View from the Peak: The Renminbi and Hong Kong

Hong Kong is playing a significant role in China’s internationalisation of the Renminbi. Hong Kong-based Australian banker, Max Mack, explains the significance of this development for China, Hong Kong and the international financial community.
At a restaurant in downtown Hong Kong recently the conversation was dominated by two topics: sport and finance.
We started with the Renminbi. Probably because it seemed like the right thing to do with a table of bankers, analysts and sundry financial types. But we really wanted to talk about sport. Not because any of us are particularly insightful about the topic. But because we think we are.
As sometimes happens when a topic keeps the stage past its use-by date, and others want to move on to the next topic, some funny sentences emerge through the transition from finance to sports.
There is a lot of talk in finance circles these days about the Chinese currency unit (the “Renminbi”, “RMB” or “Yuan”). With scandals in FIFA, and the Rugby World Cup only a few months away, it makes for a very distracting work day, with finance so often intruding.
In both arenas, there is a lot of speculation, political finger pointing, and a few myths circulating that should be clarified. Here are a few questions that demand answers:
Q: Is the game in crisis?
A: Some think so, but those charged with running the game, the Chinese government, are confident that there is no crisis, rather the continual steady development of the game. The “game” is the internationalisation of the Chinese currency unit (the Renminbi, Yuan, CNY, or ¥).
Q: Why do we need so many big words?
A: As an economist once said, “Obfuscating words are economists’ preferred tools of trade”. Internationalisation, convertibility, liberalisation, all essentially mean the ability of the RMB to be exchanged freely. A freely exchanged currency can then be used for two important things: international trade and reserve holdings. Note that “exchanged freely” is not quite the same as “floating freely” which is where the value of the RMB varies against other currencies frequently. For example, the Hong Kong Dollar (HKD) is freely exchanged, but remains pegged to the USD at approximately HK$7.78 to US$1.
Q: How long is the game, not including overtime?
A: Internationalisation depends on three things, each of which takes time to develop:
1. The Chinese economy needs to remain in good health. A recession may reduce overseas demand for RMB.
2. Clear and transparent exchange rate setting mechanism. The mechanism may be market-based, or may be set by the government (a “peg”). Whichever, orderly markets demand predictability of pricing scheme.
3. Deep capital markets. In order to reliably trade a currency, deep pools of global liquidity are required so that major players can’t easily manipulate the exchange rate for their gain. The exception is central banks that legally intervene in currency markets to maintain, raise or lower rates. (The other exception is hedge funds who try to “corner” a weak market, like Soros’s hedge funds were accused of in Malaysia in 1997).
Q: When is kick off?
A: Already RMB has been flowing out of China. There are offshore holdings of RMB in Hong Kong, Taiwan, Myanmar, Nepal, Mongolia, Cambodia and Laos. Hong Kong holdings of RMB grew from ¥62bn in 2009 to over ¥450bn today.
Q: What’s the game plan?
A: The Chinese government has outlined its plan for internationalisation.
Step 1: 2007 to 2009 Initiate an RMB-denominated bond market.
Step 2: 2009 to 2010 Begin cross-border trade settlement.
Step 3: 2010 to 2012 Develop Hong Kong as an offshore RMB centre.
Step 4: 2012 and beyond: Develop other Asian centres (called regionalisation) followed by centres beyond Asia (called full internationalisation).
Q: So what was the score in the first quarter?
A: RMB-denominated bonds grew from ¥10bn in 2007 to over ¥70bn today.
Q: And the second?
A: Cross-border trade settlement has grown from 5 cities and 350 institutions in 2009 to over 20 cities and 67,000 authorised institutions today. Cross-border RMB trade settlement handled in Hong Kong reached ¥370bn last year.
Q: What happened in the second-half?
A: As already mentioned, RMB deposits in Hong Kong have grown from ¥62bn in 2009 to over ¥450bn today.
Q: So the game plan is being executed to plan?
A: So far, the internationalisation is proceeding broadly according to the Chinese plan.
Q: Who’s coming second?
A: The US amongst others constantly apply pressure to the Central government to increase the rate of liberalisation and to allow the RMB to appreciate.
Q: What could go wrong here?
A: Aside from the ever-present risk of injury, there are two key risks that the referees will be vigilant for:
1. Increased use of RMB can lead to increased demand for RMB, which, in a free floating currency will cause appreciation, reducing foreign investment.
2. “Trilemma” is the name given to the three-pronged dilemma of currency internationalisation identified by 1960’s economist Robert Triffin: a country can have a freely traded currency, national monetary policy independence, or free capital movement, but not all three.
Trilemma predicts the Chinese government will lose some control over the internal effectiveness of monetary policy. Losing control is not something that the Chinese government is ever fond of.
Q: Where will this all end up?
A: HSBC predicts that by 2015, half of all Chinese trade will settle in RMB. And there have been rare predictions of a floating RMB within five years – although most consider that unlikely.
It is an exciting time in Hong Kong. We find ourselves with a box seat for the largest change to the global financial landscape since the global financial crisis. 
*Originally from Sydney, Max Mack is a long-time expat and banker currently living in Hong Kong. Contact the author on: MaxMackHK@gmail.com

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