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Liberalisation of the RMB

Since January 1, 2004, Hong Kong banks have been able to offer Hong Kong residents personal renminbi deposit accounts at interest rates set by banks themselves. The move may seem like the first step towards full liberalisation of the banking sector on the Mainland, but that day is still far away, says Dr Donald Hanna, Managing Director, Citicorp Corporate & Investment Bank.

"The liberalisation of capital flows in China is coming, because this is a long term objective of the country, and of course it makes sense, but it is still at least ten years away," he says.

The true benefit of this first step towards renminbi liberalisation for Hong Kong is that it creates an offshore market for the yuan which is not as controlled as that in the Mainland. But floating the RMB in Hong Kong while the People's Bank of China continues to set the rate in the Mainland creates all kinds of difficulties, he says, citing a similar situation which happened in Singapore in 1997.

Then, the lion-state became an offshore market for the Malaysian ringgit. Banks in Singapore, however, set deposit interest rates higher than the cost of borrowing the ringgit in Malaysia. This undermined the Malaysian government's ability to effectively manage the ringgit.

However, he says this is unlikely to happen with the RMB.

One of the key things needed for China's banking sector to work like that in Hong Kong, is that interest rates have to be driven by the market and the credibility of the borrower. In China the rates are fixed by the People's Bank of China. However, if Mainland banks were left to set their own rates, this could create a whole new set of problems, because banks might be tempted to set unreasonably high deposit rates to attract customers.

Perhaps the biggest implications of a freely exchangeable RMB is on the Hong Kong dollar, Dr Hanna says. Under the Basic Law, there is a provision stating that the Hong Kong dollar must exist until the end of the handover agreement. However, there is no mention of a 7.8 peg, or that the reserves must be in US dollars, just that they need to be convertible. Therefore, if the RMB were freely convertible, Hong Kong could move to RMB backing.

"The fate of renminbi liberalisation is also the fate of the Hong Kong dollar," Dr Hanna says.

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