The financial and monetary landscape in Asia is changing, creating new challenges and opportunities.
Asia is a heterogeneous region. Its monetary and financial issues can be seen from different perspectives, either from within the region or from outside. Because of the divergence of the region, the risks of exchange-rate fluctuations in different jurisdictions and their impact on economic, monetary and financial stability need to be carefully assessed and managed.
Interestingly, the sheer size and the relatively low degree of openness and external orientation of the Chinese economy suggest that greater flexibility in the exchange rate might present fewer risks to its economic, monetary and financial stability than would be the case for other economies in Asia. This will almost certainly remain the case even after the Mainland's transformation from an emerging market to a mature economy. But because of structural issues in the financial system and other considerations, caution is called for in reforming the mechanism for determining the exchange rate. The emphasis is on gradualism and controllability, and on ensuring that the authorities are in a position to initiate reform rather than having it forced upon them.
This brings me to a related issue: the increasing importance of the renminbi as a currency. Although the renminbi is still not freely convertible, we have observed an increasing correlation between its exchange rate and those of the US dollar and some Asian currencies. This may be because several Asian central banks manage their exchange rates, or because some Asian currencies are used as proxies by players in the currency market taking market positions in the renminbi. Considering the renminbi is now the currency of the fourth largest economy and third largest trading nation in the world, and the second largest economy and largest trading nation in Asia, its future role in the region and in international finance has become an issue of great interest.
Indeed, the renminbi is now a popular currency for the settlement of cross-border trade in the southern part of China. The declared policy of gradually achieving full and free convertibility suggests the possibility of the renminbi, in the fullness of time, achieving the status of an international currency and possibly a reserve currency, at least for the region. I say "in the fullness of time" without suggesting that this will be a long process: I am simply not able to predict when it will happen. But regardless of when it happens, we are preparing for it by improving the ability of the financial system of Hong Kong to handle transactions denominated in the renminbi. Our real-time gross settlement payment systems for the renminbi, the US dollar, the euro, and the Hong Kong dollar are linked up to achieve real-time payment versus payment in the Asian time zone. The use of the renminbi for financial intermediation through the banking system of Hong Kong has been possible for two years now, albeit with a limited scope. The use of the renminbi for financial intermediation in the debt market will soon be opened up, through the first renminbi-denominated debt issue in Hong Kong. And Hong Kong is in a position to facilitate the use of the renminbi in the equity market if there is adequate demand in future.
Speaking of the renminbi, a seemingly unrelated but in fact very relevant issue concerns foreign reserves accumulation in China. We all recognise the enormous and difficult task the People's Bank of China faces in monetary management. The reserve requirement ratio is now at a high of 11.5% (the People's Bank of China announced an increase of 0.5 percentage points on 18 May) and the interest rate paid on those reserves is currently around 2%, which is below the retail deposit interest rates. The amount of central bank paper issued by the People's Bank of China for the purpose of sterilisation accounts for over 7% of the total assets of the banking system, currently yielding 3%. These liabilities of the central bank are matched by foreign assets that are probably earning less in renminbi terms, given the appreciation of the renminbi by over 3% against the US dollar in the past year.
There are also issues relating to foreign-reserves management that are common to quite a few jurisdictions in Asia. In jurisdictions where the domestic currencies are appreciating, there is obviously pressure to achieve at least a positive return in domestic-currency terms, and so there is a lot of serious interest among foreign-reserves managers in Asia in diversification, in currency and asset class, and in developing an appropriate institutional framework to perform this rapidly growing task. There are understandably many possible models to achieve this, taking account of domestic characteristics and sensitivities. The international financial community also seems to be keenly interested in developments on this front, whether from a business angle or from concerns over possible impact on the trends of major financial markets. We certainly do not wish to see discussion of this subject leading to sharp adjustments in individual markets or currencies, but this possibility cannot be ruled out.
Joseph Yam
7 June 2007
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