Chinese regulators have hinted since last week that the free market, not the government, would eventually control the yuan's exchange rate. The move is part of China's effort to make the yuan--also known as the renminbi--more of an international currency and help boost slowing economic growth.
Not surprisingly, this further liberalization of China's financial markets has been welcomed by foreign investors. Not only has the yuan rallied, but stock prices have jumped over 8% in the past two weeks.
"The rise in the mainland market last week and today is primarily due to the People's Bank of China stating they would allow market forces play a larger role in determining the valuation of the RMB currency," said Charles Salvador, investment solutions director with Z-Ben Advisors in Shanghai. "As the infrastructure is being laid for the future opening of the yuan, we can anticipate there will be positive effects on the opening of the capital markets."
Though not the main goal, loosening controls over the yuan makes Chinese stocks more attractive to foreign investors. For one thing, it lowers the risk that the government will arbitrarily change the yuan's value and diminish stock market profits when translated back to a foreign currency.
"Internationalization of the yuan will have an indirect effect on markets, but when it comes down to using the currency for market trades, it will have a positive influence," said Zhao Xijun, deputy dean of school of finance at Renmin University of China
The impact of state control of the yuan was evident in August when the government decided to devalue the currency 3.5% to help exporters survive China's awkward shift from manufacturing to a consumer-based economy. The devaluation, which sent global markets plunging, was viewed by foreign investors as a a sign of desperation by the government.
Now, China is taking other steps to make the yuan more of an international currency. Last week, it began to set up an inter-bank payment system that will let foreign institutions execute transactions using the yuan.
Last Friday the International Monetary Fund said it was about to decide whether the yuan could join a $204.1 billion basket of Special Drawing Rights currencies, meaning it could be exchanged for what the IMF considers freely usable units.
Market stabilization is now "in sight," Goldman Sachs analyst Kinger Lau wrote last week in a note widely cited by the news media in Asia. Other analysts see stability in the mid-term.Individual foreign investors cannot pick Chinese "A" shares but may invest in funds sponsored by multinational investment banks with quotas from Beijing.
Those options include the Fidelity Emerging Asia Fund (FSEAX - Get Report) , the Morgan Stanley China A Share Fund (CAF - Get Report) and the ProFunds UltraChina Inv (UGPIX - Get Report) . Foreign investors can also track Chinese indices with exchange-traded funds such as the iShares MSCI China ETF (MCHI - Get Report) .