Exclusive: China eyes market forces to drive forex reform agenda

Sun Mar 3, 2013 5:19pm EST
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By Nick Edwards

BEIJING (Reuters) - China is set to use swelling offshore holdings of its tightly-managed currency worth around 1 trillion yuan ($160 billion) to justify a landmark shift in tactics to relax capital controls.

The shift means the People's Bank of China (PBOC) will abandon a time-table approach to liberalizing capital controls, favoring instead a series of reforms tied to soaring foreign demand for yuan to give more freedom to invest offshore currency deposits on the mainland.

Sources with knowledge of the latest PBOC thinking say the bank believes the strategy shift would shield the economy from the risk of a 1997/98-style Asian currency crisis that could be triggered in the wake of liberalization.

"Responding to foreign demand for renminbi products would be the best way of maintaining momentum for capital market and capital account reforms," a former top official in the PBOC's international division told Reuters, on condition of anonymity.

"The bank is very worried about opening up the capital account because when it does, it knows that anything could happen," the former official said.

"But if you give investors a market-based reason to hold renminbi (yuan) they will."

Investors expect China to make its currency basically convertible by 2015, or 2020 at the latest, and have anticipated that monetary authorities would do so according to a series of time-tabled steps. The new approach adds more uncertainty to the route Beijing may take to full currency flexibility.

A more flexible approach to currency liberalization widens the range of possibilities for policy tweaks, such as raising quotas for offshore yuan to be invested onshore, making changes to asset allocation rules for such investments and widening participation in domestic money markets.   Continued...

A Chinese national flag is seen at the headquarters of the central bank of China in Beijing February 20, 2013. REUTERS/Kim Kyung-Hoon