Time for Next Move on Yuan Liberalization

Time for Next Move on Yuan Liberalization

By PETER STEIN

Last year, China made waves by letting foreign investors get their hands on more of its currency. This year, the big question for many is what China will let them do with that money.

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A Chinese bank worker counts a stack of 100-yuan notes at a bank in Hefei, east China's Anhui province on February 27, 2011.
.The first stage of a grand experiment took place last year, when China put in place measures that let people outside its borders for the first time trade in the currency of the world's second-biggest economy, creating a new market for offshore yuan and yuan-based securities.

The take-up has been swift and enthusiastic. Daily trading in offshore yuan now totals more than $600 million, according to Deutsche Bank AG. That's small by the standards of the $4-trillion-a-day foreign-exchange market but up sharply from only around $100 million in October. After helping sell about 36 billion yuan ($5.48 billion) of "dim sum bonds" last year in Hong Kong, bankers reckon this year's issuance could easily double that figure. One company is already working on launching what could be Hong Kong's first ever yuan-denominated share offering.

The reforms are having a global impact, allowing traders in London and New York to buy and sell what was until recently an isolated, walled-off currency. But the impact in Hong Kong, an offshore finance center that's nonetheless part of China, is especially powerful. Peter Pang, deputy chief executive of the Hong Kong Monetary Authority, told investors at a Goldman Sachs conference last week the ex-British territory's role as incubator of this new market is "probably the most important development in Hong Kong's evolution as an international financial center in recent decades."

Feeding this market are the piles of yuan mounting in this city's bank accounts. These totaled 314.9 billion yuan ($47.9 billion) as of Dec. 31, up fivefold from a year earlier, boosted by Beijing's efforts to promote use of yuan over dollars to settle China's overseas trade deals, as well as by expectations that the yuan's value will continue to rise over time. Economists are expecting those deposits to reach anywhere between 500 billion and 1 trillion yuan by the end of the year.

But there's a problem: What do you do with all that yuan? Pocketing 3% to 4% annual appreciation against the dollar is all fine and good, but can you put the money to work? Offshore-yuan securities help, but they're no substitute for being able to invest directly in China. And the yuan won't appreciate forever.

It's an important question for companies looking to raise funds through the offshore yuan market, as each must seek permission to bring the money they raise into China. And China gives Hong Kong banks with yuan deposits only a limited ability to invest that money in the mainland and make a return.

.Behind the reluctance to let yuan (also known as renminbi, or RMB) flow back into China is the specter of "hot money" controlled by shadowy hedge funds that some in China fear might destabilize the country's financial system. At the Goldman Sachs conference, a senior Chinese central banker acknowledged differences of opinion on this subject within China, while dismissing the fears as unfounded.

"Maybe you have noticed there is a lot of debate about hot money and international use of the RMB," said Xing Yujing, deputy director general of the monetary-policy department of the People's Bank of China, adding: "we should be aware of some false propositions."

Some policy makers apparently believe letting yuan flow back into China isn't necessary. Fang Xinghai, director general of Shanghai's financial services office, in January suggested at a public forum in Hong Kong that most funds raised here through yuan bonds should be kept offshore to promote the yuan's internationalization. Those aren't reassuring words for many wannabe bond issuers. Nothing spoils your appetite for dim-sum debt like being told you can't invest your money in China and earn a good return.

More promising are the prospects for a new investment quota that would allow foreign institutions the right to park some of their yuan in mainland Chinese stocks and bonds. Hong Kong officials say that program, long anticipated by players in the market, is under discussion.

Victor Chu, chairman of First Eastern Investment Group, predicted Beijing will soon allow more creative ways of pumping yuan back into China. One might allow private-equity firms to raise yuan offshore and invest it back onshore. That could inject a bit more long-term investment perspective into the market, since private-equity funds raise, deploy and recoup their funds over periods as long as eight to 10 years.

"Hong Kong will have a role to play because the expertise and action is here," Mr. Chu said.

To get to that point, though, China's leadership will need to accept that their goal of internationalizing the renminbi depends on giving people enough incentive to be part of the process.

Write to Peter Stein at peter.stein@wsj.com