The pilot program to allow yuan-denominated foreign direct investment (FDI) is a milestone that will promote the popularity of the Chinese currency among foreigners and pave the way for further opening-up of the onshore yuan market.
Last month, the People's Bank of China, the country's central bank, said in a circular that "the settlement business for the yuan-denominated FDI is being carried out on a trial, case-by-case basis".
The move is a significant breakthrough, as it creates an effective way for the yuan held by overseas investors to flow back to China, killing a pain that could potentially hamper the popularity of the currency among foreigners.
Since China allowed the trade to be settled in the yuan, many foreign investors have accumulated a sizeable amount of renminbi over the years.
In 2010 alone, 506.34 billion yuan (53.85 billion euros) worth of China's trade was paid up in the yuan, according to a report by the central bank. Among it, most foreign traders are willing to make payments in US dollar and receive them in the yuan.
In addition, overseas investors are allowed to issue yuan-denominated bonds in Hong Kong. A number of multinational corporations, such as heavy machine maker Caterpillar and fast-food giant McDonald's, have raised billions of yuan through bond sales.
But overseas investors now have very few channels to invest the yuan in China. There are only two major channels for them to do so. They could pay in yuan for imports from China. The other way is to invest in the Chinese mainland's interbank bonds market in the yuan but this market is only open for Hong Kong investors.
However, these two investment channels are not very attractive to overseas investors because the return for the investment is not high.
It is under this backdrop that the yuan-denominated FDI is introduced.
As the People's Bank of China has stipulated in the circular, overseas investors are allowed to use the yuan to "set up enterprises, acquire companies, transfer the interest, increase the capital for existing companies and offer shareholder loans".
The policy enables overseas investors to boost their investment in China by using the yuan parked outside China.
Compared with imports and interbank bonds, the yuan-denominated FDI will, generally speaking, offer a better return. According to a survey by the Chinese Academy of Social Sciences, US companies, excluding those in the financial sector, reported an annual profit margin of 25 percent in 2009.
However, the deregulation will not be pressed ahead with proactively, because the central bank is still worried about the inflow of speculative capital.
This can be seen from two aspects.
First, the program is still arranged case-by-case, showing the prudence of the central bank. It is believed that the authorities want the opening-up to be gradual to prevent a massive inflow of money.
That concern is justifiable since China is still in a hard battle to tame runaway consumer prices.
Second, foreign investors are not allowed to invest their yuan notes in "strategic sectors and scrutinized industries". Although it did not specify, it is believed these industries include finance and real estate, two industries China want to maintain a tight grip on.
