China’s central bank said it will widen overseas access to its domestic bond market as part of a program to promote the use of its yuan currency in international trade.

The trial program, announced Tuesday, will allow some yuan held offshore to be invested in China’s interbank bond market, where most government and corporate debt trades and which is now largely off-limits to foreign investors. Opening up more channels for overseas investors is a key step in the internationalization of the yuan, a new priority for the Chinese government.

China has been promoting the use of yuan to settle trade transactions, while also trying to avoid rapid liberalization that could disrupt its carefully nurtured domestic financial stability. One of the hurdles it has faced is that the strict controls on funds moving in and out of China give companies outside China who are receiving yuan in payment few places to hold the currency. The new program would allow such funds to flow back into the local bond market.

While the sums involved are likely to be modest, the move shows how China’s ambitions to make its currency more widely used internationally can also require it to dismantle some of the more stringent controls over its own financial system.

Ben Simpfendorfer, China strategist at Royal Bank of Scotland in Hong Kong, said the PBOC’s latest move is “small but important step” to internationalize the yuan.

“The amount of the yuan available abroad is in part determined by this yuan trading-settlement program. There’s not a large pool of yuan liquidity [offshore] now, but that could change,” Mr. Simpfendorfer said. “What they are doing is they are building a very strong foundation and the internationalization of the yuan could be a lot faster than we expected.”

Foreign financial institutions that participate in the yuan-settlement program will be able to reinvest their yuan proceeds in the interbank bond market, giving them a channel to invest and maintain the value of their yuan holdings, the People’s Bank of China said in a statement.

Economists have long anticipated that China would widen access to its domestic capital markets in order to accommodate the increasing size of the yuan-trade settlement program. According to figures from the central bank, the volume of trade settled in yuan under the program hit 48.66 billion yuan ($7.16 billion) in the second quarter, more than double the figure in the first quarter of the year.

China said in June it would expand its yuan settlement trial to most of the country, a total of 20 provinces. The program started in 2009, allowing companies in Shanghai and the southern province of Guangdong to use yuan when trading with companies based in Hong Kong, Macau and a handful of foreign countries.

Tuesday, Mark McCombe, chief executive of HSBC Hong Kong, a unit of HSBC Holdings PLC, predicted the moves would mean increased momentum for the liberalization of the yuan.

“Allowing relevant overseas institutions to invest in the interbank bond market can offer certain channels to maintain value of the yuan funds,” the PBOC said in its statement on Tuesday.

The bond-market program is open to Hong Kong-based, Macau-based and foreign banks that participate in yuan settlement, as well as overseas central banks, the PBOC said.

The Hong Kong Monetary Authority welcomed the program, saying in a statement, “This will further promote the development of [renminbi] trade settlement in Hong Kong, and enhance the attractiveness of [renminbi] offshore business in Hong Kong.”

By AARON BACK And JOY C. SHAW

Tags: bank of china, Chinese economy, economists, financial markets, financial system, investment

This entry was posted on Tuesday, August 17th, 2010 at 11:12 am and is filed under Asian Finance, Chinese Finance, Global Economy, Global Financial, Market Finance. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.