast for the yuan to between 6.6 yuan per dollar and 6.7 yuan a dollar, from her previous projection of 6.8 to the dollar.

Esther Fung and Dominique Fong contributed to this article.

Write to Lingling Wei at lingling.wei@wsj.com

(END) Dow Jones Newswires

May 16, 2016 07:25 ET (11:25 GMT)

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