A $100 banknote is placed next to 100 yuan banknotes. Photo: Reuters
China has taken a significant step to involve the world's largest economy into its global framework set for internationalizing and liberalizing its currency. A yuan clearing bank to be established in the US and a 250 billion yuan investment quota granted to US institutional investors will help China get closer to this goal.
The investment quota allotted to the US under the Renminbi Qualified Foreign Institutional Investor (RQFII) mechanism is the second-largest after Hong Kong, which is granted an investment quota of 270 billion yuan. Launched in 2011, the RQFII scheme is aimed at allowing foreign institutional investors to invest in China's financial and capital markets with the yuan accumulated offshore, controlling capital outflows and promoting international use of the currency.
But a clearing bank in the US could lead to a wider international use of the yuan than the RQFII quota, because such a bank will make it easier for US enterprises and investors to transact in the Chinese currency, which will in turn help reduce transaction costs and simplify cross-border trade. Yi Gang, deputy governor of the People's Bank of China, the country's central bank, revealed during last month's China-US strategic dialogue that a Chinese bank and an American bank had been screened out as clearing banks for the yuan.
Chinese financial columnist Lei Sihai said that establishing a yuan clearing bank is also in the interest of the US itself, citing the fact that the internationalization of the yuan has gained global recognition, especially after the Chinese currency's admission to the US-led International Monetary Fund (IMF)'s Special Drawing Rights (SDR) elite currency basket.
"In the past, the US saw the yuan's rise as a big challenge the US dollar's dominant position in the global financial system. But with the increasing acceptance of the yuan beyond China, the US has to follow the inexorable trend (by allowing the establishment of a yuan clearing bank on its territory)," said Lei.
US Treasury Secretary Jacob Lew has said that enhancing the yuan trading and clearing capacity in the US will increase the "competitiveness of the US financial and corporate sectors" and allow "US investors' access to China's onshore capital markets".
Over the past several years, China has tried to expand its yuan trading and clearing infrastructure worldwide, with most of the international financial hubs including London, Paris, Tokyo, Frankfurt and Singapore serving as the offshore markets for the Chinese currency.
The yuan was the sixth most used currency for global payments as of April, after the US dollar, the euro, the British pound, the Japanese yen and the Canadian dollar, according to a latest report released by the Society for Worldwide Interbank Financial Telecommunications (SWIFT), a payment operator.
A yuan clearing bank would enable the US to become an additional key offshore yuan trading center in North America, which could be comparable with the one in Europe, where the UK has got a head start by renewing the bilateral local currency swap agreement with China last year for a further three years.
Ding Yifan, a researcher at the Development Research Center of China's State Council, predicted that New York City will be chosen as the location for the yuan clearing bank, adding that it will indicate a real beginning for the use of the yuan as a global currency.
Lu Zhengwei, chief economist of the Industrial Bank, said that the granting of the 250 billion yuan RQFII quota is a part of China's strategy of having the yuan traded in the US via a yuan clearing bank. "In the past, American companies and investors used foreign currencies to make investment in China under the Qualified Foreign Institutional Investor (QFII) program. But now under the RQFII program, they are unable to invest in China unless they have the yuan and the RQFII quota. And this could be an impetus for the US to further recognize the yuan," added Lu.
Lu estimated that New York City and London have the potential to become the major offshore yuan markets in the world, as the Chinese currency is increasingly used by more countries.
Analysts say that the establishment of a yuan clearing bank in the US will leave China no room to reverse the course of its reforms in the domestic financial system, predicting that more overseas financial institutions and investors will be allowed to invest in the Chinese financial and capital markets with the yuan's internationalization. But in fact, the yuan is far from becoming a freely used currency, as reflected in the fact that the Chinese currency merely accounts for a tiny part of the global foreign exchange reserve assets and that the offshore yuan market is still very small.
"But China has had the conditions to open wider its financial market, which already has some sort of depth and width. And the Chinese government is capable to shield the financial market from being affected by overseas speculators," said Mei Xinyu, a researcher at the Institute of International Trade and Economic Cooperation under China's Ministry of Commerce.
In the long run, the yuan's internationalization fundamentally needs the world's mainstream financial markets like New York City and London for deeper acceptance of the yuan, concluded Mei.
Politically, the rise of yuan as a global currency could deprive the US of its privilege of taking the advantage of its currency's paramount status to reach its political goals, as roughly 45 percent of cross-border payments are settled in the US dollar.
The announcement of setting up a yuan clearing bank in the US could be seen as a positive outcome of a presidential meeting held last fall in Washington, where Chinese President Xi Jinping and his US counterpart Barack Obama agreed to deepen financial cooperation and on a policy framework for the private sector to increase the yuan trading and clearing capacity in the US.
Following the presidential meeting, former New York City Mayor Michael Bloomberg and an all-star lineup of former top US officials including Henry Paulson and Timothy Geithner, former Treasury secretaries, and Mary Schapiro who led the Securities and Exchange Commission in November last year set up a working group in New York City in hope of building a framework for the yuan's trading and clearing in the US.
The aim of the working group is to impose pressure on the government to open the channels for the yuan's use in the US, said Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics.
But Lardy said that China still has a long way to go before turning the US into its key offshore yuan market because the establishment of a local currency swap mechanism, a series of approval procedures and the ratification by the petulant congress are needed.
The yuan is set to officially join the IMF's SDR basket in October, when China will face renewed pressure from the Washington-based financial organization and the US over its financial reforms and the yuan's exchange rate mechanism.