Yuan liberalization so far

In June, ahead of the G20 summit, China announced it would end its peg to the U.S. dollar and allow a more “flexible” regime against a basket of currencies. Since June, the yuan has appreciated against the U.S. dollar, although some critics complain the pace has been too slow.

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Aside from relaxing control over the exchange rate of the yuan, China is also freeing it in other ways. McDonald’s (NYSE: MCD) recently became the first international non-financial corporation that will issue yuan-denominated bonds.

The idea is for McDonald’s to borrow in yuan and spend the yuan-dominated money opening restaurants in China. Previously, McDonald's would have had to borrow in another currency to finance its Chinese operations.

This is an important first step for China's capital markets in its quest to become a legitimate source of debt financing for multinationals doing business in China. Further down the road, China can also develop equity financing for multinationals. In addition, China's capital markets may become a source of financing for corporations doing business in neighboring Asian countries with less developed capital markets.

China is also relaxing its rules for foreign central banks and lenders to invest in its interbank bond market. The goal is to provide an investment avenue for organizations that have accumulated yuan through trade. This makes holding the yuan more attractive and thus a more viable settlement currency used for international trade.

If China opens more yuan-denominated investment options for foreigners, the yuan would obviously become even more attractive as a settlement currency.

The liberalization of yuan ultimately means it will become more practical and attractive for foreigners, who will increasingly accumulate and use it for a variety of purposes.  In the more distant future, the yuan may gain traction as a reserve currency. In addition to its liberalization, China's growing economic importance and the perception that the yuan is poised to appreciate should further bolster its popularity among foreign central banks.

Recently, The Financial Times reported that certain prominent international banks – including HSBC (NYSE: HBC), Citigroup (NYSE: C) and JPMorgan (NYSE: JPM) – have “launched international roadshows promoting the use of the renminbi [yuan] to corporate customers instead of the dollar for trade deals with China.” And companies in China are increasingly requesting trade partners to accept yuan as payment, Citigroup's Carmen Ling told Financial Times.

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