- China plans to create new special economic zone in Qianhai Bay, Shenzhen
- Hong Kong banks would be allowed to lend money to mainland companies in the zone
- Latest in a series of steps to move towards making the renminbi a convertible currency
- Hong Kong banks are currently not allowed to lend to Chinese clients in China
China plans to create a special zone to experiment with currency convertibility in Shenzhen, the city where it introduced key economic reforms three decades ago.
The measure will enable Hong Kong banks to lend renminbi directly to companies in Qianhai Bay -- a new economic zone on a peninsula across the water from Hong Kong -- according to Chinese state media.
Bejing will unveil the details on Friday as Hu Jintao, Chinese president, visits Hong Kong for the 15th anniversary of the handover of the city from Britain.
Analysts say the experiment could prove as critical to eventually dismantling capital controls as Deng Xiaoping's reforms were to opening China to the world.
The Qianhai experiment follows a series of steps taken by the Chinese government to move towards making the renminbi a convertible currency that analysts believe could one day vie with the US dollar for pre-eminence in global markets.
Over the past two years, Chinese companies have been allowed to settle most of their international trade in renminbi. This has provided a conduit for the currency to flow abroad for the first time in large volumes.
Foreign institutions have also been given a limited but growing array of investment options for their renminbi holdings, such as Hong Kong's dim sum bond market and a programme for buying Chinese equities.
But China has installed speed bumps to ensure the renminbi cannot travel freely across the border for pure financial transactions. Beijing is aware that hasty capital account openings can spark situations such as the 1997 Asian financial crisis.
Allowing Hong Kong banks to lend to Chinese companies on the mainland creates a new, potentially wide channel for renminbi held overseas to flow back to China.
Banks in Hong Kong are currently allowed to lend to Chinese clients in Hong Kong, but not in China. If the Chinese clients want to bring that money into China, they need to obtain approval from the foreign exchange regulator. The new rules are expected to eliminate many of those controls to make it possible for Hong Kong banks to directly lend to Chinese clients in Shenzhen.
In selecting Shenzhen for the latest trial, China's planners are making a nod to the past. In 1980, Shenzhen was designated the country's first special economic zone, bringing foreign investment and free trade to China, and launching the country on its way to becoming the world's second-largest economy.
Liu Ligang, an economist at ANZ, said the risks of the latest measure were greater than those attached to the 1980s opening.
"Money is fungible. Like water, it flows to low levels. So if money can flow from Hong Kong to Qianhai, the money will flow from Qianhai to other parts of China that can offer higher returns."
He said China had to ease its control of interest rates and deepen the domestic bond market before opening the capital account to lessen the risk of speculative capital rushing in and local companies accumulating dangerously big foreign debts.
Separately on Friday, the stock exchanges of Hong Kong, Shanghai and Shenzhen said they would create a joint venture index company to give investors access to companies listed in all three cities for the first time and boost their capital markets.
Charles Li, chief executive of the Hong Kong Exchange, said it would create its first cross-border indices by the end of the year and launch derivative products and exchange traded funds based on the indices and stocks next year.