SHANGHAI – China and South Korea have announced their intention to introduce direct trading between the yuan and the won following meetings between Chinese President Xi Jinping and South Korean President Park Geun-hye last week.
The memorandum of understanding, which will help South Korea to become an offshore yuan center, was signed in Seoul during Xi’s first visit to the country since assuming office in 2013. Xi was accompanied by a business delegation made up of more than 250 Chinese entrepreneurs from a wide range of sectors.
On Friday, China’s central bank announced the appointment of the country’s fifth biggest lender, the Bank of Communications (BoCom), as the yuan clearing bank in Seoul. Following announcements regarding London and Frankfurt in June, Seoul is the third city in less than three weeks to have been assigned a yuan clearing bank.
As a result of the agreement, BoCom will be capable of settling transactions within South Korea in Chinese currency. By bypassing the use of a cross rate with the U.S. dollar, direct trading between the two currencies will help to reduce foreign exchange costs and consequently boost bilateral investment. In addition, a won-yuan market will reduce both countries’ reliance upon third-party currency by curbing U.S. dollar inflows.
As well as establishing a won-yuan market, South Korea was granted a Renminbi Qualified Foreign Institutional Investor (RQFII) quota of US$12.9 billion for South Korean investors to invest in Chinese stocks and bonds. The quota issued to South Korea was the same as the one given by China to London and Paris in recent weeks
“[These] announcements will have a synergy effect in boosting financial transactions between the two nations and lessen South Korea’s dependence on the U.S. currency,” said An Yu Hua, a senior research fellow at Korea Capital Market Institute.
“The won-yuan direct trading will cut currency risks and RQFII will encourage South Korean investors to trade the yuan.”
“Through these measures, exchange between companies and citizens in the two countries will become faster and more free,” said President Park Geun-hye.
Of late, China has been making an increased effort to promote the yuan as an alternative to the U.S. dollar as a global trade and reserve currency. Up until recently, the Chinese authorities had not allowed convertibility in a bid to control the country’s interest rate, manipulate the exchange rate of the yuan and shield China from economic and financial shocks.
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Although China’s goal of achieving full convertibility of the yuan was outlined by the governor of the central bank in 1996, plans were postponed partly in response to the financial contagion that arose during the 1997 Asian financial crisis.
Although there are some benefits of restricting cross-capital flows, these barriers also prohibit important financial competition, resulting in low interest rates for Chinese savers and restrictions regarding investing abroad. It also precludes the yuan from becoming a successful global currency.
Free capital flows would help to transform the Chinese economy. Using the yuan as a trading currency will reduce currency risk for Chinese companies and allow trading partners to buy Chinese goods in the event that they don’t have access to U.S. dollars, as occurred when the currency was hoarded during the financial crisis of 2007-08. In addition, the government will be able to issue debt in Chinese currency, with the result that borrowing money would be much cheaper.
In 2011, Chinese officials said that the yuan would achieve full convertibility by 2015. Progress has been slow but significant so far, with analysts pointing out that full capital account convertibility should not be attempted until the country’s financial markets have been modernized to the extent that they are prepared for unregulated currency flows. As well as forging new ground regarding offshore yuan centers, the government has loosened some currency conversion regulations within the Shanghai Free Trade Zone and last week announced that it would allow banks to set their own exchange rates for the yuan against the U.S. dollar in over-the-counter transactions.
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During a speech last week, Xi Jinping encouraged more South Korean investment into China and asserted both countries’ intention to finalize negotiations for a bilateral FTA by the end of this year. The 12th round of FTA talks is due to begin later this month in South Korea.
“Free trade between the two countries will push bilateral economic and trade cooperation to a higher and newer level, which will better benefit the people of the two countries. China pays high regard to this, and hopes the two sides, with prompt and constructive attitudes, speed up work, coordinate the interests from all sides and try to reach consensus by the end of the year,” he said.
Trade between the two countries amounted to US$115 billion in the first five months of 2014, which is a 2.8 percent increase year-on-year. With two-way trade worth US$270 billion in 2013, China is South Korea’s biggest trading partner and South Korea is China’s sixth largest trading partner.
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