Yuan takes another major step toward full convertibility

Banks can now set their own exchange rates for the yuan against the dollar in over-the-counter transactions - another step toward freeing the exchange rate from government control.

Banks were previously required to price the yuan/dollar rate they offered retail clients within 3 percent in either direction of the Chinese central bank's daily middle rate.

"The liberalization of the retail market implies that the People's Bank of China believes that the yuan has now reached equilibrium," said Cao Yang, an analyst at the Shanghai Pudong Development Bank Co Ltd.

Such equilibrium permits the central bank to free the yuan's exchange rate gradually without worrying about excessive volatility, he said.

The new rules do not apply to the yuan/dollar's main rate in the interbank market, which is subject to controls including the central bank setting a daily middle rate.

Under the new policy, effective immediately, banks can price OTC yuan/dollar exchange rates "in line with market supply and demand and without any restrictions", the PBOC said in a statement on Wednesday.

The move "is aimed at further perfecting the mechanisms to establish a market-oriented exchange rate for the yuan," it said.

However, the wholesale market that the banks trade in must still abide by the middle rate guidance rate. Because that primary market is an enormous source of foreign exchange supply and demand, posting around $15 billion in transactions every day, it will continue to exercise a strong influence on the retail market.

The world's second-largest economy is seeking to increase the use of the yuan in global trade and investment to reduce China's dependence on the US dollar. The move is also aimed to reduce the exposure to the economic policy decisions made by global financial institutions, in which Washington has a big influence.

Allowing the market to price the yuan against the dollar is a prerequisite for wider liberalization and at the same time decreases the need for China to accrue dollar reserves in the name of managing the exchange rate.

The PBOC has guided the yuan to stage more two-way trading over the past couple of years, letting the currency appreciate 2.9 percent against the dollar in 2013, only to push it down as much as 3.4 percent this year to convince the market not to consider the currency a one-way bet on appreciation.

With the first market-oriented yuan/dollar exchange rates in the OTC market, the central bank can collect data on dollar supply and demand from major State banks, traders said.

"Retailing is also an important indicator for yuan/dollar demand and supply and reflects sentiment toward these currencies," said a senior dealer at a major European bank in Shanghai. "As such, the OTC exchange rates will have an influence on the interbank rates and help banks discover market-oriented rates."

Chinese companies welcomed the move. "The opening will have a positive impact on corporate foreign exchange deals," said Wang Xinjiu, a representative of China International Marine Containers (Group) Co Ltd, the world's top container producer.

"Companies, just like individuals, will have better channels to meet their foreign exchange demand with more reasonable exchange rates," he said.

The latest reform comes ahead of economic talks between the United States and China later this month, during which US officials are expected to raise concerns about China's intervention in the currency market.