China dips a toe into the choppy waters of free foreign exchange markets this week. By launching trade in eight new currency pairs on Wednesday, Beijing hopes to lay the groundwork ahead of liberalising its rigid yuan regime. Officials have assembled a strong line-up of foreign and local banks, including ABN AMRO and Bank of China, but economists are divided as to whether the market will attract the volume of business needed to take off long-term. Confusion and speculation have shrouded the significance of the launch of the trading platform. Some had reckoned China would use the start to announce a yuan revaluation, prompting a rare public denial by central bank chief Zhou Xiaochuan.
Despite the brouhaha in the weeks leading up to its launch, the new trading platform does not trade the yuan.
It does represent a step towards truer capital markets. The world's third-largest trading power and top foreign investment destination is struggling to ensure capital is doled out efficiently, or to provide cash-strapped firms with money-raising avenues, and is struggling to move towards market-driven interest rates.
"The longer-term objective obviously is to develop a freer market," said Citigroup economist Yiping Huang. "The big question is, even if they can make money, whether they can actually offer the other currencies in the market, because their ability to borrow is limited."
"That's probably the main constraint. But as a first step, it's very important."
Apart from moulding a prototype that regulators can draw on before de-linking the yuan's decade-old dollar peg, Chinese lenders can try their hand in a volatile forex arena.
The new system hosts trading in the US dollar versus the euro, yen, Hong Kong dollar, sterling, Swiss franc, Australian dollar and the Canadian dollar, plus the euro versus the yen.
The country's decade-old interbank market, the China Foreign Exchange Trade System (CFETS), currently trades just four currency pairs - the yuan against the euro, yen, Hong Kong dollar and US dollar.
CFETS named seven foreign banks among 10 market makers for the system. They will step in and participate in a transaction if no other buyer or seller can be found.
Those included Deutsche Bank A.G. and HSBC Holdings Plc., plus local players Bank of China, and Industrial and Commercial Bank of China.
"China needs to improve its backward foreign exchange market, which now only does settlement, effectively," said Cheng Manjiang, an economist for Bank of China International.
The exchange commissioned news and information provider Reuters Group Plc. to help put in place the electronic platform across which the new currency pairs would be traded. Expanded currency trading is expected to give Beijing greater understanding of foreign exchange dealing and experience in regulating it.
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