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Businesses gear up for yuan foreign settlement

THE People's Bank of China has posted its long-awaited regulations on yuan settlements for cross-border trade last week in what is viewed as a giant step toward promoting the yuan as a regional and possibly future global currency.

A pilot program announced by the central bank is scheduled to start in Asia soon, with trading in the special administrative regions of Hong Kong and Macau and with the 10-member Association of Southeast Asian Nations (ASEAN).

"The regulations put meat on the bones of the central government's wider ambition for the yuan to be used to invoice and settle trade around the region," said Stephen Green, Standard Chartered Bank's head of research.

Being able to settle transactions in yuan is expected to help stabilize trade, trim the currency exposure of exporters and build up the yuan's position in the international monetary system, which now is built around the US dollar.

The central bank, which posted the regulations on July 2, said the action reflects concern that companies in China and neighboring nations are facing relatively huge foreign-exchange risks in trades because major currencies such as the US dollar and the euro have been fluctuating so wildly since the onset of the global financial crisis.

The People's Bank of China also cited the need to strengthen regional trading. The publication of the regulations came later than the market expected.

The State Council, China's Cabinet, announced late last year that it planned to inaugurate a pilot project aimed at reducing the nation's dependence on the US dollar. The yuan's official peg to the dollar was removed in 2005 but the Chinese currency still doesn't float unregulated.

In April, the State Council designated Shanghai and four Guangdong Province cities - Guangzhou, Dongguan, Shenzhen and Zhuhai - as participants in the trial.

The cross-border yuan settlement system will interface with the international payments system, Chinese customs and tax-information technology systems. Setting up the interface has delayed the start of the pilot project.

The Shanghai branches of the Bank of China and the Bank of Communications said in April that they had finished testing a system of settling overseas trades in yuan and the trial project would start soon.

The Shanghai branch of the Bank of China is scheduled to sign deals with corporations today on acting as an agent bank for companies on yuan settlement and clearance.

Agent banks

Companies that apply to participate in yuan settlements are required to provide documentation to banks proving that they are bona fide trading firms. Finance, commerce, customs, tax and banking authorities will designate which mainland companies are qualified participants.

Companies onshore will have to choose one onshore yuan settlement bank. Onshore companies using the yuan in settlement of cross-border trading transactions will also be eligible for tax rebates.

Companies offshore also can get financing in yuan from their onshore settlement bank, if needed. It's a brand new financing channel.

"The yuan trade could be a new growth engine for banks. The potential is there," said Sun Minjie, executive vice president of Bank of East Asia China.

Standard Chartered's Green said Hong Kong has its own nascent yuan market, and its two-way trade with the mainland is the most intense in Asia.

The PBOC and the Hong Kong monetary authority last Monday signed a supplementary memorandum of cooperation to prepare for yuan trade settlement between Hong Kong and the mainland.

The Macau monetary authority has yet to sign similar deal with China's central bank.

The moves come amid China's increasing calls for the world monetary system to move away from US dollar dominance. Premier Wen Jiabao said in March that China is concerned about the outlook for the US Treasuries it holds and sought assurances about their safety.

The nation is a major holder of US debt. The US has to issue an ever larger amount of Treasury bonds to finance its economic rescue packages and budget deficit, threatening a devaluation of the debt and the US dollar.

The People's Bank of China has signed six currency swap deals valued at 650 billion yuan (US$95.3 billion) with China's Hong Kong, Indonesia, South Korea, Malaysia, Belarus and Argentina. These swaps permit those overseas authorities to sell yuan to their importers who want to buy Chinese goods.

Kate Phylaktis, a professor at London's Cass Business School, said it's wise for China to make such deals and build up the yuan's stature in the region before seeking more dramatic changes in the global monetary system.

"China has to build up its regional saying power first before moving up to the global arena," Phylaktis said. "The euro is a good example."

She said China also needs to take additional steps to strengthen the yuan market and the nation's underdeveloped bond market.

Economists generally believe that a currency rises to global prominence in three steps: first it becomes convertible, then it becomes investable and finally it becomes an international reserve currency.


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