CHINA'S efforts to give the yuan a more global footing will get a boost under a pilot program allowing domestic companies to use the controlled national currency in direct offshore investments.

The People's Bank of China announced in mid-January that domestic firms located in areas already designated for yuan settlements in cross-border trade will be able to participate in the new trial project.

That means that companies in Shanghai, Beijing, and another 18 provinces or municipalities will be able to use the currency when making direct investments overseas.

"This move is an important step toward the internationalization of the yuan," said Qu Hongbin, chief China economist at HSBC.

"Direct investment" applies to money that goes into new ventures, mergers and acquisitions, and stake purchases. It does not apply to investment in overseas stock, bond or other securities markets.

Under the rules of the pilot program, participating companies must disclose the amount of their proposed outbound investment to regulators.

"The program has effectively provided another channel for the supply of yuan in offshore markets, and it will encourage the subsequent use of trade-derived yuan offshore funds for investment use outside China," Qu said.

China relaxed restrictions on the use of the yuan for cross-border trade in mid-2009, and that program also already grown to hundreds of billion yuan a month.

The number of mainland companies authorized to settle export accounts in yuan rose from 365 at the start of the program to 67,359 at the end of 2010.

International acceptability

The catalyst came in June when the program was expanded from its initial trial in Shanghai and four cities in south China's Guangdong Province to 20 provinces and municipalities across the nation.

From June to November, the trade settled in yuan amounted to 340 billion yuan (US$51.6 billion), about seven times the total before the trial was expanded.

"The dual channels of yuan trade and investment promote each other, supporting growing international acceptability of China's currency," Qu said.

China is briskly pushing the internationalization of its currency as it seeks to build up the yuan's global standing in the aftermath of the global financial crisis, which pinched the US dollar's dominance.

"The Chinese yuan appears to be rising as a potential global currency, with the US dollar trending lower and the euro at risk from Europe's fiscal problems," Moody's said in a report in January.

At the same time as the yuan is gaining a more global footing, Chinese companies are engaged in a flurry of deal-making overseas.

China is the fifth-biggest source of direct global investment.

Last year, that pool of funds from non-financial Chinese firms surged 36 percent to US$59 billion. Accumulated outbound investment totaled US$259 billion at the end of 2010, the Ministry of Commerce said.

In terms of mergers and acquisitions, outbound deals grew 31 percent in volume to 188, while the value of those transactions rose 27 percent to US$38 billion in 2010, according to PricewaterhouseCoopers.

"There is no denying the strong trend of China's growing interest in quality assets overseas," said PwC partner Nelson Lou. "There are no signs of that trend waning in 2011 or the years beyond."

Lou said China's appetite for overseas assets was insatiable, with natural resources remaining a key industry target. In that category are such industrial raw materials as oil, copper and soft commodities such as milk and grain.

China's economy grew 10.3 percent in 2010, faster than expected, and the nation is intent on securing stable sources of supply to fuel its growth.

At the same time, Chinese companies are bent on the acquisition of overseas high-technology companies to expand their grasp of technical expertise and harness it for domestic use.

In their sights are machinery, equipment manufacturers and auto parts.

Even with fewer restrictions on use of the yuan in corporate deal-making, the road to expansion overseas isn't easy.

Circulation cycle

"Allowing the yuan to be used in outbound direct investment is more of a first shot across the bow than an immediate boost to such deals," said Andrew Li, another PwC partner. "Such deals will likely be limited scale in the initial stages."

Allowing the yuan to move more freely abroad is only part of the equation, analysts said. China also needs to relax restrictions on the yuan re-entering the country if it wants to complete the currency's circulation cycle.

Jing Ulrich, JPMorgan Chase's managing director, said substantial hurdles remain in the internationalization of the yuan.

She pointed to the limited avenues for offshore yuan pools to be repatriated back to the Chinese mainland.

At this stage, China's capital account, or that for investment, is still under control. That means yuan generated or pooled overseas can't easily go back to the mainland for investment, limiting investors' interest in holding local currency.

"With policy makers concerned about excessive domestic liquidity and asset price bubbles, the current barriers are unlikely to be relaxed except through very measured steps," she said.

Domestically, banks extended 7.95 trillion yuan (US$1.2 trillion) of yuan-denominated loans last year, exceeding the official target of 7.5 trillion yuan.

Externally, the second round of quantitative easing - or printing more money - by the United States Federal Reserve last year has triggered worries of the excess flows of capital into China and other emerging markets.

China already tightened the tone of its monetary policy from "accommodative" to "prudent" to try to curb credit-driven inflation and rein in asset bubbles.

Major offshore center

Hong Kong is the major offshore center for yuan business and investment at present.

In 2010, the pool of yuan deposits in Hong Kong expanded 378 percent to about 300 billion yuan, Yuan deposits accounted for about 5 percent of Hong Kong's total deposit base last year, and that's expected to rise to 15 percent this year, according to JPMorgan analyst Joseph Leung.

Meanwhile, overseas companies are allowed to issue yuan bonds in the special administrative region. For the first time, for example, American companies such as McDonald's and Caterpillar have been allowed to finance their China projects by selling yuan bonds in Hong Kong.

In total, yuan-backed bonds valued at 41.4 billion yuan were issued last year in Hong Kong, up from 16 billion yuan in 2009.

However, Hong Kong's development as an offshore yuan center is still very much "in its infancy" when compared with the full spectrum of products and services already available in Hong Kong dollars, Ulrich said.

Dariusz Kowalcyzyk, a senior economist at Credit Agricole, predicted that the offshore deliverable market in Hong Kong will be deepened to increase the acceptance of the yuan.

"Creation of deliverable markets in other financial centers is likely," he said. "These moves will not only advance the objective of internationalization of the yuan but will also gradually chip away at the global standing of the US dollar. However, Ulrich noted that "widespread acceptance of the yuan as a reserve currency, perhaps the ultimate measure of internationalization, appears a distant prospect."