China's latest measures to shore up its currency and plug anoutflow of capital risk setting back the long-held goal for aninternationalized yuan.

The People's Bank of China said Monday that lenders in offshoreyuan-trading centers will now have to lock away a share of depositsin its accounts, ending the exemption for foreign institutions in apush to curb speculation against the currency. That followedlarge-scale intervention in Hong Kong last week that sent yuanborrowing rates in the city soaring to a record as liquidity wastemporarily crunched.

China is caught in a dilemma as it pushes toward eventuallyletting market forces determine the yuan's value, but in the shortterm clings to old government controls to defend the currency andprevent a capital outflow that could harm stability and denteconomic growth. What's not clear is how the heavy-handed statemeasures will go over in the 20-odd yuan trading hubs that nowstretch from Singapore to London to Toronto.

“In the past, the offshore market could work by itself toreflect market opportunities, but now it's a currencycontrolled by the PBOC,” said Iris Pang, a senior economist forGreater China at Natixis SA in Hong Kong. “Progress is steppingbackward.”

Top leaders in Beijing are under increasing pressure to maintainconfidence in the currency at the same time they fight off newthreats from the second bear market in equities in seven months andcontend with the slowest economic growth in a quarter century. TheU.S. Federal Reserve made life even tougher by raising its maininterest rate from near zero last month for the first time in sevenyears, pushing the dollar higher.

The PBOC reserves announcement shows outflows are a key concern,said Ding Shuang, chief China economist at Standard Chartered Plcin Hong Kong. Capital has exited for at least 10 straight monthsthrough November, while foreign reserves shrank last year for thefirst time since 1992, falling $513 billion to $3.33 trillion, amiddefense of the yuan, also known as the renminbi, or RMB.

“Under capital outflow and exchange rate pressure, China willtake a lot of measures in order to slow down capital outflows anddepreciation even at the cost of temporarily slowing down RMBinternationalization,” Ding said.

Several financial centers have set up yuan trading hubs outsideChina, a step that would help the world's second-biggest economyintegrate further into global markets. The International MonetaryFund also has given its approval for reserve currency status forthe yuan, which it will add to its Special Drawing Rights basket inOctober, alongside the dollar, yen, euro and pound.

More global yuan use dovetails with some of President XiJinping's biggest economic policy initiatives, from the “One Belt,One Road” plan to build new trade links to Asia and Europe by landand sea, and the $100 billion China-led Asian InfrastructureInvestment Bank, which formally opened in Beijing last weekendwith a ceremony led by Xi.

Premier Li Keqiang said in comments posted on a governmentwebsite late Friday that China can maintain the yuan exchange rate“basically stable at a reasonable and balanced standard,” addingthere's “no basis for a continued depreciation.”

Out of 135.7 trillion yuan ($20.6 trillion) of totalfinancial institution deposits in China, foreign-banks account forabout 0.9 percent of deposits, Citigroup Inc. analysts wroteMonday. Offshore bank deposits in mainland China amount to about1.223 trillion yuan, they said.

While the PBOC didn't say what reserve ratios it will apply,assuming the same 17.5 percent rate for domestic banks would meanliquidity in the offshore currency falling by 255 billion yuan,according to Pang. Banks in Hong Kong would have to put away 151billion yuan, followed by 55 billion yuan in Taiwan, 39 billionyuan in Singapore and 9 billion yuan in London, she estimates.

“The move will raise offshore RMB funding costs and help containbets against the currency,” China International Capital Corp.analysts Yu Xiangrong and Liang Hong wrote in a note. “The newmeasure may mark the beginning of a process to reduce theregulatory gaps between markets, which may have negative impacts onthe development of the offshore market.”

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