China takes new step to boost yuan's global role

An employee bundles up yuan banknotes at a bank in Hefei, Anhui province April 12, 2010.

BEIJING (Reuters) - China is vastly expanding a pilot programme to encourage the use of the yuan in cross-border trade in what economists say is part of a strategy to raise the profile of the currency on the world stage.

Citing a decision by the State Council, or cabinet, state media said the year-old scheme would be extended to the invoicing and settlement of imports and exports with all China's trading partners.

Until now, the only permitted overseas counterparts have been Hong Kong and Macau -- both Chinese territories -- as well as the members of the Association of South East Asian Nations.

"It is a very positive move in the process of making the yuan an international currency," said Wu Zhifeng, an economist with China Development Bank in Beijing.

Companies in 20 Chinese provinces will henceforth be allowed to trade in yuan. Currently only selected firms in Shanghai and four cities in the southern province of Guangdong are eligible.

State media said the new participating provinces include Heilongjiang, which has been lobbying for approval to conduct trade settlement with Russia in yuan.

Economists said the purpose of the scheme was to gradually make Beijing policymakers and the outside world comfortable with the wider international use of the yuan, commensurate with China's growing economic and financial clout in the world.

"The first step in making an international currency is to use it in trade payments," said Ding Zhijie, a professor with the University of International Business and Economics in Beijing.

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China retains strict capital controls, which prevent the yuan from being freely exchanged for purposes other than for documented trade and investment.

But the country's leaders also make no secret of wanting to see the yuan take its place one day as a major global currency. Invoicing more trade in yuan is a baby step towards the goal of having a freely traded, convertible currency.

"Overall they want to internationalise the yuan by making more people use it whether for investment purposes, for corporates to settle trade or for central banks around the world to use it as a reserve currency," said Kelvin Lau, an economist with Standard Chartered in Hong Kong.

"But, of course, this is a very long-term process, and in the near term it needs to be done step by step. Obviously China is much more comfortable liberalising the current account than the capital account," he said.

But Lau said Hong Kong's experience with cross-border use of the yuan showed that one followed the other; as the volume of yuan deposits derived from trade had grown, so had the demand for yuan-denominated investable assets. Hence the increasing issuance of yuan bonds in Hong Kong.

Ding agreed that China was likely to expand the channels for investing in yuan beyond China's borders and to encourage overseas investors to hold yuan.

Ding, who has advised the central bank on an ad hoc basis, said the yuan's gradual internationalisation could lead to its inclusion in the basket of currencies that make up the Special Drawing Reserve, an accounting unit used by the International Monetary Fund.

Under the IMF's charter, the SDR's components - currently the dollar, euro, yen and sterling -- must be convertible currencies.

By the end of May, trade totalling 44.6 billion yuan had been invoiced and settled in yuan since the pilot scheme was launched in July 2009, Xinhua news agency reported, citing the People's Bank of China.

That would appear to represent a marked acceleration in the popularity of the programme. As of the end of February, the cumulative total was 11.6 billion yuan, according to PBOC figures cited by Lau in an April report.

Wu with China Development Bank said it would still take a long time for the yuan to rival the dollar or the euro.

"Yes, the yuan may become more popular, but don't expect it to become a global currency overnight," he said.

(Reporting by Zhou Xin and Alan Wheatley; Editing by Ron Askew)