The rate at which banks charge each other to borrow yuan in Hong Kong surged to a record high Tuesday, with China's central bank thought to be buying huge amounts of the unit to fend off speculators.
The overnight Hong Kong Interbank Offered Rate (HIBOR) for the offshore yuan jumped 53 percentage points to almost 67 percent owing to tight liquidity. The one-week rate also surged to 33.8 percent from 11.2 percent.
But analysts say the move could backfire and further damage confidence in the Chinese economy, a key driver of global growth.
The surge comes as traders around the world grow increasingly worried about China's economy as it suffers a painful slowdown that has convulsed markets.
Beijing's decision last week to lower the value of the yuan against the dollar to a five-year low added to concerns, with the leadership's handling of the crisis being called into question.
This in turn has caused heavy selling of the Chinese unit, leading the People's Bank of China to step in to buy yuan and sell dollars, tightening liquidity.
Albert Leung, a Hong Kong-based rates strategist at Nomura Holdings said: "The PBoC's suspected intervention in the offshore currency market further tightened the liquidity. Yuan interest rates are expected to remain highly volatile in the next couple of days."
But economist Chong Tai-Leung, executive director of the Chinese University of Hong Kong's institute of global economics and finance, told AFP the intervention was a bad idea.
"I don't think it's a good method because you hurt your own economy, he said. "Rising interest rates may or may not curb speculation, but it will hurt investment."
Chong said the move could prompt a further sell-off in the country's stock markets, which have already fallen about 15 percent so far this year.
"The government is running out of tools. People will lose confidence and think the government may not have any more methods to control the stock market... in that case they will sell off," he said.
The rate rise lifted the yuan's value in Hong Kong, where it is more freely traded than on the mainland. Last week it was almost three percent below its rate in Shanghai.
"It's a conscious effort to make funding costs high for speculators," Andy Ji, a Singapore-based foreign-exchange strategist at Commonwealth Bank of Australia, told Bloomberg News.
"The Hong Kong Monetary Authority is notably absent from the market. They're trying to help the PBoC achieve its objective of converging the yuan spot rates."
The PBoC's decision in August to devalue the yuan by about five percent sparked a global rout that wiped trillions off valuations and shattered traders' nerves.
Last month the International Monetary Fund welcomed the yuan into its elite reserve currency basket, recognizing the ascendance of the Asian power in the global economy and boosting Beijing's dream of internationalising the currency.