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Friday, July 10, 2009

Yuan's internationlization: limited so far

China has a long way to go to internationalize its currency, Yuan. For one, China does not have a foreign exchange market for Yuan outside China and this would be troublesome for its trading partners to manage currency risk. Also, China's Yuan is tied to the US dollar. It can hardly offer any more stability than the US dollar.  Here is a short analysis from WSJ.

If the dollar's role in the global economy is under a cloud, the yuan isn't the cause. At least not yet.

China this week began allowing trade between companies in five Chinese cities and Hong Kong, Macau, and the ASEAN member countries, to be settled in yuan.

Starting just days before a G-8 summit at which the dollar's status could be a hot topic, the trade settlement moves are China's most tangible step toward promoting the international use of its own currency.

[yuan]

In reality, Beijing may find that its remit to mold market forces doesn't extend much beyond its own borders.

China certainly has some good reasons to invoice trade in yuan, not least as a way to slow the growth of its $2 trillion in foreign exchange reserves.

But for the practice to take off, key counterparties outside China must be willing to buy and sell using yuan. This is where the plan runs into hurdles.

Some trading partners may find they have no choice -- like those buying high-end machinery for which China's prices are so competitive it's in a position to dictate the settlement currency.

But with China's capital markets off limits to foreigners, firms dealing in yuan can only deposit funds in low yielding accounts in Hong Kong. The yuan isn't traded outside of China so companies won't have a way to manage their foreign exchange risk.

Beijing counters this limitation by trumpeting the yuan's stability. Given the currency's effective peg to the dollar for nearly a year now, it actually offers no more stability than the greenback -- the currency it would seek to replace -- something that won't offer much encouragement to Malaysian or Thai exporters, for example.

Certainly, being able to tap China's flush banks for trade financing is a draw but there's always the risk that avenue may dry up if Beijing tightens credit as it has in the past.

In truth, appreciation, rather than stability, is the yuan's only draw. China's currency regulator said as much in a recently published report, arguing that a rising currency is a prerequisite for yuan settlement.

These days, given the ongoing slump in Chinese exports, that's hardly worth betting on.