The yuan is likely to steady over the next few months as authorities step up capital controls and the pace of US interest rate rises slows, according to one of Asia's biggest investment firms.

Nikko Asset Management said the Chinese authorities are unlikely to allow the current outflow of money from the country to continue unabated, although it doesn't discount a large one-off devaluation of the currency.

China's foreign currency reserves fell by $US99.5 billion ($139 billion) in January, as the government sought to prop up the yuan and stem capital outflows. According to Societe Generale, total reserves have fallen $US663 billion since the middle of 2014.

To defend or let go ... Chinese authorities are caught between financial deregulation and currency control. Photo: Jeremy Favre

Although the world's second-biggest economy still boasts the biggest reserves of foreign currency, the decline over the past six months has left them at their lowest level in almost four years. 

A sharp devaluation of the yuan in August sparked global market unease, which has still not fully dissipated. It also set off a gradual 6 per cent depreciation of the currency against the greenback, which has since retraced a little.

On Wednesday, the US dollar was buying 6.5255 mainland-traded yuan, up slightly after the People's Bank of China (PBoC) fixed the currency in line with falls in overseas trade on Tuesday. 

The greenback has gained about 5 per cent against the yuan since August.

Devaluation '20pc chance'

Beijing announced late last year it was loosening its traditional US dollar peg in favour of a tie-up with a trade-weighted basket of currencies. 

The yuan has held steady and firmed a little since the beginning of this year, mainly thanks to the US dollar weakening amid resurgent doubts about the economy and monetary tightening.

However, Beijing's defence of its currency at a time when it is supposed to be liberalising its financial markets and capital account – as part of its commitment to special drawing rights (SDR) status from the International Monetary Fund – remains the focus of investors and commentators around the world.

"My view had been that there was a very small chance of a one-off devaluation, but I now think that the probability is closer to 20 per cent," wrote Nikko's senior portfolio manager for Asian equities Rob Mann this week.

"The PBoC is trying to stabilise the basket and hopes that by doing so they will substantially slow the capital outflow," he said.

"The question is how much of the foreign exchange reserves the PBoC is prepared to use while pursuing this policy and what it regards as a minimum level."

Reversal of carry trade

The firm's chief global strategist John Vail argues that current outflows are being led by the "reversal of huge carry trades", where companies and investors borrow in one currency at low interest rates and invest in another at a higher rate.

When the original currency starts to appreciate because of rising interest rates – as is the case now with the US dollar – borrowers rush to repay their foreign-denominated loans.

This reversal of the carry trade in China is now "halfway" through, according to Vail, meaning "the worst should be over from that perspective".

"China could always force companies to put the remainder of these into some kind of 'bad bank'," he argues,"rather than unwind them hastily." 

"Tougher capital controls . . . should stop Chinese companies from buying overseas companies or assets and would likely curtail tourist spending further," he said.

"The crackdown on anti-controls evasion will intensify and the SDR and capital liberalisation efforts will be de-emphasised."

This, coupled with a slower pace of monetary tightening by the US Federal Reserve, should staunch the flow of capital from China and take pressure off the yuan, he argued.

The PBoC can only hope that this scenario materialises, by Societe Generale's reckoning.

"We estimate that if capital outflows maintain their current pace, the PBoC would be unable to defend the yuan for more than two to three quarters," the bank wrote this week.

Its worst-case scenario is a sharp, 15 per cent devaluation of the yuan after the PBoC stops spending reserves on defending the currency.

This possibility has piqued the interest of high-profile billionaire investors such as Kyle Bass and George Soros, who have bet on further falls in the currency.

In fact Mr Soros, who made a fortune on the British pound's collapse in 1992, has been singled out by Chinese authorities for his short-selling strategy.

 "Soros's war on the [yuan] and the Hong Kong dollar cannot possibly succeed – about this there can be no doubt," trumpeted the overseas edition of the People's Daily last month.