Beijing clears yuan and yen for trade
Beijing has authorised direct trading between the yuan and Japan's yen - only the second currency after the US dollar to have such an arrangement - as part of a push to internationalise the yuan to become widely used in trade, investment and reserves.
The move, effective from Friday, would lower currency exchange costs, increase the use of the yuan and the yen in trade and investment, and support economic ties, the People's Bank of China (PBoC) said in a statement.
Essentially, this would help to shield market makers from any unnecessary volatility brought by the US dollar, said Raymond Yeung, an economist at ANZ.
He added that the arrangement would also help to develop the onshore foreign exchange market on the mainland.
'It is likely that China will launch more of this direct trade with other countries in the future,' which could erode the influence of the dollar, Yeung said.
The price of the yuan against the yen will be determined by direct quotations offered by market makers on the China Foreign Exchange Trade System based in Shanghai - the forex arm of the central bank.
China has become Japan's largest trading partner. Total trade between the two countries reached 27.5 trillion yen (HK$2.68 trillion) in 2011.
In the past, the trading price between the yuan and yen was determined by the cross rates of the yuan against the US dollar and the exchange rate of the US dollar against the yen.
While market makers could still use the value of the two currencies against the US dollar as a reference, the local market liquidity of the currencies will also play an important role, said Nathan Chow, an economist with DBS.
In Tokyo, participating banks will present their yen-yuan exchange rates to the money market brokerage, which will then announce market rates, Bloomberg reported, citing Japan's Ministry of Finance.
The timing of the policy comes as the yuan became the world's third-largest currency in the issuance of letters of credit by value in April, with a market share of 4 per cent.
China now accounts for 10 per cent of the world's gross domestic product (GDP) and about 9 per cent of world trade.
He Guangbei, chief executive of Bank of China (Hong Kong), said the Japanese government was interested in investing in Chinese sovereign bonds, and the new policy would help smooth the process.
Japan won approval from Beijing in March to buy Chinese government bonds worth about 65 billion yuan (HK$79.56 billion), becoming the first economy to do so.
Foreign investors are required to seek approval if they wish to buy Chinese government debt.
Interest in using the Chinese currency as a reserve currency has also been on the rise in recent years. At present, the central banks of Malaysia, Nigeria and Chile all hold yuan, even though International Monetary Fund rules dictate that a currency without free convertibility cannot be considered a reserve currency.
Eswar Prasad, former chief of the International Monetary Fund's China division, said he expected the yuan to be included in the basket of currencies that constitute the IMF's special drawing rights (SDR) within the next five years.
The SDR is based on a basket of four major currencies - the US dollar, the euro, the yen and the British pound.
'The IMF needs China a lot more than China needs the IMF,' said Prasad.
China began establishing bilateral swap arrangements with other countries in the late 1990s, allowing the countries' monetary authorities to swap their local currencies against US dollars for short-term liquidity, mostly to support trade activities.
Now, more countries are setting up swap lines with China using local currencies directly. At present, there are 17 countries that have swap arrangements with China.
While China's move to push the yuan as a global reserve currency has been viewed as a stunt to improve its international status, the country may also have another agenda in mind - reform at home.
'I have argued in fact that what China is doing is the 'Trojan horse strategy' - trying to use the notion of the RMB becoming a global currency to get over the barriers of domestic reforms,' said Prasad.
Beijing is still debating how to approach the internationalisation of the currency and, more importantly, how to open up the country's capital account.
More liberal forces could be using the internationalisation of the yuan to pressure more conservative factions about the importance of establishing a better financial market, corporate bond market and a flexible exchange rate, Prasad said.
Europe overtook Asia this year as the largest yuan payment contributor, accounting for this much of all yuan payments
Yuan-US$ exchange rate
Yen-US$ exchange rate
Trade between China and Japan in 2010
Foreign direct investment by Japan in China in 2011
The earliest date estimated by which Beijing could have a basically convertible yuan
Appreciation of the yuan against the US dollar last year
Sources: Xinhua, Reuters, Japan External Trade Organisation