Hong Kong's ambition to become an offshore yuan center is a step closer thanks to recent central government moves to expand the yuan's international role.

Among the most significant moves is an announcement by the State Council (China's Cabinet) early last month that exporters and importers in five mainland cities will be able to settle their cross-border trade deals in yuan under a pilot program.

The five cities include Shanghai in the Yangtze River Delta and Guangzhou, Shenzhen, Zhuhai and Dongguan in the Pearl River Delta. All have large numbers of export-oriented manufacturers in their surrounding regions and will initially likely only involve deals with the special administrative regions of Hong Kong and Macao.

No timetables for, or details of, the program have been made available.

But signs indicate the scheme could be implemented soon.

Li Feng, Shenzhen's deputy major, told Hong Kong reporters earlier last week that the city authority had chosen 100 import and export firms to participate in the pilot scheme.

He said he expects the Guangdong provincial government to approve the list soon.

Tu Guangshao, a Shanghai vice-mayor, also told media late last month that the city was selecting its first batch of companies to participate in the scheme.

The move to allow yuan settlement in cross-border trade will strengthen Hong Kong's role as a financial gateway to the mainland, Hong Kong's Secretary of Financial Services and the Treasury Chan Ka-keung said.

"Both our financial industry and trade between the two places will benefit immensely from this breakthrough," he said.

Analysts were uncertain on whether the move was intended primarily to help Hong Kong become an offshore yuan hub.

"I can't really speculate what the central government's ultimate intention is. It may not necessarily be intended to help Hong Kong become an offshore yuan hub. But it will be a breakthrough to that effect," said Irina Fan, a senior economist at Hang Seng Bank.

China's rapid growth and the scale of its economy naturally demand a bigger role for the yuan in the international arena, she said.

Yuan settlement for cross-border trade in Hong Kong would likely lead to other services such as yuan lending, issuing yuan bonds and yuan investment assets in the special administrative region, she said.

Hong Kong will enjoy a "first-mover advantage", although the central government may allow yuan settlement in trade with bordering Asian markets, such as ASEAN countries, effectively making them "first movers" too, the economist said.

"But Hong Kong would retain an edge over those countries, in terms of having a mature financial market and financial expertise," she added.

"The move will push Hong Kong a step closer to develop into an offshore yuan hub," said Paul Tang, chief economist at Bank of East Asia.

Tang said the arrangement intends not only to make Hong Kong an offshore yuan hub but also to help open up the mainland's financial system.

The ultimate intention of the move is to boost the role of the yuan in the international monetary system, said Frances Cheung, an economist at Standard Chartered Bank.

"Turning Hong Kong into a offshore yuan hub is just a side effect," she said.

Hong Kong is the only offshore market that is allowed to issue yuan bonds, which helps its drive to become an offshore yuan center, she said.

How fast Hong Kong develops into an offshore yuan center will depend on the pace at which the central government expands the role of the yuan, said economists.

Signs are encouraging in this aspect, according to some observers.

In a meeting with Hong Kong's Chief Executive Donald Tsang last month, Premier Wen Jiabao said the central government will try to expand Hong Kong's yuan bond market.

Mainland units of Hong Kong banks will soon be allowed to issue yuan bonds in the administrative region and the Ministry of Finance is considering issuing yuan bonds in Hong Kong, the Premier said.

The central government is also studying a proposal to extend financial aid to developing countries in yuan instead of in US dollars, according to a report by the South China Morning Post.

China will then allow beneficiary nations to trade yuan reserves in Hong Kong (if they do not use up all the aid) to buy Chinese products, the report said, quoting unidentified sources.

The move, if it materializes, will boost Hong Kong's chances of becoming an offshore yuan hub, Standard Chartered Bank's Cheung said.

Economists said the central government, at some point in the future, will likely announce other measures to boost yuan use in Hong Kong such as allowing yuan lending and developing yuan-based assets other than yuan bonds.

(China Daily May 18, 2009)