Benefits of direct yen-yuan may be few, far between

Effective June 1, China and Japan launched a new currency exchange program which allowed direct trading of yuan and yen, making the Japanese yen the second major currency, after the US dollar, that can be directly exchanged with the renminbi.

This new scheme, its advocates claim, will reinforce bilateral trade and investment between the two countries by lowering transaction costs and settlement risks at financial institutions, and also promote the internationalization of the yuan by building up its position in the world's third largest economy.

While there certainly is the potential for this much-lauded agreement to further these goals, there is also a chance the scheme could fall flat or run counter to China's best economic interests.

Over the past decade, China has been enlarging its commodities and energy imports and has been using these resources to develop its own high-tech equipment and precision machinery for export, a sector that was previously dominated by Japan.

While lowering settlement costs might stimulate bilateral trade between China and Japan, as the countries gradually shift away from a complimentary trade relationship toward a competitive one, the benefits of the new scheme may not have the dramatic impact many are expecting.

Moreover, the scheme will push up the weight of the yen in China's foreign reserves and as Japan's public debt snowballs, the risks of holding its currency will continue to mount. Over the past year, three of the world's most respected rating agencies - Fitch Ratings, Standard and Poor's and Moody's - have all downgraded Japan's credit rating as its debt is expected to clock in at 240 percent of its annual GDP by the end of 2012. As a Japanese economic recovery continues to remain elusive, China could find itself saddled under the weight of an ever-depreciating yen.

Meanwhile, the Bank of Japan, the country's central bank, announced on May 23, it would maintain its overnight interbank market interest rate between zero and 0.1 percent, much lower than that of most other countries, including China, as part of its monetary policies.

The direct trading of the yen and the yuan will facilitate Japanese investors who plan to profit from the difference between interest rates in the two countries' money markets, leading to an inflow of hot money.