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    China Business
     Apr 21, 2009
Yuan trade move 'far reaching'
By Olivia Chung

HONG KONG - The Chinese government's decision this month to let exporters in a small number of cities settle their overseas trade in yuan rather than in US dollars has far-reaching implications, according to economists, even though the immediate impact is minimal.

The trading hubs of Shanghai at the mouth of the Yangtze River and Guangzhou, Shenzhen, Zhuhai and Dongguan in the Pearl River Delta further south can use the yuan in overseas trade settlement, a State Council, or cabinet, meeting chaired by Premier Wen Jiabao said. The two deltas are the base for most of China's export-oriented industry.

The settlement scheme is voluntary and of benefit to relatively


small groups, said Pauline Loong, senior vice president in charge of China policy and risk research at CIMB-GK Securities (HK) Ltd, but "the implication is far-reaching. The scheme extends the use of the Chinese currency outside of the mainland. We see this as the first step on the road to full liberalization of China's capital account and full convertibility for the renminbi," one term for the Chinese currency, also known as the yuan.

Most international trade is carried out in US dollars. The Chinese scheme is aimed at reducing the risk from exchange-rate fluctuations and giving impetus to declining overseas trade, a statement posted on the Chinese government website said. Further details of related regulations will be released as early as possible, the statement said.

China's exports plunged 25.7% year-on-year in February as overseas consumer demand fell away amid the deepening global financial and economic crisis.

The move to allow international trade settlement in yuan in select cities is in line with the government's gradual approach to currency liberalization, said Jing Ulrich, China equities chairwoman at JP Morgan. Beijing earlier allowed companies in Hong Kong and Macau to use yuan to settle deals with partners in Guangdong and the Yangtze Delta.

A similar yuan settlement trial has been proposed for exporters in the Guangxi Zhuang Autonomous Region and Yunnan province in southwestern China, which would be allowed to use the Chinese currency to settle trade with their counterparts in the 10 countries of the Association of Southeast Asian Nations (ASEAN). Details of the programs haven't yet been disclosed.

Loong said the extension of yuan settlement to five mainland cities was voluntary and of benefit to relatively small groups, citing 1) foreign businesses with a need for Chinese currency, such as importers of Chinese goods who also export to China or who may have operations with yuan outgoings, such as a factory on the mainland; and 2) mainland businesses with enough commercial clout to push their partners to accept a yuan settlement or those with trade partners with a need for the Chinese currency.

Transaction volumes are likely to be modest at the outset, but "that should not worry Beijing too much", said Loong. "The scheme is to test-run convertibility on the capital account while giving a helping hand to importers and exporters. The volume will rise when the Chinese currency gains market acceptance."

China's move to extend use of the yuan comes as concern grows that increased US government spending to halt the financial crisis will reduce the value of the US dollar. That could reduce the amount of money earned by Chinese exporters if the yuan were to strengthen against the US currency. It could also reduce the value of US Treasuries held by the Chinese government.

It is estimated that of China's US$1.95 trillion in foreign exchange reserves at the end of last year, the largest in the world, 70% is invested in US dollar-denominated assets. Increased use of the yuan in international trade could help reduce countries' use of US dollars.

Ulrich said funding of the US government's stimulus plan may lead to a depreciation of the US dollar. "Encouraging China's trading partners to settle in renminbi could help reduce exchange-rate risk and save on transaction costs," she said.

China's central bank governor Zhou Xiaochuan recently said that to reduce the risks associated with the current US dollar-denominated reserve currency system, it may be ideal in the long run to replace the dollar with a new international reserve currency under the mechanism of the International Monetary Fund.

Guangdong province governor Huang Huahua last month said 300 companies in Guangzhou, Shenzhen, Zhuhai and Dongguan will be allowed to use yuan for the yuan settlement program with enterprises in Hong Kong.

Among those looking forward to the scheme is Liang Yufeng, vice general manager of Guangxi Sanhuan Enterprise Group, a leading exporter of ceramic tableware.

Liang said fluctuation of the dollar was a serious problem for the company, which gets about 55% of its sales in Europe and the US. A profit decline of 110 million yuan (US$16 million) last year was largely attributable to exchange rate changes, he said.

The yuan strengthened about 6% against the US dollar last year and has appreciated about 21% since a fixed exchange rate was scrapped in July 2005.

Liang said his company was happy to use the yuan to do business with partners and the scheme could help Sanhuan Enterprise, with employs 6,700 workers, trade with partners in Southeast Asia, where it gets 15% of total sales.

"Since the beginning of last year, the company has tried to find ways to reduce the risk from exchange rate fluctuations," he said. "The most effective is to add clauses to contracts with the permission of trade partners about the trade settlement. For example: the value of a container of goods is 10,000 yuan. In disregarding the change in the exchange rate, the buyers have to pay the same value [10,000 yuan] for the merchandise in US dollars," he said.

He conceded that only larger and long-term clients were willing to accept such a condition. Liang also had doubts whether partners would be willing to pay in yuan once the trial gets underway.

"As the yuan is not freely convertible, our partners will be forced to exchange their own currency into US dollars first before paying yuan in overseas trade settlement, which might be a trouble for them."

Importers, including Simon Shi, former president of the Hong Kong Small and Medium Enterprises Association, also saw difficulties with yuan settlement if China does not relax its foreign-exchange controls.

"Even if I have a personal renminbi account, I cannot withdraw a million yuan and move it between the mainland and Hong Kong," Shi said. "This is because in Hong Kong, we cannot change more than 20,000 yuan in each transaction, and cannot remit more than 80,000 yuan a day."

Frank Song, head of the Center for China Financial Research at the University of Hong Kong, echoed this concern, saying China's foreign-exchange controls could hinder acceptance of the yuan. This meant, for example, that a country couldn't sell yuan to defend its own currency in a balance of payments crisis.

Song saw yuan trading settlement and clearing as a first step in the move towards making the yuan fully convertible into other currencies.

Expanding the use of the yuan globally would be beneficial to China, even if this takes time, Ulrich said.

"Besides, setting up of the basic framework of currency conversion and hedging, foreign companies will need to become confident in using the yuan for settlement," she said.

"Full convertibility is first required for China's currency to truly become international. While it may not replace the dollar in the near future, with continued liberalization, the renminbi may become a regional standard similar to the euro," she said.

Olivia Chung is a senior Asia Times Online reporter.

(Copyright 2009 Asia Times Online (Holdings) Ltd. All rights reserved. Please contact us about sales, syndication and republishing.)

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