China's central bank has doubled the size of a currency swap with Hong Kong to 400 billion yuan (£40bn), a move aimed at giving the financial centre a bigger relief valve to cope with rising demand for trade settlement in the currency.
The expansion will also boost confidence that Beijing intends to internationalise the yuan, which took a knock in recent weeks as trade limits between Hong Kong and the mainland were hit and offshore yuan prices diverged significantly from onshore prices.
China has used Hong Kong as its main testing ground in the past two years for boosting trade settlement in the tightly controlled yuan as Beijing slowly opens up its financial sector to the world.
The new swap agreement will "surely facilitate" yuan trade and settlement, said Tang Yunfei, an economist with Founder Securities in Beijing.
"Through the expanded currency swap deal, Hong Kong could get more liquidity from China," Tang said.
Indeed, the yuan traded in Hong Kong, popularly known as CNH, briefly rose after the swap news was announced to narrow its spread against yuan traded on the mainland, dealers said.
The offshore yuan and bond market took a knock in recent weeks as the offshore price deviated as much as three per cent from mainland prices, an unwelcome fluctuation for many companies that rely on thin margins.
The new agreement supercedes a 200 billion yuan currency swap deal signed in January 2009, the Hong Kong Monetary Authority said in a statement.
The move is the latest by China to restore investor confidence. It has formalised yuan-denominated direct investment rules and allowed large Chinese state owned companies to sell offshore yuan-denominated bonds in Hong Kong.
Since 2008, China has signed a number of yuan swap agreements with countries including South Korea, Malaysia, Indonesia, Argentina, Singapore and New Zealand to promote the currency in international trade.
The result has been a relative surge in the use of the currency, particularly in Hong Kong.
More than nine per cent of China's total trade was settled in yuan in 2011, up from just 0.7 per cent a year earlier.
City A.M. Reporter