Yuan as a World Currency? Getting There Fast

Jaap2 | E+ | Getty Images

As Beijing eases control over its currency and opens up its financial markets to foreign investors, the yuan is gaining ground as a global currency and is headed for further gains.

The yuan, also known as the renminbi, hit a record high of 6.2124 against the U.S. dollar this week and analysts said the currency is at its strongest level since China's government unified official and market exchange rates in 1993.

The significance here is not the trend in the yuan, which has been slowly edging up ever since China dropped its currency peg against the dollar in 2005, but the growing use of the yuan internationally, said China watchers.

"This is all about the function of the currency and not the value, which moves just a little bit," HSBC's global head of forex strategy David Bloom, said about the recent gains in the yuan on CNBC Asia's "Squawk Box" Friday.

"The yuan is at much more of an equilibrium value right now and this currency is all about opening up. We are talking about death and decay in other markets, but China's going its own way. This is about the liberalization of the currency and that's going to be fascinating over the next few years," he added.

Data released last week by SWIFT, a global transaction services organization, showed that international payments in China's yuan soared 24 percent in November from the month earlier and hit a record 0.56 percent of the global total.

While tight capital controls limit the use of the yuan outside of mainland China and Hong Kong, Beijing has been encouraging greater use of the currency globally via bilateral currency swaps and trade settlement deals.

Chinese central bank data last week show that cross-border trade settlement in the yuan stood at 2.94 trillion ($467 billion) last year, a rise of 41 percent from 2011.

(Read More: How the Yuan Could Take the Dollar's Crown)

Countries with close trade links with China have been leading a push to use the yuan in global transactions because it lowers costs and currency risks for companies. Australian businesses are increasingly settling their Chinese trade in yuan rather than U.S. dollars, according to an article in The Australian this week. China is Australia's biggest trading partner.

Bigger Changes a Foot

A comment this week, meanwhile, by China's top securities regulator that foreign investment could be allowed to rise as much as tenfold is another sign of China's willingness to open up its markets and implies increased use of the yuan as a world currency.

China last year more than doubled the amount of Chinese shares that foreign investors could own, increasing the quota for qualified foreign institutional investors or QFII to $80 billion from $30 billion.

This year China's central bank is expected to promote a pilot scheme for renminbi-denominated QFII.

"Forget the acronyms, look at what has happened. What's going on is renminbi internationalization," Peter Alexander, managing director at China investment advisory Z-Ben told CNBC.

"The measures (we are hearing about) are about internationalizing the renminbi, without messing up the capital account. Now we should have more volume in the renminbi, which is where the government wants to go," he added.

(Read More: Can China's New Leaders 'Revolutionize' With Financial Reforms?)

Patrick Bennett, forex strategist at CIBC agrees, saying: "China is increasing both the inflow and outflow of funds and this is another step along the path of eventual liberalization, of having the currency freely tradable."

Heading Where?

Bennett said he expected the yuan to gain about 2 to 3 percent this year, adding that the yuan was one of three currencies CIBC favored in 2013. The other two are the U.S. dollar and the Canadian dollar.

Dariusz Kowalczyk, senior economist and strategist, Asia ex-Japan at Credit Agricole, in Hong Kong expects the yuan to strengthen to 6.10 per dollar by year-end, a gain of about 2 percent from current levels, on the back of a strengthening economy and the prospect of tighter monetary policy in the second half of the year to keep inflation at bay.

(Read More: China Inflation Accelerates – Time to Remove the Punch Bowl?)

Data on Friday showed China, the world's second biggest economy, grew a better-than expected 7.9 percent in the fourth quarter from a year earlier, bouncing back after seven straight quarters of slowing expansion.

Some analysts however are more skeptical about the scope for further gains in China's currency.

"What the Chinese are doing is opening up little bits of capital account convertibility, without taking a one-step big-bang approach because that's not their policy. On the yuan, I don't like it. It really is not a free-market currency still," David Roche, global strategist, Independent Strategy told CNBC. "Also you're looking at a cyclical bounce in the Chinese economy to 8 percent. That's not a reason to revalue the renminbi."

- By CNBC's Dhara Ranasinghe.