* Capital account opening in FTZ will be closely managed
* Institutions and individuals can now open special accounts in FTZ
* Only yuan-denominated accounts are eligible, FX accounts at least 6 months away
* Opening must serve real economy, investment and trade - central bank
By Lu Jianxin and Pete Sweeney
SHANGHAI, May 22 China's central bank announced measures on Thursday to create a closely managed opening in the country's capital account for the Shanghai free trade zone (FTZ) in a cautious but critical step towards allowing full convertibility of China's currency.
The measures allow special privileged accounts - known as tagged accounts - that can be used to conduct transactions only in the zone, and are isolated from transfers to accounts outside the zone.
Economists say these accounts are needed if the FTZ is to allow further financial liberalisation such as freeing up deposit rates and allowing Chinese individuals in the zone to invest offshore.
Without a way to distinguish between FTZ and non-FTZ accounts, waves of arbitrage would quickly make the financial reforms in the FTZ de facto national reforms.
In detailed rules written to guide implementation of a set of principles issued in December, the People's Bank of China (PBOC) allowed institutions and individuals in the FTZ to set up specially tagged bank accounts in the zone, effective immediately, its Shanghai headquarters said in a statement.
These accounts will be allowed to exercise privileges reserved for designated zone residents, both individuals and firms, including bringing money in and out of the zone from abroad and investing in offshore markets, according to the statement published on the FTZ headquarters website, shanghai.pbc.gov.cn.
However, the pace of implementation of specific reforms will remain restrained and not all reforms will be made available at once.
"There will no free convertibility, but managed convertibility," Zhang Xin, a spokesman for the PBOC's Shanghai headquarters, was quoted as saying, adding that the liberalisation would be conducted in a step-by-step fashion.
INITIALLY, ONLY YUAN ACCOUNTS
In addition, banks in Shanghai will be allowed to offer services to these companies and individuals immediately, according to new rules to be published soon, the statement said.
Banks can only open tagged accounts denominated in yuan for the time being. Six months after the rules are officially published, the PBOC and China's foreign exchange regulator will evaluate the outcome of separating the accounts in and outside the zone to decide when to start tagged accounts holding foreign currencies.
The central bank will permit "limited filtration" between the two types of accounts, it said without elaborating.
But banks are required to open five different accounts for Chinese and foreign institutions and individuals as well as for interbank trading accounts, the statement said, implying that there could be different types of liberalisations for different account types.
China set up the Shanghai FTZ in September as a venue to conduct experiments of economic reforms, in particular in the financial sectors, but progress has so far been slow due mainly to cautious attitude and bureaucratic disagreements between the multiple regulators charged with managing different aspects of liberalisation.
"It's not a process of convertibility for the sake of convertibility. It's a move based on serving the real economy and facilitating investment and trade," the bank statement said.
($1 = 6.23 Yuan) (Reporting by Lu Jianxin and Pete Sweeney; Editing by Richard Borsuk)