China starts direct currency trading with Japan

China and Japan began direct trading of Chinese yuan and Japanese yen in Tokyo and Shanghai on June 1, in a move to boost trade and investment between the world's second- and third- largest economies, and also viewed as a further step to enable the yuan to become a truly global currency.

For years, the greenback has been the only major direct trading currency of the yuan. Therefore, the move marks the first time for China to allow a major currency other than the U.S. dollar to be traded directly against the Chinese currency.

By abandoning the existing system, which calculates yen-yuan rates on the basis of their respective values against the dollar, the direct exchange rate would be based on a weighted average of prices given by market makers, excluding the highest and lowest offers, according to the China Foreign Exchange Trade System.

The move came after Japan said in December that it would become the first developed economy to hold yuan-denominated bonds as reserve assets. Tokyo obtained approval to buy about 10 billion U.S. dollars of Chinese bonds in March.

The Chinese yuan fetched 12.33 Japanese yen in Tokyo foreign exchange market at 9 a.m. local time Friday, the first day for direct yen-yuan trading.

The Bank of China (BOC), China's third-largest lender, announced Thursday that it had obtained approval as one of the country's first market makers in yuan-yen direct trading.

The BOC's announcement came after HSBC Bank (China) Co., Ltd. said Wednesday that it was approved as a market maker in yuan-yen direct trading on China's interbank market.

Mizuho Corporate Bank (China) Ltd., a subsidiary of the Japan-based Mizuho Corporate Bank, has also been granted the status

Lowering transaction costs

The direct trading will lower transaction costs and reduce settlement risks of the financial institutions and facilitate the use of both the Japanese and Chinese currencies.

The move will also gradually reduce the dependence on U.S. dollar in terms of trade and investment, playing a significant role in enhancing regional economic cooperation and safeguarding financial stability.

By using the dollar as an intermediary in setting exchange rates, many Chinese and Japanese enterprises incur extra trading costs and are confronted with uncontrollable settlement risks. The weakening U.S. dollar status and fluctuating dollar value will eventually distort the parity rate between yuan and yen, thus bringing huge losses to the enterprises.

Trade between China and Japan hit the record high of 344.9 billion U.S. dollars in 2011, with only less than 1 percent of it settled in yuan and most of it settled in the U.S. dollar, according to Japanese statistics. The direct trading will save the two countries some 3 billion dollars of transaction fees annually.

Moreover, for the common people going to Japan for travel or study, the direct trading between yuan and yen will save them one percentage trading cost.

Japanese Finance Minister Jun Azumi highlighted that by not using the dollar as an intermediate currency, "We can lower transaction costs and reduce settlement risks at financial institutions as well as making both nations' currencies more useful and energizing the Tokyo market."

"This will help lower currency conversion costs for economic entities, facilitate the use of the yuan and Japanese yen in bilateral trade and investment, promote financial cooperation and enhance economic and financial ties between the two countries," the People's Bank of China, the central bank, said in a statement.

Ding Zhijie from University of International Business and Economics pointed out that the direct trading of yuan and yen will help form the direct yuan/yen exchange rate and reduce the trading costs for entities as well as help step up financial cooperation between the two countries.

Echoing Ding's opinion, Lian Ping, chief economist at the Bank of Communications, said direct trading between yuan and yen would reduce dollar influence on the two currencies.

"And it will better reflect the supply-demand relation between the two economies and facilitate trade."

Facilitating bilateral trade

Statistics show that, currently, Japan is China's fourth largest trading partner after EU, U.S. and ASEAN. Amid economic doldrums in the euro zone and lackluster prospect of euro, the direct currency trading will contribute to the bilateral trade.

Until now yen-yuan rates were calculated on the basis of their respective rates against the dollar, so the move to allow direct trading is expected to boost bilateral investment, as well as imports and exports due to more convenience in business and considerable reduction of risks caused by the fluctuation of the dollar's exchange rates on the world market.

China is Japan's largest trading partner, and bilateral trade reached as high as 300 billion U.S. dollars in 2010. About 60 percent of Japan-China trade is estimated to be conducted in the dollar.

The trading also can encourage Japanese investors to purchase Chinese financial products and better protect the interests of Chinese enterprises in the global supply chains.

Internationalization of Yuan

Analysts agreed that the direct trading is conducive to the use of yuan to settle cross-border trade, therefore pushing forward the implementation of the strategy of raising the yuan's status as an international currency.

"The move is considered an important step towards yuan internationalization, as the RMB is entering the international monetary market without the U.S. dollar serving as intermediary," said Zhang Bin from the Chinese Academy of Social Sciences,

"Direct trading of the yuan with other currencies like the euro and the pound may also be realized in the future, driven by demand for bilateral trade and investment with other economies," Xiang Songzuo, deputy director of the International Monetary Institute with the Renmin University of China, told the Global Times.

Since the financial crisis, China has quickened the pace of RMB (renminbi) internationalization. While actively conducting the cross-border trade and investment settlement in RMB, China has signed currency-swap agreements worth 1.5 trillion yuan with more than 10 countries and regions, including South Korea, Malaysia, Hong Kong, Belarus, Argentina, Turkey and Australia.

Japan remained the world's largest creditor nation in 2011 with a net 253 trillion yen (about 3.19 trillion U.S. dollars) in foreign assets at the end of 2011, according to the Japanese government.

Though the level of Yen's internationalization is not in parallel with that of U.S. dollar and euro, yen's trading volume in the global foreign exchange market is just next to that of the two

currencies. Behind the move of direct currency trading and Japan's decision to buy Chinese government debts is Japan's confidence in China's stable economic growth, which signifies a key step on the process of yuan internationalization driven by economic power.

As for Japan, jumping on the bandwagon of yuan internationalization will inject fresh vitality into the decaying Tokyo financial market.

Direct trading of the yuan and yen does not mean full convertibility of the yuan, Liu Weiming, an analyst at China Citic Bank, said.

"As the two currencies are directly traded, the use of the yuan in settling trade between China and Japan will increase. And Tokyo is likely to become a yuan offshore center like Hong Kong, London and Singapore."

Lessons drawn from the yen internationalization show that total economic volume itself is not enough to make a country's currency become global one. The global currency should have the functions of pricing, settlement and reserve. To achieve that, RMB will face such difficulties as opening capital account and interest rate liberalization.

When western developed countries are deeply mired in heavy debts, risks in international financial market are perpetually accumulating. At this moment, China-Japan financial cooperation can jointly push forward yuan internationalization and defuse risks, thus helping establishing a new global currency pattern, which is composed of multiple reserve currencies including major Asian currencies.

The yuan's wider use is gaining strength as more than 9 percent of China's total trade was settled in yuan last year, up from only 0.7 percent in 2010.

Anita Fung, chief executive officer of HSBC Hong Kong, forecast that in five years the yuan would become one of three major currencies most widely used to settle trade worldwide, together with the dollar and euro.

China has recently taken several steps to promote the yuan's use internationally.

Last month, the central bank announced it would allow the yuan to fluctuate by a slightly wider margin against the dollar in daily trading — up to 1 percent each day from 0.5 percent previously.