HONG KONG/BEIJING, Feb 22 (Reuters) China may allow the issue of yuan bonds in Hong Kong and permit cross-border trade to be settled in yuan, Hong Kong's financial secretary said on Wednesday, presaging another step towards a freer-floating currency.
Calling Hong Kong a ''testing ground'', Financial Secretary Henry Tang said the two measures under consideration would spur bilateral trade while developing the city's bond markets.
If the proposals were approved, Hong Kong would benefit by being the only place outside mainland China to host trading in yuan-denominated securities.
Economists said a market in such bonds may dampen speculative inflows into China betting on yuan appreciation. It might also shed more light on the market value of the yuan, also known as the renminbi (RMB), which can be converted for trade and foreign direct investment but only for limited capital transactions.
But they did not expect Beijing to allow such a market to expand rapidly in the short term.
Tang did not say when -- or if -- he expected the twin proposals to win approval.
''They are vitally important in reinforcing our position as an international financial centre, and will at the same time provide a testing ground for the move towards full RMB convertibility,'' Tang said during his annual budget speech.
''We need, however, to synchronise in tandem with the pace of financial reform on the mainland and move forward gradually.'' Beijing dropped the yuan's long-standing peg against the dollar in July, and has long said it would eventually make the currency freely convertible.
PILOT SCHEME Economists said Hong Kong was the logical choice for monitoring how the yuan would respond to market forces -- a stated intent of Beijing.
James Malcolm, a currency strategist with Deutsche Bank in Singapore, said it made sense to launch a pilot scheme in Hong Kong, where China can keep close track of it, but he described it as just an incremental step towards liberalisation.
''It's like an incubator for experiments. It'll start very very small,'' Malcolm said.
Dangling the prospect of partial internationalisation could help calm tempers in Washington, which is angry that Beijing has let the yuan rise just 0.8 per cent since the revaluation, despite breakneck growth and a bulging balance of payments surplus.
The top U.S. Treasury official for international affairs is expected to press the case for swifter appreciation when he visits Beijing next Monday as part of an Asian tour.
''In the longer term, they plan to open the capital account,'' said Bank of East Asia economist Paul Tang. ''It makes sense to do it on a small scale in Hong Kong.'' The immediate impact of such a market would be more localised, providing an investment outlet for the nearly