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Economy

China using its control on yuan transactions for diplomatic gains

China's central bank in late May made its first use of foreign funds under a currency swap agreement, raising 400 million won to promote trade with South Korea.

TOKYO -- China is strategically and actively using its tightly controlled currency, the yuan, to expand its economic sphere of influence while promoting its diplomatic agenda.

     Since June, the People's Bank of China, the nation's central bank, has opened new facilities for the clearing and settlement of transactions in the yuan in Asia and Europe.

     The primary objective of these moves is to promote yuan payments for trade by making it easier to settle transactions in the Chinese currency.

     The Chinese central bank has set up new official clearing services for the currency in the U.K., Germany and South Korea.

     The People's Bank has designated the branches and local units of three leading Chinese commercial banks -- the China Construction Bank, the Bank of China and the Bank of Communications -- in these countries as "clearing banks" for the yuan.

     Beijing is using big Chinese commercial banks under its control to promote the yuan as a major currency for international settlements.

     China has maintained strict control on trading in the yuan in offshore markets, demanding that yuan transactions be settled through agent banks in mainland China or the Bank of China in Hong Kong.

     The new services mean that overseas yuan transactions can be settled through the clearing banks in London, Frankfurt and Seoul without involving remittances to China.

     The international stature of the yuan has risen rapidly in recent years. But it remains far behind the dollar, the euro or the yen as a settlement currency because Chinese government controls still make it troublesome for businesses to make payments for cross-border trade directly in yuan.

     If Beijing fully liberalizes its currency and capital markets, such overseas clearing banks will become unnecessary.

     But it is totally unclear whether and when Chinese authorities will take the deregulatory step.

     Japan carried out full capital market liberalization in the 1980s under pressure from the U.S.

     Washington played the central role in all key currency trade developments in the postwar era, including the shift to a floating exchange rate regime in the early 1970s and the yen's appreciation in ensuing years.

     China has a history of making diplomatic goodwill gestures before major political events with the U.S., such as expanding the daily trading range for the yuan.

     But there are no signs that the Chinese government is warming to the idea of floating the currency in the near future. Beijing is especially cautious about loosening its grip on capital flows.

     Unlike Japan, China is not under strong influence of the U.S. Rather, China's principal goal under its currency strategy is to insulate its economy from the influence of the dollar as much as possible.

     China is making decisions concerning overseas settlements of yuan transactions from the viewpoint of its diplomatic strategy.

     In a move that indicates the diplomatic implications of China's currency policy, the People's Bank of China in late May raised 400 million won ($390,000) to promote trade with South Korea in its first use of foreign funds under a currency-swap agreement with the country.

     It was the first time the Chinese central bank had borrowed foreign funds to increase international yuan transactions.

     This move is hard to understand without considering China's recent diplomatic maneuverings to expand its economic ties with South Korea against the backdrop of its strained relations with Japan.

      A Xinhua news article on this financing scheme said the Chinese-South Korean trade zone could expand fast while talks for a trilateral free trade agreement among China, Japan and South Korea are showing no progress.

     It is difficult for other countries to resist such currency proposals by China when the Chinese economy is still growing at annual rates of over 7%.

     There are few countries that are willing to throw away opportunities to build close business ties with a rising economic power which could eventually rival or even surpass the U.S.

     Beijing is using its strictly regulated currency as a key driver of this strategy.

     China, of course, cannot keep such tight control on its currency forever as its economic becomes bigger and more globalized.

     The day will eventually come when Chinese leaders decide to liberalize yuan transactions in order to make it a truly international currency that can be a challenger to the dollar supremacy in global trade.

     Until that time, however, China will continue to use the yuan as a powerful diplomatic tool while loosening its control on the currency bit by bit.

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