Ruble move reflects China's yuan strategy

Policymakers have shown their confidence in the currency

Allowing foreign currencies to be freely traded with the home currency is common in many countries. But giving a foreign currency the same status as the home unit is not, and China has acted differently.

On Dec 8, the country announced that it was allowing the Russian ruble to circulate unrestricted in Suifenhe, Heilongjiang province, bordering Russia. Although the rule applies to only one city, it is the first time that Beijing has given a foreign currency the same legal status as the renminbi on Chinese territory.

This deregulation tells a few things.

First, Chinese policymakers are indeed increasingly embracing market forces.

Generally the government remains prudent in liberalizing the foreign exchange system and insists on setting what it believes the right value for the yuan.

But Suifenhe, as a place where the yuan and the ruble have already been traded freely by residents, travelers and businesses, has proven that the market itself can do a good job in finding the right point between two currencies.

For years, underground dealers in the city have brokered deals on their own. Their exchange rates could at times differ widely from official rates. But their rates appeared to reflect the market better, with official rates having taken gray-market rates as a reference over the years. Now the differences between market rates and official rates are small, which shows the power of the market.

On the demand side, the ruble has virtually become the second currency in the city, where one-tenth of the China-Russia trade is taking place.

So giving ruble legal status in the city is in line with what the market has been calling for. The government decided not to follow the old practice of simply cracking down on what it used to deem as underground transactions. It realized that legalizing this trade, instead of blocking it, is the way to go, which represents a remarkable change of thinking.

Second, allowing the ruble to be used in Suifenhe displays policymakers' confidence of the yuan's lure across the border.

A big reason that a country usually does not allow a foreign currency to be used in its territory stems from worries that it will threaten the status of the country's home currency.

But for Chinese policymakers, it is not a cause of concern.

As the yuan is appreciating and its value remains strong, the currency's demand in border trade is always big, often making it a preferred choice.

In an open and free foreign exchange market, a stronger currency will ultimately have a bigger share.

In the case of Suifenhe, the ruble is mostly used as a settlement for trade and sometimes as a payment unit for Russian travelers. As the ruble's value can fluctuate sharply and it is depreciating, Suifenhe residents would like to exchange rubles for yuan after they collect some of the currency, and Russian businesspeople are also willing to hold yuan.

So long as China's economic growth bolsters the yuan, its neighbors' currencies, even if they are given access to China, will be unable to challenge the renminbi.

By opening Suifenhe to the ruble, Chinese policymakers are casting a vote of confidence in the yuan, confident that its value can be maintained.

Third, the deregulation in Suifenhe could be copied in other border cities.

China may allow other currencies to legally enter its territory. Cities bordering Southeast Asia and Central Asia could be the next candidates.

The opening-up will certainly make trade easier.

But more importantly, the move can create a reference for Chinese authorities to better set the yuan's exchange rates, as a free market will provide the best reflection of demand and supply.

Last but not least, by allowing foreign currencies to be used in designated Chinese cities, China can have an upper hand in negotiating with neighbors on financial opening-up.

China's ambition to internationalize its currency is clear. But before the yuan becomes a global unit, it has to be a regional one. Therefore, boosting the use of the yuan in neighboring countries is an immediate task for China.

By accepting their currencies, the chances are enlarged for China to persuade neighbors to give a wide access for the yuan to enter their markets.

The author is a Shanghai-based analyst.