SHANGHAI is riding on the take-off of the yuan as a future global currency to rise as a Made-in-China international financial center.

China in early July kicked off a pilot project to let companies settle trade in yuan in an essential step toward building up the status of the local currency. Shanghai is one of the five cities where the pilot started.

"The yuan settlement trial in Shanghai has great significance for the city's plan to become an international financial center," Shanghai Mayor Han Zheng said. "The program will also benefit cities in the Yangtze River Delta region with sustained and healthy trade growth."

On July 6, three Shanghai-based firms became the pioneers in using the yuan to settle cross-border trade by signing contracts worth more than 14 million yuan (US$2.05 million) with companies in Hong Kong and Indonesia.

Shanghai and four cities in Guangdong Province can settle trade in yuan with businesses in Hong Kong, Macau and the 10-member Association of Southeast Asian Nations.

Previously, Chinese companies had to convert yuan into US dollars or other currencies to settle international trade.

"It's always good to have an additional option," said Xu Weimin, chairman of Shanghai Silk Group which is among the first batch of companies to join the pilot. "The foreign exchange fluctuations have hurt us badly. If our clients agree, we prefer to use the yuan to settle trade."

Innovation and reform

About 100 companies are expected to take part in the yuan settlement trial in Shanghai.

"The yuan settlement in trade is a key step for the currency's internationalization," said Lu Zhengwei, an Industrial Bank senior economist. "It's the first step in the trade, investment and reserve mode of a global currency."

The program's launch in Shanghai also reflected the central government's determination to build the city into a global financial hub through pressing ahead with a series of financial innovations and market reforms.

The rise of Shanghai as a future financial magnet doesn't stand alone - it is rising in tandem with the local currency's fledging but ambitious internationalization.

The State Council in March passed the first national guidelines to boost Shanghai as a major global financial center by 2020, which indicates the Chinese currency's global status.

Shanghai is already China's financial hub, home to the country's largest stock market, its major futures market for metals and energy, its gold bourse, the foreign exchange bourse and a major bond market.

Economists said the Chinese currency enjoys the potential to gain more say in the global arena as the country's economy grows.

China, the world's fastest growing major economy, is set by 2025 to overtake the United States as the world's biggest economy, according to a PricewaterhouseCoopers report in June 2008.

China's sizzling growth has already pushed the accounting firm to revise its projection - in 2006, PwC said China would rise as the world's biggest economy by 2050.

Even during bad times, China is widely expected to recover ahead of the curve of the worst financial crisis since the Great Depression.

Despite its hard-hit exports, China still managed to grow 7.1 percent in the first half of this year as momentum picked up with a growth of 7.9 percent in the second quarter.

Settling trade in yuan with neighboring markets is a step forward in building the yuan as a regional currency before it becomes a global currency.

Economists said it takes three steps for a currency to rise up as a global currency - it is convertible, investable and then becomes a reserve currency.

China is gradually loosing its control on its forex regime. The local currency has gained 21 percent since July 2005 when China depegged from the greenback.

Meanwhile, China is expanding the yuan's investment market. China's bond market enjoys huge growth potential as institutional investors use bonds as one of their main investment options.

Shanghai is the platform to increase the market participation.

More plans being studied include enabling overseas corporations to issue yuan bonds in Shanghai.

Local currency bonds

In an April rule made by the city government, local authorities showed its stance to support locally incorporated foreign banks to issue yuan-denominated bonds to meet long-term capital needs.

Seventeen locally incorporated overseas banks have started operations in Shanghai by the end of 2008, accounting for half of the group in China.

They include HSBC, Citi and Bank of East Asia. The combined assets of these banks totaled 845.1 billion yuan by the end of 2008 in China, contributing 84.8 percent of all assets of overseas banks in China.

The yuan bond market is not the end. Overseas companies will also be allowed to issue yuan-backed shares on the Shanghai Stock Exchange, one of the world's top-10 stock markets in terms of market value.

"The focus today is clearly on developing the renminbi as a unit of account, not as a store of value," said Stephen Green, Standard Chartered's head of research in China.

"In later stages, as more banks are allowed to settle yuan and more yuan bonds are issued, a renminbi market will develop."

Landmarks in China's foreign exchange regime

July 21, 2005

China dropped the yuan's decade-long peg to the greenback and shifted to a basket of currencies that includes euro. The yuan appreciated 2.1 percent one-off.

September 23, 2005

The People's Bank of China doubled the floating band of the yuan against non-greenback currencies to 3 percent.

January 3, 2006

The central bank introduced the over-the-counter mechanism.

May 15, 2006

Yuan broke the historical level of 8 against the US dollar.

February 1, 2007

Individuals in China are allowed to increase their yearly foreign exchange quota to 50,000 yuan from 20,000 yuan.

May 18, 2007

The central bank increased yuan's trading band against the greenback from 0.3 percent to 0.5 percent.

August 2007

The State Administration of Foreign Exchange canceled the quota on current account forex accounts.

September 2007

China set up its sovereign wealth fund, China Investment Corp, to expand investment channels of China's mounting forex reserves.

April 10, 2008

The yuan broke the historical level of 7 against the US dollar.

July 6, 2009

China started trial program to settle cross-border trades in yuan in five cities.