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Archive
Cover Stories Series 2012> Q1 Economic Growth Stable> Archive
UPDATED: March 12, 2012 NO. 11 MARCH 15, 2012
Perfect Timing
China will gradually relax controls over the capital account and boost the yuan as a global currency
By Hu Yue
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"For China, it is necessary to keep a vigilant eye on cross-border financial transactions to prevent speculation and money laundering," he said.

"Another cause for concern is that many Chinese enterprises and residents have weak awareness about the risks of investing abroad," said Zhou. "So a pressing task of the government is to strengthen risk education."

Although internationalization of a currency is not tantamount to capital account liberalization, many economists believe the degree of globalization is conditional on capital account liberalization.

"Internationalization of the yuan can be achieved without opening up the capital account, and that is likely to be a complicated process given simmering financial risks," said Li Xunlei, chief economist at the Shanghai-based Haitong Securities Co. Ltd.

"Partial convertibility under the capital account means China's currency could only fulfill 10 percent of its potential international role, and the growth momentum of overseas yuan accumulation for trade use would dry out in two to three years," said Ma Jun, chief economist at Deutsche Bank Greater China.

He suggested China further loosen the quota limit for qualified foreign institutional investors to invest in the domestic capital market, and allow domestic non-residents to raise yuan funds through borrowing, bond issuance, stock listing and transfer the capital out of China in foreign currencies.

Zhang Yongjun, a researcher with the China Center for International Economic Exchanges, said China should take a gradual approach to capital account liberalization. "With a solid economy and deep foreign exchange reserves, China is able to withstand external shocks," he said. "But the challenges would be daunting due to fledgling financial markets, limited depth of bond markets and slow progress in marketization of interest rates."

Going global

In a bid to widen the global presence of the yuan, China has spared no effort. In its latest move, the country in December 2011 initiated a pilot program, allowing Hong Kong subsidiaries of qualified fund management companies and securities firms to use yuan funds raised in Hong Kong to invest in mainland securities within a permitted quota.

Prior to this, in July 2009 the government started a trial scheme of yuan settlement in cross-border trade in five cities, and in August 2011 expanded the scheme to cover the whole country.

In 2011, 2.08 trillion yuan ($330.16 billion) worth of cross-border trade was settled in the yuan, accounting for more than 10 percent of the country's total foreign trade, according to data from the State Administration of Foreign Exchange.

Meanwhile, China's experiment with Hong Kong as a test bed for internationalizing the yuan has proved successful. More than 80 Chinese and overseas institutions have issued yuan-denominated bonds in Hong Kong, including the World Bank, German automaker Volkswagen and Chinese steelmaker Baosteel. Data from the Hong Kong Monetary Authority showed yuan deposits in the city's banking system surged 87 percent from a year ago to 588.5 billion yuan ($93.4 billion) at the end of 2011.

"China's growing weight in world trade, the size of its economy and its role as the world's largest creditor will make the internationalization of the yuan inevitable," said the World Bank, in its latest report.

"The financial crisis has compromised the U.S. dollar and the euro as safe-haven stores of value, and the world urgently needs a greater role for alternative currencies," said Guo Tianyong, Director of the Research Center of China's Banking Industry at the Central University of Finance and Economics.

"Acceptance of the yuan as a major global reserve currency will depend on the pace and success of financial sector reforms and opening of its external capital accounts," said the World Bank. It suggested China press ahead with financial reforms, including commercializing the banking system, gradually removing interest rate controls, deepening the capital market and further developing independent and strong regulatory bodies to support the eventual integration of China's financial sector within the global financial system.

Ding Zhijie, a finance professor with the Beijing-based University of International Business and Economics, said the yuan is bound for a slick prospect of becoming an international currency.

"To achieve that, China needs to strike a balance between regulatory controls and capital account liberalization," he said. "Moreover, the country must retain health of the financial markets and safeguard against risks while it tries to liberalize interest rates and exchange rates."

Timetable for the Yuan Internationalization

- In one to three years, lifting restrictions on Chinese enterprises' direct outbound investment

- In three to five years, loosening controls over commercial credit for cross-border trade

- In five to 10 years, strengthening financial market construction and opening up the real estate, stocks and bond markets to foreign investors

(Source: People's Bank of China report)

Email us at: huyue@bjreview.com

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