RMB trade settlement puts upward pressure on forex reserves (3)

09:18, July 29, 2011      

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RMB-denominated FDI likely to boost RMB backflow and aggravate inflation

The central bank has taken small steps to make the RMB internationalization more flexible since June. The People's Bank of China released the "Circular on Clarifying Relevant Issues Regarding Cross-Border RMB Business" in early June, stating that the RMB settlement of foreign direct investments was in trial run. This means that the RMB will be used not only in overseas trade settlement but also in foreign direct investments in China.

At present, 70 percent to 80 percent of cross-border RMB trade settlement transactions are conducted in Hong Kong. RMB deposits in Hong Kong reached 548.8 billion yuan by the end of May.

Hong Kong investors, who are holding RMB deposits, are looking for more effective investment channels. However, given the massive RMB deposits outside the Chinese mainland, it is obvious that neither the dim sum bonds issued by mainland financial institutions nor the RMB-denominated property trust funds can meet the demand of investors.

China's central bank has taken some measures to solve this problem, including issuing a directive in August 2010 allowing foreign central banks, RMB clearing banks in Hong Kong and Macau and participant banks in the cross-border RMB trade settlement project to invest RMB holdings in the country’s inter-bank bond market on a trial basis.

Although the central bank has lifted certain restrictions on the backflow of RMB to the Chinese mainland, the quota for overseas financial institutions has been limited. Even the Hong Kong Monetary Authority only has a small quota, which is totally negligible in the huge bond market. This has showed the central bank's great caution in this pilot project.

"China must treat the backflow of RMB to the mainland with great caution. Hong Kong alone has massive RMB deposits. If the RMB could easily flow back to the mainland, the domestic inflation would be aggravated. This would be contrary to the central government's aim of stabilizing consumer prices and curbing inflation and to the purpose of China's monetary policy," Gao said.

By Tan Jialong from China Ecnomic Weekly, translated by People's Daily Online
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