Casting fears aside, China chases yuan ambitions
To reach their goal of turning the yuan into a global currency, China's leaders are willing to push for full convertibility and eventually swing open the country's capital account.
That was the apparent message Chinese Vice Premier Li Keqiang delivered on his visit to Hong Kong last week, when he outlined a series of steps to boost the territory as a place where the yuan can trade with fewer constraints.
The measures, which include allowing foreign investors to buy up to 20 billion yuan ($3.1 billion) of mainland Chinese stocks and bonds, encourage foreign demand for yuan by giving investors more places to invest the currency.
To be sure, a freely convertible yuan isn't right around the corner -- China's leaders face an arduous journey that will involve numerous political and economic pitfalls.
"Things are all going as planned but an international yuan is four or five years away, at the earliest," said Mark Williams from Capital Economics in London. "To say right now how China's future currency regime would look is pure speculation at best."
China has already made significant progress in Hong Kong, its testing ground. The yuan is nearly convertible in that territory.
But, among other steps, China needs to first free its interest rate market, relax investment curbs in its equity and bond markets, and allow investment funds to leave and enter China with ease before the yuan can be made convertible.
Last week's announcements merely add up to another stride in China's long march toward the internationalization of the yuan, a goal that academics predict the country will reach by 2020.
"Li's visit sent a positive message. It set in stone the trend of yuan internationalization," said Zhang Zhiwei, chief China economist at Nomura in Hong Kong.
Having a convertible yuan -- or one that can be readily bought or sold with few restrictions -- is a precondition for Beijing's long-sought goal of promoting the Chinese currency as one used for global trade and investment.
That would burnish China's rising economic prowess and could also help China kick its dollar addiction by staunching a rapid build-up in its dollar reserves.
By encouraging the free trade of the yuan in Hong Kong and creating new channels for that money to flow in and out of the mainland, Beijing is refining a template that could prove valuable once it decides to liberalize the currency more widely.
"It is an important step to develop the offshore yuan market Hong Kong," said Wang Jun, an economist at CCIEE, a government think-tank in Beijing. "The yuan can now go out of mainland China and also flow back."
Even before Standard & Poor's triggered a rout in world financial markets this month by stripping the United States of its top-notch debt rating, Beijing had already made clear it intended to relax its grip on the yuan.
Under the five-year plan unveiled in March, Beijing aims to expand the use of the yuan in international markets and "gradually make the yuan convertible on the capital account."
Its latest actions, including this week's move to let merchants across China settle trades in yuan, shows Beijing is acting on its yuan ambitions as planned, analysts said.
But the unprecedented cut in the U.S. debt rating made the task more urgent, since China keeps an estimated 70 percent of its $3.2 trillion foreign exchange reserves in dollar assets.
In theory, letting the yuan rise sharply would slow the accumulation of foreign exchange reserves, but such a move would threaten the country's export sector.
Enabling China's customers to use yuan to pay for imports is naturally more attractive -- if an American company pays for its shipment of toys in yuan, that transaction wouldn't lead to more dollars being added to China's foreign exchange reserves.
To get to the point where the yuan can be a truly international currency, China wants to use affluent Hong Kong to create a deep and liquid offshore yuan market where investors can trade yuan freely and get decent returns, and use the territory as a test-bed for nurturing global yuan demand and easing capital controls, analysts say.
Beijing is making progress
The yuan is already fully convertible in Hong Kong, where the pool of yuan deposits is estimated to hit 2-3 trillion yuan in coming years, paving the way for the yuan's full convertibility and setting the benchmark for China's reforms to make the onshore yuan rate more market-driven.
"They will first open up channel between the offshore and onshore yuan market, allow markets forces to find an equilibrium rate for the yuan on the offshore market, and then influence the onshore market," said Chen Xingdong, chief China economist at BNP Paribus in Beijing.
Until then, analysts say it is to early to judge if Beijing would allow a free yuan to emulate the Singapore dollar and trade in a managed float as that depends on how U.S. and European economies recover from their debt in coming years.
Of course, risks abound.
A top concern is that Hong Kong's exploding offshore yuan market may complicate Beijing's fight against inflation by attracting waves of speculative hot money into China.
"Along with increased renminbi convertibility and the opening of the domestic financial market, cross-border capital inflows would increase, posing a challenge to China's financial stability," a group of Chinese officials and researchers said in book on the internationalization of the yuan.
Another worry is that the plan could backfire: rather than shrink, Beijing's foreign exchange reserves might actually balloon.
With few of China's trade partners holding enough yuan on hand to pay for goods, more merchants might use the yuan to pay for Chinese imports than exports, said Mark Williams from Capital Economics.
This leave China's central bank saddled with even more foreign currencies -- mostly dollars.
But China appears willing to try its luck.
"China is building this step by step," said Dong Tao, an economist at Credit Suisse on Hong Kong.
"If you get your currency internationalized, you don't have to keep buying foreign currencies and you will have less reserves."
[Source: By Kevin Yao and Koh Gui Qing, Reuters, Beijing, 24Aug11]
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