A different beast

Renminbi: Investors in China's offshore yuan have had a rude awakening. Chinese currency traded in Hong Kong fell sharply on September 23 against the dollar. Yet, the onshore yuan, protected by China's capital controls, remains flat. Investors probably didn't expect the yuan to be buffeted by capital outflows in the way other Asian currencies have. This may pour cold water on the rapid development of the offshore market.

The Chinese yuan traded in the offshore Hong Kong market, known as the CNH, fell to 6.56 per dollar, implying a sizable 2.6 per cent discount to the onshore rate. Normally, offshore yuan, which is not freely exchangeable for the onshore kind, trades at a premium. That's because investors wanting to bet on China's managed currency appreciating have been aggressively buying CNH in Hong Kong.

Not only has that premium reversed, but there's little chance of China's authorities intervening in the way Brazil and Korea have done. After all, China is safeguarding its currency already, only within the country. That may be why the percentage drop in the offshore yuan in the past two days is even steeper than many other Asian currencies including the Korean won and Taiwanese dollar.

Until now the offshore market has expanded very quickly. Issuance of bonds denominated in yuan is already three times the amount issued in 2010, according to HSBC, even though they typically enjoy lower yields versus similar dollar bonds. Investors have counted on yuan appreciation to boost their returns, believing the Chinese currency is a one-way bet.

That pace of expansion may now slow as holders of offshore yuan realise Beijing has little reason to help them out. The overseas yuan markets are too small to affect the much bigger onshore markets. The Hong Kong traded yuan mostly serves as an experiment to see what would happen if Beijing removed capital controls. Investors should see this as a reminder that China's capital controls are still going strong, and the offshore yuan is a lot more risky than its onshore counterpart.