The move is also expected to help Singapore in its bid to become a renminbi offshore center.
According to the arrangement, China's interbank foreign exchange market will kick off direct trading between the yuan and the Singapore dollar via spot, forward and swap contracts.
With direct trading of their currencies, China and Singapore will be less dependent on the U.S. dollar to settle bilateral trade and investment deals.
Previously, the exchange rate between the two currencies was calculated based on the yuan-U.S. dollar central parity rate and the Singapore dollar-U.S. dollar rate.
Now that the two currencies can be directly traded, the yuan-Singapore dollar rate will be set based on the average prices offered by market makers before the opening of the interbank foreign exchange market.
The CFETS will publish its yuan/Singapore dollar central parity rate at 9:15 a.m. each trading day. The exchange rate on the spot market will be allowed to trade 3 percent higher or lower from parity.
The People's Bank of China (PBOC), the central bank, authorized and welcomed the CFETS announcement, saying it is an important measure between the Chinese and Singaporean governments to jointly push forward bilateral and economic relations.
"The direct yuan-Singapore dollar trade is good for forming a direct exchange rate between the two currencies and reducing exchange costs," the PBOC said in a statement on its website.
Vowing to "actively support" yuan-Singapore dollar direct trade, the PBOC said the move will also help boost financial cooperation between the two countries.
To boost the use of the yuan internationally, China has also signed multiple currency swap agreements totaling 2.9 trillion yuan (472 billion U.S. dollars) with 26 overseas monetary authorities.
The PBOC has also authorized offshore renminbi clearing and settlement arrangements in Singapore, London, Frankfurt, Seoul, Paris and Luxembourg, as well as Taiwan, Hong Kong and Macao.
The Chinese government is gradually relaxing its hold over the yuan and making it a global reserve currency.
China is also under pressure to diversify its foreign exchange reserves, which stood at 3.89 trillion U.S. dollars at the end of June.
