The People's Bank of China, the Chinese mainland's central bank, signed an agreement with Taiwan's "central bank" on Friday to establish renminbi clearing in Taiwan, the PBOC announced in a statement on its website on Friday.
Effective in 60 days, the agreement allows each side to set up a clearing bank and directly process currency transactions. Before the agreement, the US dollar was used as an intermediary currency.
The PBOC will appoint a commercial bank — either Bank of China Ltd or Bank of Communications — as the yuan-clearing bank in Taiwan, said the statement. But Taiwan has not decided on a clearing bank yet.
"The establishment of the cross-Straits clearing mechanism signals that currency cooperation between the two sides has entered into a new phase and marks an important milestone in mutual financial cooperation," the PBOC said in the statement, adding it expects direct currency convertibility will facilitate cross-Strait trade.
Under the agreement, the yuan, which will be designated as "CNT" in Taiwan, will have its own spot and interbank markets. Banks in Taiwan will also offer RMB savings accounts.
A currency swap agreement is currently under consideration, but the size has not been decided yet.
"While (Friday's) announcement paves the way for a direct currency trade, the authorities will have to work out the technical details including pace, scope and other technicalities. It seems that Taiwan's RMB market will not replicate the model in Hong Kong," said Raymond Yeung, senior economist at the Australia and New Zealand Banking Group Ltd.
The total value of cross-Straits merchandise trade amounted to $120 billion in the past year.
An average of 4 percent of global payments with the Chinese mainland were settled in RMB, according to latest statistics of Society for Worldwide Interbank Financial Telecommunication.
As Taiwan and the mainland establish a closer economic relationship, that figure could reach 10 percent within six to 12 months, said ANZ.
"Cross-Straits trade settlement in RMB could reach $12 billion a year, and CNT deposits could build up very quickly."
The development of the RMB market will likely be much slower than that in Hong Kong, said Yeung.
"Besides, the statement does not mention any arrangements between the RMB markets in Taiwan and Hong Kong. At this stage, it is difficult to assess whether a CNT market will generate arbitrage opportunities."