China will allow unfettered exchange of its yuan currency in its first free trade zone, a draft plan seen by AFP Thursday showed, in a bold push to reform the world's second largest economy.

The free trade zone (FTZ) in Shanghai is intended to make the city into a true international trade and financial centre and challenge the free economy of Hong Kong, a special administrative region of China, analysts and government officials said.

Premier Li Keqiang, who took office in March, is backing the zone -- which his cabinet approved last month -- to be one of the crowning achievements of his administration, they said. The draft plan seen by AFP showed the FTZ goes beyond greater liberalisation of trade to take in investment and financial services -- including free convertibility of currency. "Under the pre-condition that risk can be controlled, in the zone convertibility of the renminbi on the capital account will be conducted, the first to carry out and test (it)," the plan said. It does not explicitly state that the exchange rate will be purely market set. China's yuan currency, also known as the renminbi, is convertible for trade but the government keeps a tight grip on the capital account on worries unpredictable inflows or outflows could harm the economy -- and reduce its control over it.

A government official familiar with the plans said companies registered in the FTZ could open special accounts to freely exchange yuan, but with only a few exceptions they would be required to close their onshore Chinese accounts. Under the draft plan, the FTZ would let interest rates be set by the market. China currently fixes deposit rates by administrative order, but the central bank began allowing banks to decide their own lending rates in July. According to the Ministry of Commerce, the 29-square-kilometre FTZ groups four existing areas in Shanghai: the international airport, deepwater port, a bonded zone and a logistics area.

The draft plan said the FTZ would "support" establishment of foreign and joint ventures banks and welcome privately-funded financial institutions. At present China's banking sector is overwhelmingly dominated by state-run institutions. "They want an offshore harbour, basically like Hong Kong," said a financial industry executive briefed on the plans. The government tapped commercial hub Shanghai because of the success of its Waigaoqiao bonded zone, the executive said, which allows goods to be imported tax-free, unless they are to be sold on within the domestic Chinese market. The FTZ project as a whole "will be a bold step to escalate China's economic development to the next level", ANZ Banking Group said in a research report this week. "Its success could be a model for the next stage of China's economic reform, opening up and capital account liberalisation." But it warned such liberalisation would increase the risk of large capital flows, which could impact the economy.

For trade, the government envisions making the zone a centre for cross-border e-commerce transactions, a plan which may require cooperation with a payments provider, officials said. The zone would create a "platform" for trading commodities such as metals, energy and farm products and "gradually" allow foreign companies to directly trade commodities futures, the draft plan showed. Within the FTZ regulatory controls will be relaxed in 19 different business sectors, ranging from banking to culture. But authorities have ruled out allowing casinos in the FTZ, officials said, a privilege enjoyed by Macau, another special administrative region of China. Some Shanghai officials opposed the FTZ because ultimate authority will be in the hands of the central government, causing local resentment, the financial industry executive said.

The State Council, China's cabinet, gave the FTZ its go-ahead in August and details will be announced after the "overall plan" is approved on September 27, officials said. China's parliament will have to approve rules for the zone at its annual meeting in March next year, but the process will be a formality. Preparation work on the more sensitive financial reforms will take until the second half of next year, according to an official timetable. "The free trade zone undertakes China's vigorous push for structural innovation in the new era, accelerating the transformation of economic development," the draft plan said.