Getting ready to live with a stronger yuan
Until a few years ago, the Hong Kong dollar was welcome on the mainland as cab drivers and others happily accepted our currency in lieu of the yuan, since its value was always greater than that of the Chinese currency. No more.
In January 2007, the yuan first achieved parity with the Hong Kong dollar and then powered past it. Now, our dollar is worth only about 0.88 yuan.
This is because, from 2005 to 2008, China allowed its currency to appreciate against the US dollar, to which the Hong Kong dollar is pegged. During that period, the yuan rose 21 per cent. This progression halted with the global financial crisis, but China is again under heavy pressure to allow the yuan to rise against the dollar.
All signs are that Beijing has decided to allow its currency to rise again, not necessarily as a result of foreign pressure but because Chinese officials believe such a move would be good for the country, in part to counter inflation.
Many economists say that the Chinese currency is undervalued by 20 to 40 per cent but, of course, Beijing will not allow any big-bang revaluation. Instead, the likelihood is that it will once again allow its currency to rise gradually, probably at about 5 per cent a year, beginning this year and continuing for a decade.
What would that do to the purchasing power of the Hong Kong dollar? Well, a back-of-the-envelope calculation suggests that, in 10 years, our local dollar would be worth little more than half a yuan. That is to say, compared to the 1990s, it would have lost half its purchasing power.
Recently, Fred Bergsten, director of the Peterson Institute for International Economics, told a US congressional committee that Hong Kong was manipulating its currency to 'maintain a close relationship' with the yuan. Of course, we haven't been doing that. In fact, Hong Kong has pegged its currency to the US dollar since 1983 and, as the American currency has declined in value, so has the Hong Kong dollar.
But it is time to look again at our link to the US dollar and whether the currency peg still serves our interests. Logically, Hong Kong should link its currency to that of the jurisdiction with which it has the closest economic relationship - the mainland, and that relationship will only get closer over time.
Hong Kong buys virtually everything from the mainland. If the value of the yuan goes up, vis-a-vis the dollar, the cost of living here will inexorably rise, leading to inflation.
It is often said that Hong Kong cannot switch from the US dollar to the yuan as long as the yuan is not fully convertible. But Beijing is already making the yuan much more of an international currency - and Hong Kong is helping in that process.
Hong Kong is being used as the testing ground for the liberalisation of the mainland currency. Beginning last July, a yuan trade settlement pilot scheme came into operation. Also last year, Hong Kong banks were given the green light to issue yuan bonds for the first time. And, in October, Beijing launched the first yuan sovereignty bonds in Hong Kong.
Partly to diversify away from the US dollar, Beijing has talked about heightening the role of the renminbi through such steps as offering yuan-denominated loans as well as using national currencies in mutual settlements. There is little doubt that, in the long run, the yuan will become a major international currency.
Last year, China announced that Shanghai would become a global financial centre by 2020, which means the yuan has to be fully convertible long before that. The time has come for Hong Kong to take a serious look at what can be done in the meantime.
We cannot afford to sit on our hands and wait.
Frank Ching is a Hong Kong-based writer and commentator.