Rewards and risks in U.K. yuan push

British PM's China visit gives a nudge to London's trading hub goals, but an inflow of Chinese funds could push up interest rates, analysts say

PUBLISHED : Friday, 06 December, 2013, 1:32pm
UPDATED : Saturday, 07 December, 2013, 12:52am

British Prime Minister David Cameron's visit to China this week will boost London as a yuan trading hub, but there are risks, analysts said.

"This is a very opportune time for Cameron to visit China," said Diana Choyleva, head of macroeconomic research at Lombard Street Research, a British economic think tank.

"One of the biggest positives for the UK is it can establish itself as a key offshore renminbi centre. The UK has a comparative advantage vis-à-vis China's reform. The UK's fund management industry is one of the biggest and most advanced in the world, along with the US," she said.

During his meeting with Cameron, Premier Li Keqiang announced China would support the development of London as an offshore yuan centre.

Opening China's capital account - allowing the free movement of capital in and out of the mainland - could lead to the British capital establishing itself as a key offshore yuan centre, Choyleva said. China's domestic savings every year total US$4.2 trillion, more than the US and Japan combined, she pointed out.

"If China opens up its capital account, UK fund managers can take a large chunk of that business," she said. The risks, however, are higher interest rates

It was fairly likely that China would open its capital account within three years, Choyleva predicted. "There is going to be a lot more reform in the Chinese economy than in the past 12 years," she said. "What came out of the third plenum was the best the world could have hoped for. It makes China's emergence as a consumer economy much more likely."

The UK housing market could bubble up with the inflow of Chinese money

If China did not open its capital account, it would be very hard to have consumer-driven growth, Choyleva said.

The Shanghai free-trade zone will launch a pilot project for capital account liberalisation in the next few months, said Benjamin Kroymann, a Shanghai-based corporate partner of Squire Sanders, a US law firm.

Alexander Doorman, corporate partner of Freshfields Bruckhaus Deringer, an international law firm, said the growth of London and other international cities as offshore yuan trading centres would be closely connected with the reform of China's financial sector, including the liberalisation of interest rates and the opening up of the capital account. "A gradual liberalisation of the capital account could be a great outcome for Chinese investors looking to invest in the UK market," Doorman said.

However, Choyleva said one negative factor was that it would mean higher interest rates in the US, Britain and the European Union.

Britain and the rest of the European Union still had excessive domestic debt, so higher interest rates would hurt Britain and the EU, she warned.

Michael Watson, a partner at British law firm Pinsent Masons, said: "If high interest rates are driven by China, the UK and Europe could fall behind other economies and risk becoming uncompetitive.

However, Watson said higher interest rates would not necessarily be a bad thing, provided some of the Chinese funds were invested in infrastructure in Britain.

Li said Britain and China would promote bilateral investment, including Chinese investment in high-speed railway in Britain.

A spokesman for HS2, the planned high-speed railway between London and Birmingham, said the firm welcomed Chinese investment in the £42.6 billion (HK$540.3 billion) railway.

Watson said Chinese investors also had expressed strong interest in British real estate.

Choyleva said that if China opens its capital account, some of China's huge savings would probably go into the housing market. "The UK housing market could bubble up with the inflow of Chinese money, without improvement in the UK economy. Then the Bank of England will have a difficult time managing monetary policy, as it will have to raise interest rates," she warned.

Cameron should prepare policies to deal with the pressures that the property market - especially in London - would come under if China's capital starts to flow freely, Choyleva said.

The next two to three years will see a very difficult adjustment in China as it moves towards consumer-driven growth, she said. "Next year, the adjustment will be accompanied by weak growth and financial distress as companies and banks struggle."