China Global Yuan Push Faces Challenges, Adviser’s Report Says

China’s Economy Will Bottom Out This Quarter, PBOC Adviser Says
China has been promoting wider use of the yuan in international investment and trade settlement to reduce the U.S. dollar’s global dominance and curb its own reliance on the currency of the world’s biggest economy. Photographer: Nelson Ching/Bloomberg

China’s efforts to make the yuan a global currency may be hampered by the lack of an independent monetary policy, fragile domestic financial markets and an “unbalanced” economy, a report edited by an adviser to the nation’s central bank warned.

“In the process of yuan internationalization, it will be hard to gain the confidence of the international community in the value of the yuan if monetary policy lacks sufficient independence,” according to the report from the International Monetary Institute of Renmin University in Beijing. Chen Yulu, the editor-in-chief of the report, is an academic adviser to the People’s Bank of China and president of the university.

China has been promoting wider use of the yuan in international investment and trade settlement to reduce the U.S. dollar’s global dominance and curb its own reliance on the currency of the world’s biggest economy. China controls the value of the yuan and restricts flows of capital in and out of the country for investment purposes, limits the U.S. says must be lifted before the currency can be part of the International Monetary Fund’s currency basket.

While Europe’s debt crisis will dominate discussions when leaders of the Group of 20 nations meet in Mexico on June 18-19, Germany plans to call attention to a number of issues including the yuan exchange rate, two government officials said in Berlin on June 12.

Artificially Weak

The yuan jumped the most in eight weeks on June 15 as the central bank strengthened its reference rate, helping fend off criticism of China’s currency policy in the run-up to the G-20 meeting. The yuan, which rose 4.7 percent against the U.S. dollar last year, has dropped 1.1 percent this year. The U.S. contends China is keeping its currency artificially weak to boost exports.

China’s central bank isn’t independent, with financial decisions such as changes in the exchange rate and interest rates made by leaders of the ruling Communist Party.

In its first formal evaluation of China’s financial system published in November, the IMF warned the nation is confronting a “steady buildup of financial sector vulnerabilities” and needs to overhaul its state-dominated banking system. The government needs to change the way interest rates are set and allow the yuan to trade more freely to help contain risks in the financial system, it said.

The nation’s “excessively rigid” exchange-rate system “casts doubt on” the independence of the central bank, according to yesterday’s report from the institute.

Significantly Undervalued

Policy makers should make the system “more open and transparent” by designing a mechanism where the yuan is valued against a basket of currencies “as soon as possible,” according to the report. That would send a “clear, convincing” signal that the yuan isn’t pegged to a single currency and that fluctuations are a result of many factors including market demand and supply, the authors said.

The U.S. Treasury Department last month said the yuan was “significantly undervalued,” and urged China to allow it to strengthen, while declining to brand the nation a currency manipulator. Premier Wen Jiabao said in March that the yuan is close to “equilibrium” levels.

China may make the yuan convertible on the capital account by 2020, the institute estimates, basing the projection on the experiences of Japan, Germany and other advanced economies in opening their capital accounts. The yuan could become an international reserve currency within 20 to 30 years, it says.

More Flexible

While China’s leaders haven’t publicly given a timetable for convertibility, which would allow capital to flow freely for investment purposes such as securities transactions, officials told European Union business executives “full convertibility” will happen by 2015, EU Chamber of Commerce in China President Davide Cucino said in September.

Policy makers pledged in a five-year plan running through 2015 to keep loosening controls on currency flows and make the exchange rate more flexible. The central bank in April widened the yuan’s daily trading band against the dollar for the first time since 2007, allowing it to fluctuate up to 1 percent either side of a daily reference rate from a previous 0.5 percent.

China has signed currency swaps with countries from Australia to Mongolia, eased rules to allow foreign companies to invest in the country using yuan raised offshore and promoted direct trading of currencies including the yen. In April, China more than doubled the amount of funds foreign investors can invest in domestic stocks, bonds and bank deposits to $80 billion under the Qualified Foreign Institutional Investor program.

Offshore Center

Standard Chartered Plc Chief Executive Officer Peter Sands said in March he hopes London will as soon as this year become an offshore yuan center where companies can raise funds denominated in the Chinese currency. HSBC Holdings Plc in April became the first European bank to list an international yuan-denominated bond in the U.K. capital.

China will need to retain limits on the yuan even after capital-account convertibility is achieved in order to prevent destabilizing capital flows, according to the institute’s report. “If no strict controls are imposed on speculative hot money, monetary and fiscal policies won’t be effective and the safety of the nation’s financial markets and the real economy could be seriously jeopardized.”

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