Yuan Sets Sail

By LAN XINZHEN

Yuan Sets Sail

By LAN XINZHEN

Wide use of the yuan in direct investment overseas marks a step toward a fully convertible currency

In its first document of the year, the People’s Bank of China, the central bank, outlined new measures for a pilot program to allow non-fnancial enterprises to use the yuan, also called the renminbi, in settlement while making investments in overseas markets. For foreign entrepreneurs, this means they can get funding denominated in the currency of China—one of the most dynamic economies in the world.

According to the central bank’s measures, non-financial enterprises incorporated in areas where pilot programs of yuan settlement in cross-border trade have been launched are permitted to participate in the new scheme. These areas include Shanghai, Beijing, Chongqing, and Tianjin municipalities; Guangdong, Liaoning, Jilin, Heilongjiang, Jiangsu, Zhejiang, Fujian, Shandong, Hubei, Hainan, Sichuan, and Yunnan provinces; and Inner Mongolia, Guangxi Zhuang, Tibet and Xinjiang Uygur autonomous regions.

The measures allow investors to use the yuan in direct investments in overseas enterprises or projects where the aim of the investment is to acquire full or partial ownership or actual control of the enterprise or project, whether by way of merger, acquisition, equity participation or otherwise.

In the past, Chinese enterprises had to exchange the yuan for U.S. dollars before investing overseas. The Ministry of Commerce’s statistics show that domestic investors made outbound direct investments (ODIs) in 3,125 overseas companies in 129 countries and regions in 2010, with total nonfnancial ODI reaching $59 billion, growing 36.3 percent year on year. In the past five years, the aggregated amount of ODI from China totaled $216.6 billion.

Guo Tianyong, a banking professor at the Central University of Finance and Economics, said against the backdrop of the yuan’s appreciation, most foreign entrepreneurs are eager to get yuan investment and domestic enterprises will be more willing to invest overseas after the measures are adopted.

Fully prepared

Managers at domestic and foreign banks have all stated the yuan payment and settlement systems are prepared and are readily available for customers.

Li Ru, an account manager of the Beijing Branch of the Bank of China, said in 2009 China allowed yuan settlement in foreign trade, which provided experience for its use in ODI practice.

According to the measures, before remitting any yuan funds out of China—whether in relation to the direct investment or pre-investment expenses—investors must register the remittance with local bureaus of the State Administration of Foreign Exchange. For the purpose of registration, investors are required to submit the approval letter issued by, or, in the case of remittance of pre-investment expenses, the application document for the proposed overseas investment to, the relevant Chinese authorities in charge of approving the outbound investment. After the registration, investors can remit the yuan funds, domestic banks can also provide yuandenominated loans to the investors’ ODI projects. Profts that investors obtain in overseas investments can also be remitted back to China in the form of yuan.

Montgomery Ho, managing director with commercial banking of HSBC Bank (China), said China has made remarkable progress in ODI. Judging by the global scale, China has become the fifth largest source of ODI and China’s ODI is expected to grow at an annual rate of 40-50 percent.

At present, nearly 90 percent of Chinese ODIs have been invested in emerging markets, which also have the most potential in the need of the yuan. Ho believed the measures will also help satisfy the emerging markets’increasing demand for the yuan settlement in cross-border trade.

A step forward

ZHU LIYI

SHA DATI

Allowing yuan settlement in ODI, Guo said, will help avoid settlement risks brought about by the third-party currency—like the U.S. dollar. More importantly, the measures will spur convertibility of the yuan under the capital account of the balance of international payments, and will bring positive infuence on the yuan’s internationalization.

Guo said in the past, efforts have been mainly made in trade areas. On July 2, 2009, the central bank issued the Administrative Rules on the Pilot Program of Renminbi Settlement of Cross-border Trade, the offcial launch of yuan settlement in cross-border trade. Shanghai, Guangzhou, Shenzhen, Zhuhai and Dongguan were the frst fve pilot cities and overseas regions were limited to Hong Kong and Macao special administrative regions and ASEAN countries. On June 22, 2010, the central bank said the program would be expanded to 20 provinces, municipalities and autonomous regions (mentioned above) and there would be no restrictions on overseas destinations.

But since China adopts foreign exchange controls and the yuan is not fully convertible on the current account, foreign entrepreneurs, after getting a large sum of yuan but unable to exchange it to their own country’s currency or the U.S. dollar, might be less willing to use the Chinese currency.

Since the Chinese Government now allows yuan settlement in ODI, it means China is ready to make breakthroughs in liberalizing its capital account.

The latest progress is that starting in 2011, U.S. citizens can buy the yuan worth up to $4,000 a day per person at the Bank of China’s New York Branch.

A research report published by the Agricultural Bank of China also pointed out the yuan settlement in ODI further stimulated the yuan’s convertibility under the capital account.

In the wake of the fnancial crisis, some of China’s trading partners have started using the yuan as a settlement currency to avoid currency risks from sharp fuctuations in the U.S. dollar and the euro. The international community needs to diversify the risks of relying too much on the U.S. dollar so that the yuan will gradually become a choice for settlement, said the report. Meanwhile, the expected yuan appreciation creates an advantageous condition for its internationalization.

Guo said the yuan’s internationalization is conducive to the development of the Chinese economy—it opens the way for the yuan to flow into overseas markets and increases the yuan supply in the international market to ease infation and excess liquidity on the domestic market.

Major concerns

Allowing the yuan to be used directly in overseas investments is bound to increase the stocks of yuan in those markets. Therefore, the yuan’s fowing back into China becomes a problem.

As for China, building a yuan return fow mechanism is a necessary step in realizing the free convertibility of the Chinese currency. Meanwhile, it is necessary to increase the scale of the yuan’s circulation and use to make it fully convertible under the current account and make overseas institutions or individuals willing to hold the yuan.

As a matter of fact, with yuan settlement implemented in foreign trade, China has been confronting the return fow problem. A report released by the auditing frm Deloitte at the Asian Financial Forum held in Hong Kong on January 17 said the low yield in overseas markets led the yuan to flow back to the Chinese mainland market.

Zhang Jianjun, head of the Shenzhen Branch of the People’s Bank of China, said Shenzhen and several other inland cities have facilitated overseas yuan investment in the form of foreign direct investment (FDI) on the Chinese mainland, but the amount involved in the 20-30 transactions has been small. For now, relevant departments are working on regulation guiding the yuan return fows.

Wang Yong, a professor at the central bank’s training institution in Zhengzhou, Henan Province, said apart from the problem of the yuan’s return fow, there are three important issues that need immediate attention.

First, along with the progress of the yuan settlement in both cross-border trade and ODI, overseas enterprises may lack yuan funds and investment channels.

Second, China should immediately readjust the supervision method of cross-border capital movements. When dealing with ODI businesses, Chinese banks must be vigilant against money laundering and terrorist financing.

Third, after the yuan is used to crossborder trade settlement, overseas yuan debt will be formed. When the debt reaches a certain scale, the yuan will be held in a large amount by overseas investors. The sum of money will flow in and out along with the yield fluctuations in domestic and foreign currency markets. Reasonably managing capital supply will become a challenge to the central bank’s policymaking skills.