Revolution from China: Yuan as a world currency (Feature)

By Andreas Landwehr Jan 18, 2011, 9:43 GMT

Beijing - China has started taking steps to make the yuan into a world currency in the long term.

During the visit of China's President Hu Jintao to Washington, which begins on Wednesday, American demands to allow it to appreciate stronger to reduce the US trade deficit will be high on the agenda.

But the dispute deflects attention from the fact that China has slowly and steadily been taking steps to carry out more trade and investment globally using its currency, even though it has no intention to lift the controls of the yuan exchange rate or to give in to US pressure for a faster appreciation.

Looking at the trend of internationalisation of the yuan, banking experts are already talking of a 'financial revolution' that will have significant effects on the world markets.

The plan to make the yuan into a leading currency should not come as a surprise to anyone. It is the logical consequence of the rise of China to be the world's top exporter and the second largest economy.

Given China's importance today for the world economy, its currency has been very much underrepresented in global trade and capital markets so far.

Ahead of his visit to Washington, Hu has confidently declared the current international system with the US dollar as key currency 'the product of the past.'

The fear of the US at the rise of the 'redback,' as some call the yuan compared to the 'greenback', is by no means unjustified. While the dollar and the euro have been left battered by the economic crisis, financial experts assume that the yuan will become one of the top three global treading currencies in a few years.

The demand for the yuan - also called the renminbi (RMB) - is especially strong in developing countries and emerging markets with which China does 55 per cent of its trade.

In three to five years at least half that trade could be done in yuan, according to a study by HSBC bank. In 2010, the figure was just 3 per cent. If the prediction becomes reality, trade worth 2 trillion dollars a year could be denominated in yuan every year.

Preparations for the yuan's rise go back one and a half years when China first allowed limited trade settlement using the yuan.

In the middle of last year the pilot project was extended to all countries and several hundred Chinese companies and then in December to almost 70,000 companies.

The savings in foreign currency transactions, the abolition of currency risk and the expected appreciation make it attractive to change from the dollar to the yuan.

The central bank last week allowed Chinese businesses to carry out investments abroad using the yuan for the first time.

'The on-going pilot programmes for RMB settlement of cross-border trade and investment transactions are a concrete step that China has taken to respond to the international financial crisis, with the purpose of promoting trade and investment facilitation,' Hu said.

'Making the RMB into an international currency will be a fairly long process.'

But he said the transactions fit in well with market demand as the rapidly expanding scale of the transactions has shown.

The more deals are done in the yuan, the more slowly China's currency reserves - the world's largest - will grow. In 2010, they grew 18.7 per cent to 2.85 trillion dollars.

Exporters will soon be allowed to park their foreign currency takings outside the country instead of having to exchange them immediately.

The Bank of China has for the first time offered yuan-denominated accounts at its branches in Los Angeles and New York. Western banks like HSBC in Hong Kong already provide such services but it is the first time that a Chinese state-owned bank has set up these services in the US.

Yuan-denominated bonds are now being offered outside China. The demand is so large that investors talk of a dim sum market, in reference to the popular Cantonese lunch.

Fast-food chain McDonalds, the US heavy machinery manufacturer Caterpillar and oil giant BP have already sold bonds in yuan. The amount involved doubled in 2010 to more than 5 billion dollars. The World Bank issued its first yuan-denominated bonds this month.

The worldwide use of the Chinese currency, however, will not inevitably lead lead to full convertibility, at least not initially.

But it will bring about major change in a few years, according to the HSBC study.

'The internationalisation of the renminbi will have significant implications on China and the global economy over the long term,' the bank said.

'We may be on the verge of a financial revolution of truly epic proportion.'

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