2013-09-05

Major Reform Threshold Crossed: Yuan Will Be Fully Convertible in Shanghai Free Trade Zone...Or Will It?

Here it comes. As I've consistently said, this is bearish for the yuan in the short-run because of built up imbalances, but bullish long-term.

China to allow free yuan exchange in Shanghai zone: draft plan
China will allow unfettered exchange of its yuan currency in its first free trade zone, a draft plan seen by AFP Thursday showed, in a bold push to reform the world's second largest economy.

The free trade zone (FTZ) in Shanghai is intended to make the city into a true international trade and financial centre and challenge the free economy of Hong Kong, a special administrative region of China, analysts and government officials said.

Premier Li Keqiang, who took office in March, is backing the zone -- which his cabinet approved last month -- to be one of the crowning achievements of his administration, they said.

The draft plan seen by AFP showed the FTZ goes beyond greater liberalisation of trade to take in investment and financial services -- including free convertibility of currency.

"Under the pre-condition that risk can be controlled, in the zone convertibility of the renminbi on the capital account will be conducted, the first to carry out and test (it)," the plan said.

It does not explicitly state that the exchange rate will be purely market set.
Risk cannot be controlled, and it doesn't matter whether the market sets the yuan price or the central bank continues to set it. If the yuan is freely convertible, the market will set the price in Shanghai and funds will pour in or out. If not, the price will be set in Hong Kong and funds will flow in or out of Shanghai. The "fake exports" yuan rally will be a small blip compared to the fiscal imbalances that will come out of this free trade zone.

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