Central bank keeps grip on new China forex system

Shanghai, June 5: China has announced a primary dealer system for currency trade, further reforming its foreign exchange market, but traders say the new system is unlikely to lead to a faster appreciation of the yuan.

The system, published in official newspapers on Monday, formalises an existing practice of several local banks handling People's Bank of China transactions.

The designation of primary dealers could be an important move toward other, more significant changes, traders say, though the central bank intends to keep a firm grip on activity, a fact that may disappoint major trading partners who hope a freed up Shanghai foreign exchange market will let the Chinese currency appreciate faster.

''The announcement of the primary dealer system confirms our suspicion that the central bank has begun to use major state banks to express its monetary policy intention,'' said a Shanghai-based dealer at a European bank.

''That is a step forward compared with the central bank's direct intervention in the market, but it means Beijing still has the final say on the yuan's exchange rate.'' In its new rules, the People's Bank of China said it would allow designated lenders to trade directly with the central bank as ''primary dealers''.

The central bank had declared in its first-quarter monetary policy report last week that it would gradually phase out its operations in the currency market.

The primary dealer system is potentially one way to achieve this, because it allows the central bank to deal with the market through a few agents, rather than intervening directly in trade.

''The guidelines are issued to help effectively implement monetary polices and maintain the reasonable and balanced stability of the yuan,'' the central bank said in its new rules, which took immediate effect.

However, the new system will operate under considerable secrecy.

The central bank said it would not disclose the primary dealers nor their transactions with it, and it would place restrictions and requirements on the dealers' activity - for example, they must not disclose information about the system.

Primary dealers must keep close contact with the central bank and immediately report to it major events in the market, the rules specify.

The dealers must also provide transaction details and trading analyses to the central bank upon request. Given the secrecy imposed on dealers, this provision gives the central bank unmatched knowledge of the market -- and potential control of it.

Violators will face penalties including having their qualifications as primary dealers revoked.

Foreigners may be excluded

To a large degree, an informal primary dealer system already existed in China's currency market as the central bank influenced trade through a small number of local banks, such as the ''Big Four'' state-owned banks, traders said.

But Monday's announcement formalised the arrangement and signalled that it would remain for some time, they said.

In contrast, few if any foreign banks in Shanghai have been asked to become primary dealers. Three major foreign players told Reuters on Monday they had not become such dealers.

A central bank spokeswoman, declined to comment, as did officials at the Big Four -- China Construction Bank Corp., Bank of China, Industrial and Commercial Bank of China and Agricultural Bank of China Many traders suspect the central bank helped to engineer a recent pause in the yuan's appreciation, through trading by the Big Four banks and by setting a reference rate for the yuan/dollar rate every day.

Last Tuesday, the yuan hit a 10-week low of 8.0325 to the dollar, bringing its losses to 0.44 percent since May 15. It was the yuan's longest period of weakness and the steepest fall since Beijing revalued the currency by 2.1 percent and freed it from a dollar peg in July last year.

The yuan has recently clawed back, and it traded around 8.0100 on Monday. But traders said many banks were reluctant to resume pushing the yuan up aggressively without a signal from the central bank in the form of reference rates.

Reuters