Beijing and Taipei signed a yuan clearing agreement yesterday, a move that analysts say will help globalise the use of the currency but create competition with Hong Kong.
Taiwan would allow interbank trading of the yuan, creating a new exchange rate for the currency, central bank governor Perng Fai-nan said yesterday.
The two monetary authorities are also negotiating a currency swap deal that will allow Taiwan to hold yuan assets in its foreign-exchange reserves.
"The deal will help Taiwanese companies move their yuan assets back to the mainland and lessen their exchange risks," Perng said in Taipei. "Taiwan will have its own yuan spot rate, called 'CNT', as opposed to 'CNH' in Hong Kong."
Yang Yi, a spokesman for the mainland's Taiwan Affairs Office in Beijing, said the pact would lower the costs and currency risks of cross-strait trade and deepen economic co-operation between the two markets.
Mainland China has been expanding its currency relations with trading partners to promote greater use of the yuan in global trade and investment. With the latest agreement, the yuan can now be cleared offshore in three locations - Taiwan, Hong Kong and Macau - with London and Singapore vying to be next.
About 30 per cent of Taiwan's exports are bound for mainland China, while the island is the mainland's fourth-biggest importer.
Relations across the Taiwan Strait have thawed since Taiwanese President Ma Ying-jeou came to power in 2008 and the two sides signed a trade accord, namely, the Economic Co-operation Framework Agreement.
Paul Mackel, head of Asian foreign exchange research at HSBC, said yuan policy would continue to be much more focused on internationalisation.
Raymond Yeung, senior economist with Australian bank ANZ in Hong Kong, said an average 4 per cent of global payments with mainland China and Hong Kong were now settled in yuan, based on the latest Swift statistics.
"As Taiwan and the mainland now have a much closer economic relationship [due to the new currency pact], it is possible that a higher penetration to 10 per cent could be reached within the next six to 12 months," he said.
"Trade settlement flow in the yuan across the strait could potentially reach US$12 billion a year and we believe the so-called CNT deposit market could also be built up very quickly."
The agreement might lead to a transfer of yuan liquidity to Taiwan from Hong Kong, which Beijing designated an offshore centre for trading in 2010, said Dariusz Kowalczyk, senior economist and strategist at Credit Agricole.
Yuan trade settlement conducted in Hong Kong in July dropped 7.4 per cent from June to 223.4 billion yuan, while yuan deposits rose 1 per cent to 563.2 billion yuan as at the end of July, the Monetary Authority said.
"The deal will likely allow development of the offshore deliverable market in Taiwan across asset classes, and create more arbitrage opportunities for the onshore and offshore yuan curves," Kowalczyk wrote.
"There may be some withdrawal of yuan liquidity from Hong Kong to Taiwan as a result."
Yuan trading in Shanghai has weakened 0.9 per cent this year, after strengthening 31 per cent from when it was revalued in July 2005 up to last year. In Hong Kong, it traded at a premium of as much as 2.6 per cent in October 2010; yesterday it traded at a discount of 0.1 per cent.