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Shanghai finance hub gains currency

NEWS of plans to expand Shanghai's financial market and turn it into a global center for trading in the yuan by 2015 quickly dispelled the languid atmosphere of the Spring Festival holidays and caused a buzz in financial circles.

It is almost three years since the State Council, China's cabinet, first announced plans to make Shanghai an international financial center on par with New York and London by 2020.

At the time, the blueprint was a bit fuzzy. This week's announcement by China's top economic planning agency and the Shanghai municipal government has finally put some meat on the bones, setting up a clearer picture of the city's financial makeover.

The plan seeks to put Shanghai at the forefront of the nation's efforts to turn the yuan into an international currency. It also lays out a framework for expanding the market in stocks, bonds, futures and derivatives. The yuan plan has garnered the most discussion - both positive and negative.

On one hand, many economists believe policy makers have chosen good timing for Shanghai to benefit and accelerate the internationalization of the yuan, which, in turn, will benefit the economic reforms of the country as a whole.

At a time when the West is struggling with debt, political conflicts and sluggish economic growth, the East may be poised to seize an opportunity and enhance its influence in the world economy.

On the other hand, skeptics argue that the yuan has not been sufficiently unyoked from central controls to create a currency market of international stature in Shanghai. The big question remains: Is China ready to let foreigners make money from yuan trading? Without a strong financial incentive, foreigners may not show much interest.

Market-driven

But let's look at the plan itself.A glance at the targets set by the authorities can be encouraging for those hoping to see a more market-driven currency.

The plan envisages Shanghai becoming a global center for yuan trading, clearing and pricing by 2015. The Shanghai interbank offered rate and the yuan central parity rate are to become major benchmarks for both domestic and international transactions. It aims to nearly triple the transaction value of financial markets in Shanghai, barring foreign exchange markets, from 386.2 trillion yuan (US$61.2 trillion) in 2010 to around 1,000 trillion yuan a year by 2015.

Meanwhile, the plan calls for Shanghai to remain the world's largest market for spot gold trading, to become among the top five markets for financial derivatives and to be among the top three in terms of balance of securities depositories.

Fang Xinghai, director of the Shanghai Financial Services Office, explained on Tuesday that the figures are actually not as surprising as they may first appear. "The targets are set based on the growth rate of the past five years," he said. "We think development will remain stable by 2015 and the targets are reasonable."

Some economists have expressed confidence that Shanghai can meet these goals. "It is a wise choice to focus on the expanding use of the yuan," said Zhou Hao at ANZ Bank. "Two years ago, few people could realize what role the yuan would play in trading and investment, but now it has shown its potential, and Shanghai really is the best choice of a site in the mainland to carry on with the mission."

China has taken slow but steady steps in recent years to liberalize the yuan. During the past two-and-a-half years, the yuan has risen some 20 percent against the US dollar.

Foreign institutional investors can now invest in mainland industries and financial markets using both the US dollar and the yuan under specialized programs approved by Chinese regulators.

Last year, the Canadian and Australian dollars were added to the US dollar, euro and five other exchange rates that can be directly priced in exchange rates.

Finally, love it or not, China's yuan-backed stock market has been growing faster than any other bourse since 2010, with the introduction of short-selling tools, stock futures and margin trading.

Long road ahead

Only the level of the yuan's convertibility remains an issue.

"Non-residents cannot participate in the market freely if they can not get the currency freely," said Ma Jun, chief economist at Deutsche Bank. He pointed out in earlier research notes that the yuan can realize no more than 10 percent of its potential if the mainland's capital market is not fully opened.

Questions about the financial expertise available in China to operate according to world standards also vex some analysts. A high-level financial conference held last month disappointed many analysts and economists with its conservative tone.

One example cited is the People's Bank of China's longstanding pledge to promote a market-oriented reform of interest rates. Little action on that front has been seen to date. It doesn't take much financial savvy to know that market-driven interest rates would hurt the profitability of Chinese banks - something policy makers are loathe to do in the name of reform.

The tax issue also plays a hand. China levies a 5 percent business tax on financial institutions, which is not standard practice internationally.

The move to replace the business tax with a value-added tax across the services sector, including finance, has not yet materialized. Financial transactions in Shanghai, which have grown drastically in the past, slowed last year with a mere 2 percent rise due to a poor stock market. How can domestic and foreign investors have much confidence in a market losing 20 percent in a year?

The long-touted launch of a new International Board where foreign companies can list shares in yuan for the first time keeps getting delayed. Stock market regulators are also grappling with criticism about slack oversight, insider trading and dodgy accounting procedures.

There's a long road ahead to turn the Shanghai market into the London or New York of the East. In the end, investors will decide the success of the plan.


 

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