Wider Doorway for Yuan Trade Settlement

Chinese companies trying to avoid currency exchange rate risks found new reasons for hope when a top official from China's central bank recently hinted at a future expansion for cross-border trade settlements based on the yuan.

The message from the bank's vice director for the Second Division Monetary Policy office, Li Bo, was delivered January 21 at the eighth annual China Import and Export Enterprises Conference.

"Under the premise of controlling risk, the central bank is currently researching progressive expansions for experiments in cross-border trade using the yuan," he said.

These would include "trials within the range of domestic urban areas and overseas regions, and increasing the number of pilot enterprises," Li said, without announcing a timetable.

The nation's pilot program for cross-border yuan trade settlement was launched last July, giving domestic and foreign traders a new means for navigating global currency issues. Many had experienced hardships when, in the course of the global financial crisis, customers canceled orders and major currencies for international settlements such as the U.S. dollar and euro fluctuated.

The program's boundaries mean that demands from many enterprises seeking yuan settlements have not been met, leading to calls for an expansion. Meanwhile, however, interest among foreign companies has been less than enthusiastic in part due to banking and yuan convertibility issues.

Century Weekly has learned that central bank plans to work with six ministries, including the finance and commerce ministries, to promote an expansion. Technical issues have already been addressed, raising hopes for action soon.

Gradual Growth

Chosen as the pilot's trial cities were Shanghai, Guangzhou, Shenzhen, Dongguan and Zhuhai. In addition, 365 enterprises qualified as pilot enterprises. The program affected trade with companies in Hong Kong, Macau and members of the Association of Southeast Asian Nations (ASEAN).

Data shows that yuan settlements have been minuscule compared to total trade volume in trial areas.

Between July 6, when the Chinese government announced program rules, and January 22, the cross-border trade settlements exceeded 4.5 billion yuan – far less than expected.

China Construction Bank Vice President Fan Yifei admitted in mid-December that neither the yuan levels nor the total volume of transactions had reached forecasted targets.

Nevertheless, the pace of yuan trade deals has been accelerating in recent months, according to statistics from the central bank.

As of late October, the total volume since July was less than 1 billion yuan. But the situation changed in November, and by mid-January, transaction volume had topped 4 billion yuan. Then in just one week between January 16 and 22, total trade volume reached close to 500 million yuan.

Officials say significant demand for yuan settlement has yet to be met, particularly among Chinese enterprises reacted to fluctuations in the exchange rates of other major currencies.

Li said a study led by the central bank in November found demand for the program exceeded supply. The study concluded that enterprises with the ability to engage in international settlement negotiations should be allowed to use the yuan.

Local governments have been enthusiastic about yuan settlement. Currently, more than 10 applications have been submitted to the State Council from governments in places including Beijing, Zhejiang, Jiangsu, Tianjin, Chongqing, Liaoning, Guangxi and Yunnan.

Foreign demand can be found beyond China's neighbors in countries such as Ukraine and Mongolia, which frequently trade with China, as well as Chinese enterprises that have invested in Africa and the Middle East.

Roadblocks Ahead

But unlike Chinese enterprises, overseas counterparts have been somewhat cold to the program. These often lack sources and operational channels for the yuan. And restrictions on the yuan's cross-border flow have created bottlenecks. 

China's regulations say foreign banks participating in the program must go through Chinese representative banks when moving yuan in or out of China. They also must buy and sell the currency according to prescribed quotas.

Statistics from the central bank show that, as of January 15, local representative banks had sold 450 million yuan and purchased 356 million yuan.

In practice, Chinese enterprises using yuan trade settlement to avoid exchange rate risk have inadvertently transplanted that risk to overseas enterprises.

A foreign enterprise that's paid in yuan has only two options: deposit the funds in an overseas branch of a Chinese bank, or wait to pay for products imported from China with yuan. But neither choice is desirable.

In addition, for now, the yuan is merely being used as a settlement instrument, lacking investment and interest-bearing value. So even if the central bank widens the domestic yuan settlement market or establishes an offshore market, the currency's partial convertibility will continue to pose challenges.

1 yuan = 14 U.S. cents

Full article in Chinese: http://magazine.caing.com/2010-01-31/100112359.html