China is resisting international pressure to let its currency float freely, but the yuan is already being widely exchanged in its Special Administrative Region.
Hong Kong is testing ground for yuan trading
China's size is an asset most of the time. But when it comes to trying out new policies, it is a disadvantage since it is easier to deal with mistakes in a small country.
As the rest of the world leans on China to make its currency convertible and let the yuan's value rise, Chinese authorities have to worry about the impact it will cause on the economy.
Fortunately help is at hand in the form of Special Administrative Regions (SAR) of China of which Hong Kong is the most important and the richest. Hong Kong already has its own dollar that is freely convertible and solidly backed by the US dollar. At the same time Hong Kong, which is connected to China both geographically and economically, receives millions of tourists and businessmen from China every month. Traffic is not just one way either.
Since Hong Kong and mainland China use different currencies there are a lot of small money changers who have set up shop in Hong Kong, especially near the entry points of trains and ferries that connect the city with China.
Since there is a two way liquid market in both the Hong Kong dollar and the Chinese yuan it is possible to buy either currency in reasonably large numbers, with the traders taking only small commissions. So in this market, the Chinese yuan is already freely convertible despite what the central government might say.
For a few years now, Hong Kong residents have been allowed to buy or sell up to a maximum 20,000 yuan (Dh11,065) a day using their Hong Kong bank accounts. Given this background, it is not too much of a stretch for China to allow the use of yuan for trade settlements done within Hong Kong. That would be one more small step towards free convertibility.
Those who follow Chinese government policies are always struck by how cautious and gradual they are rather than the "big bang" changes often favoured byfree-market countries. To the Chinese government, "big bang" is what happened in the Soviet Union in 1990 when it introduced radical capitalism overnight or when Japan was forced to revalue the yen sharply upwards in 1985 after the Plaza Accord, which was a co-ordinated programme to weaken the dollar.
The Chinese policymakers have seen the severe economic dislocation that followed those "big bang" measures and they are not about to repeat that now.
Hong Kong has always been a laboratory for China. Even after the mainland was taken over in 1949 by the communists, Hong Kong was allowed to thrive as a capitalist enclave under British colonial rule for purely pragmatic reasons.
The Chinese plan now seems to be to allow the gradual growth of an offshore market in Hong Kong. Since there is demand from buyers and sellers for the yuan, Hong Kong's' financial institutions will be able to "settle" currency transactions within their borders.
Over the next few years we can expect the offshore yuan market based in Hong Kong to operate as a precursor to the fully fledged convertibility of the Chinese currency.