China Allows Trade Settlement in Yuan in Hong Kong

China approved use of yuan to settle cross-border trade with Hong Kong, part of a drive to broaden the use of the currency and reduce reliance on the U.S. dollar.

Hong Kong Monetary Authority Chief Executive Joseph Yam said he hopes the first transactions will start next month after signing an agreement with People’s Bank of China Governor Zhou Xiaochuan at the city’s airport today. Zhou said the program would reduce foreign-exchange risks and transaction costs.

China is promoting greater use of the yuan in international trade and finance after Premier Wen Jiabao in March expressed concern that a weakening dollar will cause losses on holdings of U.S. assets. The greenback slumped on June 26 in New York after the People’s Bank of China renewed its call for a new global reserve currency to replace the greenback.

“It’s an important step to make the yuan an international currency,” said Fang Ming, an analyst in Beijing at Bank of China Ltd., the nation’s biggest foreign currency trader. “In the long-term, the world reserve currency system will consist of several major currencies, including the yuan and the euro, instead of just the U.S. dollar.”

The Dollar Index that measures the currency’s performance against six trading partners rose 0.4 percent today, after dropping 0.7 percent on June 26. Zhou told reporters in Basel yesterday that the nation won’t alter the composition of its $1.95 trillion in foreign-currency reserves suddenly. U.S. President Barack Obama needs the support of China as his government tries to spend its way out of a recession.

Yuan Settlement

The government said on April 8 that it will allow Shanghai and four cities in the southern Guangdong province, including Shenzhen and Guangzhou, to settle international trade in yuan. Companies currently have to convert yuan into dollars or other currencies to settle international trade.

“Our long-term goal to promote Hong Kong as an overseas yuan trade settlement center for China, and today’s arrangement is a big step towards this goal,” Hong Kong Chief Executive Donald Tsang told reporters before the signing.

About 50 percent of Hong Kong’s trade with China may be settled in yuan after the program starts, Stanley Wong, deputy general manager at Industrial & Commercial Bank of China (Asia) Ltd., the Hong Kong unit of China’s biggest bank, said in an interview on May 5. Hong Kong companies want to use yuan in trade because it will probably appreciate against the U.S. dollar more than 3 percent every year, he said.

The Chinese yuan has strengthened 21 percent against the U.S. currency since a dollar peg was scrapped in 2005. China has limited the yuan’s advance in the past year as a stronger currency makes its goods less competitive overseas at a time when the economy is forecast by the World Bank to expand 7.2 percent in 2009, slowing from 9 percent last year.

‘Testing Ground’

Hong Kong Financial Secretary John Tsang said the city will be a “testing ground” for use of the yuan outside mainland China. Zhou said that there was “still a big distance” between China’s trade relations between Hong Kong and those with Taiwan, when asked whether a similar arrangement could be made with the island.

The People’s Bank of China has agreed to provide 650 billion yuan ($95 billion) to Argentina, Belarus, Hong Kong, Indonesia, Malaysia and South Korea through so-called currency- swaps to expand its usage. China and Brazil in May began studying a proposal to move away from the dollar to settle trade and use yuan and reais instead.

Story by: John Liu in Shanghai at jliu42@bloomberg.net. Nipa Piboontanasawat in Hong Kong at npiboontanas@bloomberg.net