A booming future

On June 1, 2012, the yuan and Japanese yen started direct convertibility and bilateral trade between China and Japan accounted for 9.4 percent of China's foreign trade and 20.6 percent of Japan's. Most market participants thought the amount of the yuan converted into yen would remarkably increase, but the transaction volume amounted to a mere 3 percent of the total amount of yuan converted into U.S. dollars.

Lu Zhengwei, chief economist at the Industrial Bank Co. Ltd., said the prospect of direct trading between the yuan and Australian dollar will be better compared to the yen. One reason is that after the Diaoyu Islands dispute between China and Japan exacerbated in the second half of 2012, companies in Japan have not been keen on seeing a more international yuan. To Chinese people, except for traveling purposes, there is no obvious benefit from direct trade between the two currencies. Interest rates in Japan are much lower than in China, and Japan is not a good destination for stock market investment or resource development.

On the contrary, bilateral trade between China and Australia is frequent and large in volume. Among China's imports, one third are from Australia. In recent years, China has made active overseas investment in mineral resource projects, and Australia has become a major destination for that investment. The number of Chinese studying in and immigrating to Australia is growing. Moreover, the Australian dollar is a currency favored by Chinese investors. Direct trading between the yuan and the Australian dollar will further stimulate the desire among Chinese investors to hold the Australian dollar.

Now China and Australia are negotiating setting up a yuan offshore center in Sydney, and those talks will only accelerate once trade between the two currencies expands.

At present, nine foreign currencies are convertible to the yuan in the foreign exchange market. Of them, the U.S. dollar, Japanese yen, ruble, ringgit and Australian dollar are directly traded with yuan, while exchange rates with the euro, Hong Kong dollar, pound and Canadian dollar have to be calculated according to yuan's exchange rate with the U.S. dollar.

During the yuan's internationalization process, more currencies are expected to be directly convertible to yuan, but it's anyone's guess which currency is next.

Experts say Brazilian real is on dock. When meeting Brazilian President Dilma Rousseff in Rio de Janeiro in June last year, former Chinese Premier Wen Jiabao suggested both sides should strive for yuan settlement in bilateral trade as soon as possible. During the meeting, China and Brazil also struck a 190-billion-yuan or 60-billion-real ($30 billion) currency swap deal.

Trade between the Australian dollar and yuan began in 2011, and only after two years were the currencies directly convertible. Brazilian real could likely duplicate such a speed. However, some industrial insiders say China's central bank also has its eyes on the Canadian dollar next given the growing ties between the two countries and Canada's status as a sophisticated and developed economy.

Responding to these conjectures, Zhang said direct trading of the yuan with other currencies is an important step toward making the currency less dependent on the U.S. dollar, but China must consider factors related to its economy and the financial markets before making any decisions.

Far from international

The Australian dollar is now the world's fifth most traded currency. Bai Ming at the Chinese Academy of International Trade and Economic Cooperation, which is affiliated with the Ministry of Commerce, said that while direct trading with the Australian dollar is a step toward yuan internationalization, only after the yuan becomes a "hard currency" in the international market can the currency become truly international. Because conditions are not fully ripe, yuan internationalization should advance in an orderly and gradual way.

Yu Yongding, a researcher with the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, said a crucial point for internationalization is the willingness of the international community to use the yuan. Two things must happen on that front. First, China's economic strength must be strong enough so that the trade volume settled in yuan increases in world trade. China's influence in this aspect is growing. Second, offshore yuan markets must be established to ensure that enough of the currency is supplied in overseas markets. However, among the existing yuan offshore centers, only Hong Kong has active transactions.

Moreover, there are few channels for offshore yuan to flow back into China, restricting the yuan's status as an international currency. After companies and banks receive the yuan, they can only use them to issue bonds in offshore markets or invest in the mainland market via renminbi qualified institutional investors in a limited quota. This has discouraged overseas clients from using the currency.

To make the yuan an international currency, China must also resolve some issues closer to home, said Yu.

"It is unfeasible to accelerate the yuan's internationalization when China's financial markets are not well developed, the exchange rates and interest rates are not market-formed, financial institutions are not competent in risk management and there are asset bubbles and excess liquidity."

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