Partner or parasite? Time for Hong Kong to choose
Never before has a chief executive of the Hong Kong stock exchange written an open letter, especially on mainland policy. Yet, this week Charles Li Xiaojia did exactly that.
In a 10,000-word Chinese-language piece posted on the HKEx website titled 'Six Questions Regarding the Internationalisation of the Renminbi (yuan)', he outlines some key issues on the currency's future.
The media has been focusing on the concrete proposals he has mentioned as clues to what new policies Beijing will put forward next.
The more important question, however, is why he has written the open letter in the first place. The signs are worrying.
This is because Li is no foreign executive with a big head who just wants to speak his mind. He is someone who has tiptoed through China's corridors of power for decades.
He blew no trumpets when Beijing dazzled the market with announcements of new measures to internationalise the yuan over the past three months.
But he is now speaking up. Rather than a wish list, his letter reads more like a wake-up call on the difficulties Hong Kong will face on its way to becoming an offshore yuan financial centre.
Li noted that the yuan can now flow out of and back into the mainland with little restrictions as long as they are for trade settlement purposes. However, few people or companies, especially those outside Hong Kong, are willing to take yuan as there are few investment opportunities offshore. The flows are just a trickle.
'If we see RMB flows as water and RMB products as fish, the logic will be clear. Fish do not exist where there is no water and they cannot survive if the water is stagnant. Without nutrients in the water, fish don't grow,' Li wrote.
'The nutrients, representing returns on RMB products, can only come from the home market. That's why the offshore RMB must be allowed to flow back, at least at the initial stage.'
What Li does not say is how controversial the flow back of offshore yuan can be.
So far Beijing has made two 'nutrients' boosting moves. First, foreign banks can gradually take part in the mainland interbank bond market, hoping that the higher bond yield will result in more attractive yuan products. Second, foreign yuan holders will soon be allowed to invest in the mainland stock market.
These are the relatively easy moves, politically at least. The interbank bond market is governed by the People's Bank of China (PBOC), the major supporter for yuan internationalisation. The A-share investment scheme brings money into the stagnant stock market.
Yet, their limitation in terms of liquidity and scale is obvious. For instance, the A-share investment scheme is likely to have a 20 billion yuan (HK$23.11 billion) quota and restrictions on investors exiting the market.
To get foreign investors more interested, we need products of higher return and liquidity such as the issue of yuan-denominated shares, bonds and derivatives.
On the surface, yuan-denominated share issues by mainland firms is a sensible move for all parties. The issuer sends home the proceeds in yuan instead of HK dollars. He has no exchange risk. The country suffers no increase in foreign reserves from that. The investor enjoys the liquidity of the stock, the yuan's appreciating potential and the growth of the mainland economy.
Hong Kong benefits from the robust trading of the yuan stocks. More importantly, the yuan internationalisation campaign sees not only an increasing demand for yuan overseas but the recognition of the currency as a medium of investment.
But there is a crucial twist. 'Offshore issuers of any higher-yielding RMB products need their proceeds to be able to flow back to the mainland in order to access the returns they need,' Li wrote.
'Efforts are needed to convince the policy makers to treat RMB foreign direct investment from offshore product issuers differently as the inflow itself would not create any incremental pressure on onshore foreign reserve accumulation. An entirely different regulatory regime needs to be adopted for the RMB inflow.'
To put it more bluntly, the approval process has to be simplified. That means ministries other than the PBOC have to give up some power.
In the background of this issue is the sibling rivalry between Hong Kong and Shanghai. The Hong Kong government's opposition to the introduction of an international board in Shanghai; and the 'self-interested' image of Hong Kong among many senior cadres is well known.
Opponents of these liberalisations will not be short of reasons. They can easily argue that Beijing has already done a lot in a few months and it is best to leave the market to chew on it for while.
They can argue that while Washington is talking tough on yuan appreciation, further currency liberalisation by China will be seen as kowtowing. They can even argue that it is tantamount to an opening up of the capital account.
Is Li sensing a growing hesitation if not suspicion in Beijing? Or is he sensing a loss in steam in the reform momentum generated by the earlier financial turbulence in the US and Europe and the pain heaped on China?
Is that why he has written an open letter that emphasises the strategic importance of yuan internationalisation to the country; the importance of the yuan's 'home trip' to the internationalisation; and the readiness of different measures to manage the various flows?
We have no answer to these questions as Li was unavailable to comment.
But we can be sure of one thing. If we continue to see yuan internationalisation as a distant experiment, complain about the little tangible short-term benefit and do nothing, our critics will win.
Only by recognising this as a once-in-a-lifetime opportunity, bearing the short-term cost and getting our financial systems ready, can Hong Kong stand out as a value-adding partner instead of a self-interested parasite in the eyes of Beijing.