Fully Convertible RMB In Shanghai’s Free Trade Zone?

The author is ANZ (The Australia and New Zealand Banking Group) Research

The media has reported that China may allow convertible Yuan in the proposed free trade zone in Shanghai.

Companies registered in the free trade zone could open special accounts to freely exchange yuan. Interest rates would be set by the market, according to media reports.

We believe Shanghai is planning to replicate another Hong Kong through the free trade zone. Its plan may involve amendments to financial regulation. The liberalization will also be much bigger in scale and broader in scope than other similar initiatives in China, such other Shenzhen Qianhai.

Many companies may choose to move their principal business activities currently in Hong Kong to Shanghai. In addition, the proximity to Shanghai’s main market may also expand the volume of cross border flows and hence offshore RMB activities.

It is unclear how the Shanghai scheme can prevent arbitrage-driven capital flows, as onshore and offshore interest rate differentials remain large.

The improper use of re-export trade between Hong Kong and the Mainland for financially-driven gain had partly contributed to the large dollar position of onshore banks earlier this year.

Our view remains that China should expedite domestic financial sector reforms, notably interest rate liberalization and establishing deposit insurance scheme.

Failure to adopt reform measures in proper sequence may risk China’s overall financial stability.

(The article has been edited for clarity)