China's new leaders to quicken yuan reform, but caution remains

BEIJING Tue May 7, 2013 10:43am BST

Chinese Yuan bank notes are seen in a vendor's hand at a market in Beijing April 10, 2013. REUTERS/Kim Kyung-Hoon

Chinese Yuan bank notes are seen in a vendor's hand at a market in Beijing April 10, 2013.

Credit: Reuters/Kim Kyung-Hoon

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BEIJING (Reuters) - China's new batch of leaders may quicken the process of making the yuan fully convertible over the next few years to boost the currency's global clout and support wider financial reforms, but the pace of market opening could disappoint as caution remains.

A cabinet meeting on Monday called for "operational plans" to achieve yuan convertibility under the capital account, a seemingly bolder push for change after a new administration took the helm in March.

As the world's second-largest economy grapples with slowing growth, the government is keen to accelerate reforms to sustain momentum and boost investment opportunities.

A tightly controlled yuan only impedes overall financial reforms and progress toward a market-oriented economy.

Analysts' best guess is that China will make the yuan convertible within five years but still retain some controls on short-term fund flows.

The central bank could lead efforts to map out plans on yuan convertibility, which may even imply a deadline, although it will not be made public, according to Chinese economists familiar with internal policy discussions.

Chinese officials, including central bank chief Zhou Xiaochuan, have never given a specific timetable on yuan convertibility, even though the government's 12th five-year plan (2011-15) vaguely called for the yuan's basic convertibility.

In the near term, the government may boost two-way capital flows especially emphasising outbound investment by Chinese individuals, they say.

The People's Bank of China (PBOC) may further relax its tight grip on currency trading by widening the daily trading range for the yuan. In April 2012, Beijing doubled the yuan/dollar band to 1 percent either side of a midpoint.

Deputy PBOC governor Yi Gang said at a forum in Washington in April that conditions were now appropriate to further open China's capital account and widen the yuan's trading band.

"Yuan convertibility is an important link in financial reform which needs to be quickened, or it could hamper other financial reforms and the yuan's internationalisation," said Xiang Songzuo, chief economist at Agricultural Bank of China.

"They will probably get it done by the end of the tenure of the current government, or in the next five years."

The yuan is convertible under the current account, the broadest measure of trade in services and goods. But the government maintains tight restrictions on the capital account, particularly debt and portfolio investments, worried that freeing up the yuan too quickly could leave the economy vulnerable to rapid movements in capital in and out of the country.

A restricted yuan, however, may hamper China's drive to internationalise the yuan as foreign investors who hold the currency have limited access to the domestic capital market.

BROADER REFORMS

At the cabinet meeting, Premier Li Keqiang sent a clear signal that his administration will push forward key reforms, including market-oriented liberalisation of interest rates and exchange rate regimes, to help revitalise the economy.

China leaders have pledged to unleash fresh "reform dividends" to underpin the economy as annual growth unexpectedly slowed to 7.7 percent in the first quarter from 7.9 percent in the previous quarter despite a credit boom.

"All the problems in the economy are caused by the fact that the price of capital in China is not yet market-determined," said Zhang Zhixiang, a professor at Renmin University.

"I think the yuan trading band could be widened and interest rates could be liberalised further, but the process will be gradual," said Zhang, a former central bank official who also had a stint at the International Monetary Fund.

China is keen to see the yuan added to the IMF basket of currencies, which currently includes the pound, yen, euro and dollar, that make up the IMF unit of account, the Special Drawing Right.

Beijing has ambitions to make the yuan an international currency to rival the dollar and euro. It has been promoting the use of yuan in trade settlements, signing a series of currency swap agreements, alongside the gradual capital market opening through its qualified investor programmes.

"If we want to let the yuan enter the SDR basket by 2015, it's something we can get around," said Lu Zhengwei, chief economist at Industrial Bank in Shanghai.

Still, Beijing will tread cautiously on the currency.

Chinese officials, including PBOC's Zhou, have repeatedly said opening up the capital account does not mean China will give up capital controls completely.

Also, drafting the detailed plans on yuan convertibility may involve different government departments with conflicting interests, analysts say.

"There is no problem with the direction of reforms, but there are disputes over the sequencing, the speed and the timetable," said Zhang Bin, an economist at the Chinese Academy of Social Sciences (CASS), a top government think tank in Beijing.

(Editing by Jacqueline Wong)

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