The Renminbi

inSight

17 Feb 2000

The Renminbi

The markets are taking an increasingly rational view of the renminbi and its relationship - or lack thereof - with the Hong Kong dollar.

Attending the many spring receptions to mark the entry into the Year of the Dragon, I have been struck by the much more optimistic feeling about economic prospects among those I talked to. This is a realistic optimism, not euphoria, which is a sign that Hong Kong is handling the good news on the same practical terms on which it responded to the bad. Despite the strong recovery that our economy is experiencing, there is no room for complacency. Nor is there any shortage of concerns. Domestically, the unemployment rate remains high, interest rates are trending upwards, the stock market is unusually volatile, and the fiscal imbalance persists. Internationally, uncertainty remains about how the worldwide technological revolution will play out and how it will affect Hong Kong. There is also uncertainty over how the Mainland's accession to the World Trade Organisation will affect Hong Kong's role as an intermediary, notwithstanding the many opportunities it will open up. And we should not forget the destabilising influence of the explosion of international finance that is likely to continue after the recent lull in activity arising from credit concerns and the pause by some highly leveraged institutions to lick their wounds after the excesses of 1998.

But for the time being everyone is enthusiastically looking forward to better times ahead. It is encouraging that no one questioned me about the Hong Kong dollar exchange rate. The standard question on such occasions --- whether the Hong Kong dollar's link with the US dollar will hold --- did not come up at all. That indeed is another good sign. It reflects a high degree of confidence in the linked exchange rate system and in our ability to maintain it. The much higher degree of transparency with which we operate the rule-based system and the way in which we approach the structural issues of that system, through the timely publication of the minutes of the Sub-Committee on Currency Board Operations, has obviously helped. Indeed, for those who have been monitoring closely the work of the Sub-Committee, it is quite clear that not only have we not been complacent, we have been continuously vigilant, at both the structural and operational levels, introducing refinements well ahead of time and adhering strictly to the operational rule.

One surprising question that I got from someone who is quite well connected to sources in the Mainland, albeit non-financial sources, was, not just whether, but when the renminibi would be devalued. I am not, of course, a spokesman on the renminbi. But, as far as I can understand the subject, the Mainland authorities have since 1994 pursued a consistent exchange rate policy, and this is for the exchange rate to be determined by the market. With exchange controls this means that the exchange rate is dependent upon the overall balance of international payments. The Mainland has been running a balance of payments surplus and there have been substantial, though reduced, foreign direct investments. On this basis, one would expect the renminbi exchange rate to strengthen with some accumulation of foreign reserves. Indeed both have occurred recently.

Perhaps the question was asked on the assumption that the Mainland's accession to the WTO might lead to the balance of international payments going into deficit. This is possible but I think unlikely. Imports will undoubtedly rise, but so would exports, as Europe and other major export markets of the Mainland catch up with the US, benefiting from the spread of the technological revolution. The Mainland’s balance of payments will also likely be supported by increased capital inflows as it opens up previously closed sectors, such as telecommunications, distribution and financial services, to foreign competition.

Market behaviour confirms this view. The one-year forward premium for the renminbi, imputed from the trends in the non-deliverable forward exchange market, has been falling quite markedly: from about 10,000 points at the beginning of September last year to around 3,000 now (1,000 points represent 10 cents in the exchange rate, see Chart 1). Putting the one-year forward premium for the Hong Kong dollar alongside and extending the chart over a longer period (see Chart 2), we can observe another interesting phenomenon. While there was a remarkable correlation between the two during the year 1998, suggesting that market sentiment believed that a devaluation of one of the two currencies would similarly affect the other one, the correlation has disappeared since the fourth quarter of 1998. Market sentiment now suggests instead a de-coupling of the two exchange rates – a position well supported by rational economic analysis.

 

Joseph Yam
17 February 2000

 

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