Dec 26, 2011

Can China Micromanage the Convertibility of its Currency?

China has recently signed a series of bilateral agreements for limited direct settlement of FX transactions. First with Russia, Indonesia, Australia and more recently with Thailand and now Japan (see BBC article). All of the agreements are aimed at facilitating trade settlement without the need of using US dollars. Also they all seem to be restrictive enough to allow for careful monitoring and control by Beijing. As an example, the agreement with Thailand only allows CNY/THB settlement in the province of Yunnan (bordering Thailand) by the local branches of 4 designated banks. This approach to gradual convertibility is similar to the Special Economic Zone model that China used in the past to introduce capitalism to the country in a limited way. Despite all the media hype, the yuan is very far from challenging the dollar as a global reserve currency. But gradually allowing convertibility of the current account (currency flows based on trade in goods and services) may just work out.

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