CNH Tracker-China's move to quicken capital reforms may be risky

By Michelle Chen and Saikat Chatterjee

HONG KONG, Dec 5 (Reuters) - As China looks to rapidly prise

open its tightly-controlled capital account, analysts say the

move could have unintended consequences for domestic financial

markets if policy makers fail to carefully calibrate the

changes.

Beijing's expected nod to allow unprecedented freedom for

funds to move across its borders has raised concerns that the

economy is too fragile to handle such volatile capital flows.

The capital market, for example, is still underdeveloped,

which raises the risk of skewed market pricing as these fund

flows start to impact various assets, the analysts add.

Forging ahead with financial liberalization without

accompanying reforms in other areas will only push interest

rates higher and force local governments and State-owned

enterprises (SOEs) to default.

Such a scenario can have a wrenching impact across the local

financial markets -- not to mention globally -- as Beijing is

already battling to bring down trillions of dollars of local

government debt. Piles of loans taken by SOEs and surging

property prices have also raised the spectre of a nasty asset

price collapse.

This week, the People's Bank of China (PBOC) unveiled

details to develop the newly-launched Shanghai free trade zone

on Monday and surprised the market by allowing much

easier-than-expected cross-border fund flows via the zone.

Most of these measures will be implemented in the next three

months and experience drawn from the zone will be copied and

extended to other areas in about a year, according to PBOC

Shanghai chief Zhang Xin.

The reform plan as well as the ambitious timeline to

implement them have surprised market watchers and prompted some

economists like Mizuho's Shen Jianguang to warn that risks for

liberalising the financial sector is rising quickly.

"Financial reform must be coordinated with changes in

government functions, SOE reforms, and fiscal reforms. Without

such coordination, lopsided financial liberalization may occur,

and that could easily backfire," Shen said.

While that ambitious roadmap has been greeted with caution

on the mainland, the excitement is palpable among overseas

market participants with some expecting a fresh impetus to the

growing offshore yuan centers outside Asia.

Standard Chartered Bank said on Monday it will

cooperate with Agricultural Bank of China to provide

yuan clearing services in the UK, helping financial institutions

and corporates execute yuan transactions.

It is set to breathe fresh life into the declining yuan pool

in London where deposits in private banking accounts stood at

only 2.8 billion yuan ($459.65 million) at the end of 2012, a

fraction of Hong Kong's nearly 800 billion yuan deposit pool,

according to a June 2013 City of London (LSE: CIN.L - news) report.

In October, Britain said it would ease banking rules for any

non-European bank that wants to set up investment banking

operations in London, a move seen as especially aimed at Chinese

banks to expand their European operations.

Across a few time zones in Singapore, its stock exchange

signed an agreement to cooperate with each other to promote the

internationalisation of the yuan by exploring joint product

development.

"The MOU allows us to build on Hong Kong's position as the

premier offshore Renminbi centre by developing closer links with

Singapore and helping regional investors deploy a growing pool

of investable offshore Renminbi," HKEx Chief Executive Charles

Li said.

The city-state with 140 billion yuan deposits at the end of

July is hurrying to keep its status as he second-largest

offshore yuan pool given the rapid growth in Taiwan this year.

Regulators in the island recently gave the greenlight to

allow mainland firms to issue yuan bonds there, which already

saw the five biggest Chinese state-owned banks tapping the

market in the past two weeks.

WEEK IN REVIEW:

* China's yuan currency overtook the euro in October,

becoming the second-most used currency in trade finance, global

transaction services organisation SWIFT said on Tuesday.

* Far East Horizon returned to the dim sum market

on Wednesday and sold a 700 million yuan three-year bond priced

at 5.45 percent, according to a term sheet seen by Reuters. The

book amounted to 1.5 billion yuan with orders from 48 accounts.

* China Construction Bank is to apply for a branch license

to operate in London following an easing in UK rules on how

overseas banks can be set up, a person familiar with the matter

said on Monday.

* Industrial and Commercial Bank of China

plans to issue 1 billion to 2 billion yuan

of yuan bonds in Taiwan, joining four other major mainland banks

to do so, two sources with direct knowledge of the matter said

on Thursday.

CHART OF THE WEEK:

China's yuan surpassed the euro in Oct (KOSDAQ: 039200.KQ - news) . to become the 2nd

most used currency in trade finance:RECENT STORIES:

CNH Tracker-Taiwan's Formosa (Taiwan OTC: 8171.TWO - news) bond market to remain a local

affair

Hong Kong offshore yuan deposits seen extending October's rapid

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China's free trade zone plans herald quicker FX reforms

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