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China plans greater yuan convertibility

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China plans to take a giant step toward making the yuan more convertible by extending a pilot scheme allowing the currency to be traded with few restrictions to all its Free Trade Zones (FTZ), before taking the scheme nationwide later this year. Reuters News says this plan underlines China’s ambition to transform the yuan into a major global currency.

“Once this is done, this will be a big step forward in opening China’s capital account,” said one of the sources, who all declined to be named as they were not authorized to speak to the media.

The timing would aid Beijing’s campaign this year to persuade the International Monetary Fund to include the yuan in its currency basket. Under the pilot scheme, firms in the Shanghai free trade zone can move the yuan and other foreign currencies in and out of China for capital account transactions. That lets them raise money overseas and bring the funds back to China for real investment – a practice that is otherwise banned in China.

In coming months firms in China’s other Free Trading Zones – in Tianjin, Fujian and Guangdong – will be granted the same right, the sources said, though one said the roll-out would be staggered due to concerns over rising capital outflows.

Thereafter, the plan is to expand the scheme across China by the end of the year, they said. No details were available on how the experiment will be expanded nationwide, and the central bank did not comment when contacted for this story. But analysts, many of whom have been surprised by the pace of China’s recent reforms, said the intentions were clear.

“It is a signal to the financial market that policymakers want to push forward the convertibility of the yuan,” said Ma Xiaoping, an economist with HSBC in China.

Analysts say the expansion of the pilot showed China is freeing the yuan and its capital account in steps.

“This is actually poking a hole in the capital account,” said Lin Jianjun, an analyst at the Bank of China. “The interest rate and foreign exchange markets will be forced into changes, and it will pose a challenge to China’s financial market as interest rate controls will no longer matter.”

Full liberalization will be a slow process that includes eventually widening the yuan trading band and letting households invest overseas more easily. Banks and China’s currency regulator could resist the changes, one of the sources said.

China currently operates an administered peg exchange rate system, whereby the yuan-dollar exchange rate is allowed to fluctuate by 2 percent either side of a midpoint fixed by the central bank each day.

Launched in 2013, the Shanghai FTZ was hailed as a test bed for bold reforms aimed at creating a more market-driven economy.

After a slow start, some firms said reforms in the zone, which include allowing foreign companies to repatriate funds more easily, have yielded results.

Reflecting Beijing’s hopes that deepening financial reforms will energize a flagging economy, one of the sources said the authorities had decided to broaden the pilot beyond the Shanghai FTZ in the hope that it would lower funding costs for companies.

Expensive financing cost is a perennial problem in China, especially for private companies, partly because state-owned banks prefer to lend to large state-run firms.

To temper borrowing cost and stoke economic growth – which hit a six-year low between January and March – China twice cut interest rates and twice lowered the amount of reserves that banks must hold in the five months since November.

But with banks becoming increasingly cautious of lending as China’s slowdown raises bad debt levels, policymakers worry that rate cuts are not enough to cap financing cost.

“It’s very difficult to rely solely on domestic reforms to solve the problem of expensive financing,” the source said.

“The higher-ups hope that by opening (the capital account) to the outside world, new solutions will be available and the domestic financing cost will move toward the international level,” the source said.

Source: Reuters News

 

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