Yuan settlement unable to dent reserves

Cross-border yuan trade settlement has deviated from its original policy target of alleviating pressures on the country’s bulging foreign exchange reserves, the People’s Daily reported on Tuesday.

A rapid accumulation in foreign reserves has created complicated issues for monetary policy at the time of high inflation, and the yuan settlement scheme has only been “counterproductive,” said the newspaper.

“The original plan was to encourage using yuan settlement in exports, however, in cross-border trade settlements, the share of imports accounts for 80 percent,” the newspaper said.

China maintains a capital account control which proscribes free convertibility of yuan. To do so, the central bank has to constantly mop up foreign currencies in the banking system resulting from foreign trade, while effectively injecting an equivalent amount of the local currency into the banks.

This has become difficult as policymakers are taking monetary tightening measures to curb elevated inflation.

The country’s foreign exchange reserves stood at $3.2 trillion at the end of June, up about 30 percent year-on-year.

For imports, the foreign counterparts are willing to accept yuan because they are betting on yuan appreciation, but, for exports, only 10 to 20 percent of the foreign traders pay in yuan, the People’s Daily reported, citing an unnamed employee in Bank of China’s Shanghai branch, who has been involved in the yuan settlement pilot programs.

China now has pilot cross-border yuan settlement programs in 20 provinces and municipalities.

At the end of April, the total yuan settlements since the beginning of the program in 2009 reached beyond 1 trillion yuan ($155 billion), the central bank said.

“The expansion of cross-border yuan settlement is largely dependent on the expectation of a short-term appreciation of the currency. What about when the expectation ends?” said Liu Shengjun, deputy director of CEIBS Lujiazui International Finance Research Center in Shanghai.

For the internationalization of yuan, there should be an exchange where a variety of financial products can be traded in yuan so that investors can get reasonable returns from their yuan investments, Liu said.

“Domestic financial innovation, reform and liberalization should be deepened,” he added.

“I think the Chinese government is very determined to keep internationalizing the yuan, and trade settlement is a major channel to do so. The next step will be to promote the use of yuan on capital and financial account items,” said Frances Cheung, a senior strategist at Crédit Agricole CIB in Hong Kong.

The French bank expects 20 percent of China’s trade to be settled in yuan in 2013.

Global Times

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