Letter from... Hong Kong

Peta Tomlinson reports on the announcement by China of the ending of its currency's direct peg to the US dollar

Barely had the ink dried on China’s historic yuan (RMB) revaluation than pundits were wondering if the honeymoon was over.

On 21 July, Beijing’s announcement that it was ending its currency’s direct peg to the US dollar, and repegging it to basket of currencies, was met with cautious enthusiasm. Though the move of 2.1% to $8.11 on the greenback was well short of the US’ hoped-for 10%, it was the first move for more than a decade, and represented a major regime change for China. Many believed this was the soft launch of an ongoing process that could nudge down China’s low-cost competitive edge over foreign firms, and help correct imbalances in global economies. The world waited… all it heard was the sound of silence.

By September, questions were raised over whether that first step - if indeed it was to be the only one - could actually have done more harm than good. Fears where expressed about further tightening of Sino-US trade tensions, with Fred Bergsten, director of the Institute for International Economics, predicting an economic clash between the world’s largest economies was now “virtually inevitable”.

Then it seemed even Hong Kong - which had earlier hoped the yuan revaluation would accelerate the pace of its economic recovery - had lost its enthusiasm. At the end of September, the Hong Kong Exchange Fund Advisory Committee Currency Board conceded the yuan revaluation would have a limited impact on Hong Kong’s growth and inflation.

But was the fanfare overly optimistic to begin with? Hong Kong based senior economist Kent Yau, deputy head of Hong Kong research with investment bank Core Pacific - Yamaichi (CPY), believes it was. Pouring cold water on the idea of increased spending power of Chinese Mainland visitors to Hong Kong and the city’s enhanced cost effectiveness as a regional hub, Yau says it was never realistic. “Frankly, unless the appreciation was going to be huge (20%+), the spending power and cost effectiveness story cannot hold; the Hong Kong-Mainland cost differential is too big,” he said.

HSBC chief economist for China, George Siu-kay Leung, who from the outset had argued that the Hong Kong economy would not be much affected if the yuan did not appreciate by more than 5% within six months, agreed. “Although China’s exports are indeed under some pressure as the profit margin is squeezed, the price competitiveness of exports remains strong,” he said. “Hong Kong does not see slower re-export business as a result. Of course, the growing trade protectionism in the US and the EU is a prime concern, which could drag on China’s exports notably in the form of either re-imposition of import quota or further appreciation of the yuan. If that happened, Hong Kong would then suffer a slowdown in trade business.”

The floating of the yuan had, to some degree, eased the pressure on China regarding the accusation of export dumping, Leung said. This helps to improve global relationships and also defers the need for re-imposition of import quota. “However, the key is whether the existing appreciation is sufficient in the eyes of the West. Unless China buys more from the West to moderate the deterioration in trade balance with the US, the issue will likely continue to be an excuse, politically, to force Chinese yuan appreciating further.”

CPY’s Kent Yau adds that the move should be viewed as a whole package. By letting the yuan appreciate, Mainland authorities have shown their determination in finding a way to vent excess capital out of the country, making them more likely to allow controlled schemes permitting Mainlanders to invest overseas.

The Qualified Domestic Institutional Investors (QDII) scheme is one example, Yau says. As the leading financial centre in Greater China, Hong Kong would gain from these measures.

He adds that another significant one-off move revaluation seems unlikely in the near term, as the market may form a view that it is a “once every x months” exercise. This would lead to more speculation in RMB appreciation, thus defeating the purpose of the original move.

Furthermore, Yau says that political pressure from abroad could only exacerbate the situation. “Practically, vocal pressure from foreign countries has been prompting more speculation at times, making the exchange rate regime reform more difficult. Wait and see may not be a bad strategy as the leaders in Beijing also see the need to reform the exchange rate already.”

Peta Tomlinson is a freelance journalist who writes for the South China Morning Post and the Hong Kong Trade Development Council.