Published: September 01, 2011
by Peter Wong, Chairman, IACCT (China)China entered the ‘brave new world’ in 2001 when it became the latest member of the World Trade Organization (WTO). State-owned banks at the time were saddled with non-performing loans. Foreign exchange reserves were at a modest US$200bn level. Standard & Poor’s then assigned a BBB sovereign credit rating to China.
A decade later, China became the world’s second largest economy with the most sizeable foreign exchange reserves (US$3.2tr as of August 2011). All the Big Four state-owned banks are listed with CAR above the 11.5% minimum set by the domestic regulator. ICBC ranks No.1 among banks globally and has set its goal to achieve 10% of global business by 2016. Standard & Poor’s have assigned a double-A-minus rating on China.
Towards a market economyChina is in dynamic mode and change is constant. As it moves from a state-controlled central planning to a market-based economy, policy tools are gradually moving towards fine-tuning rather than achieving specific quantifiable goals. China continues to experiment, to innovate, to invest and to adjust. The expectation is changing for the better.
With a per capita income of less than US$10,000, China is going through a process of metamorphosis – shifting its future focus from quantity to quality of growth (in areas including environment protection, low carbon, improved income equality, social mobility, a social security safety-net, medical and retirement issues), development of the private sector, a more balanced export and domestic sector and resolving the issues arising from rapid urbanisation. There is ample room for commercially viable technology and knowledge transfer.
China is in spending mode (supported by high savings) whereas the US and Europe are in deleveraging mode. Global trade and investment relations with China should therefore expand instead of contract.
The western world is ahead of China on the learning curve of social and economic development. Knowledge transfer (overseas education for Chinese students) and Overseas Direct Investment (ODI) by Chinese enterprises are both set to expand at a rapid pace. [[[PAGE]]]
Foreign exchange control in China is likely to be liberalised at a controlled pace. The external trade and current accounts have already been opened. Capital accounts are still carefully guarded to ensure the inflow and outflow of hot money will not impact China’s domestic monetary control policy.
While the Chinese currency has appreciated over 30% between 2001 and 2011, the market perception is that the RMB is undervalued. Domestic interest rates in China are higher than international rates, as the country is still experiencing growth while the US and Europe are implementing quantitative easing and cannot afford to raise interest rates. The expectation of a further strengthening of the RMB and the higher interest rate differential will promote the attractiveness of RMB assets as a new asset class.
Because of foreign exchange control in capital accounts, external trade flows, rather than portfolio hot money flows, will be the main factor for determining the exchange value of RMB. A stronger RMB will make imports cheaper for Chinese consumers but can’t fully relieve inflation which is partly structural in nature as more commodities move from state-subsidised rates to market price. Recent data indicated that inflation may have peaked, and so there is less urgency to use RMB appreciation to curb inflation.
In summary, it is likely that RMB will follow a stable strengthening pathway instead of a dramatic appreciation trajectory like the Japanese yen in its journey towards internationalisation. Between 1985 (the year of the Plaza Accord) and 1995, the JPY strengthened three times from 239 to 80 JPY per USD. This lost decade resulting from the asset bubble is a lesson China does not want to repeat.
Looking ahead, the RMB is expected to be increasingly used as the payment currency when Chinese importers can influence the choice of currency in trade settlement. The increased outflow of RMB has already increased its deposits in offshore RMB centres such as Hong Kong SAR. Recent policy measures announced by China’s executive vice premier Li Keqiang during his recent visit to Hong Kong will significantly promote the development of offshore RMB centres.
Measures that enable RMB to be used in China
1. New rules to permit foreign enterprises (including Hong Kong companies) to use RMB to make foreign direct investment (FDI) in China.
2. Allowing foreign banks to use RMB for capital contribution in China.
3. Allowing overseas institutional investors to use RMB Qualified Foreign Institutional Investors (QFII) to invest in the onshore market (up to an initial quota of RMB 20bn).
Measures that promote financial services through Hong Kong
4. Expanding the number of Chinese cities that can use RMB to settle trade with Hong Kong from 20 to the whole nation.
5. Promoting more Chinese companies to come to Hong Kong for IPO.
6. Allowing onshore Chinese companies (financial institutions and corporations) to issue offshore bond in Hong Kong (initial quota up to RMB 50bn).
7. Promoting development of inter-bank market in Hong Kong for bonds.
8. Promoting more innovative offshore RMB financial products to be launched in Hong Kong.
9. Allowing Hong Kong stocks-based Exchange Traded Funds (ETF) to be issued in China.
Measures that promote financial institutions to do business in China
10. Allowing Hong Kong-based banking subsidiaries in China to sell mutual funds.
11. Allowing Hong Kong-based banks to grow a branch network in South China (Guangdong).
12. Allowing Hong Kong-based insurance companies to set up sales offices or M&A in China.
Foreign currency deposits represented about half of Hong Kong’s total deposit base, reflecting the open nature of the financial centre. RMB deposits (currently representing less than 10% of total deposits) are set to increase, as over time RMB will become attractive as an investment currency compared with other foreign currencies.
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