While the U.S. and Europe pressure China to weaken the yuan, Beijing is trying to reduce China's reliance on the dollar and promote the yuan as a top currency for international transactions.
The center of the action is Hong Kong. Policymakers from Beijing and Hong Kong are trying to make it easier for the city's importers, exporters, banks, insurance companies, and other businesses to use China's currency for transactions. If the experiment succeeds in Hong Kong, Beijing is likely to roll the idea out globally. "It's the birth of possibly the third international currency," says Julia Leung, Hong Kong's under secretary for financial services and the treasury.
Until recently, the yuan wasn't even widely accepted in Hong Kong, which kept its dollar-pegged currency after the departure of the British in 1997. Companies importing and exporting to the mainland haven't been able to use yuan to settle their deals, and locals couldn't use the currency freely. Thirteen years after the handover, residents still can buy only a maximum of 20,000 yuan ($3,000) a day.
Now demand for yuan is surging. High-end retailers, after initial reluctance, accept payment in yuan from Chinese tourists. With analysts expecting Beijing to let the yuan appreciate steadily against the greenback, Hong Kong citizens can't get enough of the currency. Yuan deposits in Hong Kong have gone from 62.7 billion yuan in January to a recent 130 billion.
Hong Kong has to figure out what to do with all this yuan. One solution is for its citizens and companies to take the yuan they get and spend it in China, an approach Beijing is allowing. "You can use [yuan] to pay salaries, settle bills cross-border, pay your electricity and water in China," says Stephen Chan, deputy general manager for corporate banking at Bank of China (Hong Kong).
Another way to soak up Hong Kong yuan is to issue yuan-denominated securities. In August, McDonald's (MCD) became the first U.S. company to sell a 200 million-yuan bond to Hong Kong investors. The proceeds will boost the company's working capital in China.
Hong Kong insurers now have permission to settle Hong Kongers' life insurance and savings plans in yuan. Hong Kong banks can invest their yuan holdings in the Chinese interbank bond market. Hong Kong's securities regulator authorized Shanghai's Haitong Securities to raise as much as 5 billion yuan from Hong Kong investors for a fixed-income fund. "The pace of relaxation has been particularly spectacular the past few months," says H.S. Tong, chief operating officer at Bank of East Asia.
The Chinese government still keeps its capital account closed and restricts changes in the yuan's value. "China is trying to internationalize its own currency before it becomes convertible," says Leung. The full liberalization of the yuan is a ways off. The Chinese, however, are moving in that direction.
The bottom line: Hong Kong is becoming a financial laboratory for the yuan, which Chinese authorities want to make into an international currency.