CHINA will take another important step today to greater currency flexibility when it introduces a long-awaited system of foreign exchange market-making alongside “over-the-counter” trading in the yuan.

The key moves are the latest in a series by Beijing to promote a slow but steady liberalisation of its exchange rate regime after its landmark revaluation of the yuan by 2.1 per cent against the dollar last July, when it also replaced its 11-year old peg to the US currency.

Last week Beijing paved the way for today’s further reforms when it approved a total of 13 foreign and domestic banks, including Britain’s HSBC and Standard Chartered, and ABN Amro, the Dutch group, to act as market-makers for trading in the yuan.

The introduction of a market-making system is a step intended to promote deeper and more liquid currency markets — conditions that are seen as essential if the yuan is ever to be allowed to float freely on global foreign exchanges.

Market-makers are large institutions that continuously offer prices and carry out currency dealing so that trades can be made at any time, with this greater liquidity in turn helping to smooth out volatility and allow more exchange rates to be set more efficiently.

The creation of over-the-counter trading is an essential counterpart to market-making, with this form of dealing accounting for the bulk of spot transactions in currencies around the world.

Economists said that with the People’s Bank of China still in strict control of the yuan, today’s changes would not lead to any market fireworks. The yuan’s value will still be allowed to fluctuate up and down by a mere 0.3 per cent against a daily “parity” versus the dollar, while it will continue to be restricted to daily moves of no more than 3 per cent against other currencies.

Analysts agreed that, with wider participation and some more flexibility in its trading, the Chinese currency would be less of a “one-way” bet under the latest changes. Since July, the yuan has crawled slowly but steadily higher thanks to a built-in dynamic that now looks set to disappear.

Julian Jessop, of Capital Economics, said that the yuan was likely to follow a pattern of “two steps forward, one step back” versus the dollar. Mr Jessop said that today’s change was small in itself, “but if you add it to all the other reforms that have taken place over the past year, it’s part of a painfully slow crawl towards a more flexible and ultimately floating exchange rate”.

Gerard Lyons, chief economist at Standard Chartered, said that it was a “further sign that the Chinese are opening up their foreign exchange market”. He emphasised that Beijing would need to be confident that Chinese companies and economy were more resilient before more radical steps.

Nick Parsons, of Commerzbank, agreed that the latest changes “should not be exaggerated”, but they were “one more step towards fully liberalising the currency”.

MARKET MOVE

• July 21, 2005: yuan revalued by 2.1 per cent against the dollar
• November 25: first yuan currency swaps allowed
• December 30: 13 foreign and domestic market makers named
• January 4, 2006: Market-making and over-the-counter yuan trading system introduced

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