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Monday, September 23, 2019, 02:46
HK has been mainland's financial partner for 70 years
By Victor Zheng and Roger Luk
Monday, September 23, 2019, 02:46 By Victor Zheng and Roger Luk

Hong Kong was always a part of China, even from the perspective of its evolving as an international financial center. Looking back, one can see that it was not incidental that Hong Kong became a free port for China trade in 1841, but nobody would anticipate the “barren rock” ever becoming an international financial center and having a close financial partnership with the mainland for the last 70 years.

Actually, Hong Kong was chosen for its proximity to the official port of Guangzhou. The original intent was simply relocating trade and settlement from the imperial Qing Dynasty (1644-1911) bureaucracy to British law and practice instead. Above all, it would help resolve perennial problems of the trade imbalance with China and the unsustainable loss of silver. The colonial administration was smart to keep Chinese currency and alternatives as legal tender. Meanwhile, foreign banks were authorized to issue currency notes redeemable for popular Spanish or Mexican silver dollars as substitutes. Chinese traders were willing to deal and settle in the Hong Kong dollar at the offshore free port instead of on the mainland.

When China abandoned the silver standard in 1935, the Hong Kong dollar switched to the British-pound standard under the currency-board-linked exchange-rate system. Nobody would ever envisage the far-reaching implications on postwar reconstruction of China a decade later and the subsequent comprehensive reform for modernization.

New China was founded amid geopolitical turmoil. The Chinese yuan was under exchange control but convertible to Hong Kong dollars and by default the US dollar and other foreign currencies. Thus, Hong Kong used to be China’s global hub for foreign receipts and payments. Apparently, State spring and autumn trade fairs were held in Guangzhou from the outset instead of Shanghai simply for business and financial convenience.

China’s Belt and Road Initiative is a mega-project of assistance in development across the globe in the decades ahead. The 18th and 19th National People’s Congresses have further promoted national and regional integration and development. Apparently, the yuan is the working currency by default to develop an international exchange zone in parallel with the US dollar in the region and the globe. The offshore banking market of Hong Kong will be crucial to specialized banks and funds like the Asia Infrastructure and Investment Bank in payment, financing and funding

Hong Kong had never overlooked the mainland’s interest in financial reforms. When banking law was overhauled in 1964 to tighten reserve and liquidity standards, there were provisions allowing overseas branches, including Chinese-mainland banks, to borrow liquidity from the head office by default. When the British pound was devalued by 14.3 percent in 1967, it would adversely affect export earnings of the mainland that were mostly settled in Hong Kong. Eventually, the Hong Kong dollar was devalued by only 5.7 percent as a tacit mutual understanding to safeguard China’s interests.

When the British pound was floated in 1972, the Hong Kong dollar switched its peg to the US dollar. It was later floated but still unofficially pegged for exchange stability. Anxieties over the outcome of the Sino-British talks on the question of 1997 led to the successive depreciation of the Hong Kong dollar in the early 1980s. Following a dramatic fall in September 1983, the Hong Kong dollar was repegged to the US dollar formally at 7.8 Hong Kong dollars per US dollar. Again, the interests of the mainland had not been neglected.

Over the years, the linked-exchange rate system has been refined in response to changing market circumstances with a view to maintaining currency stability against the dollar. For instance, the new accounting arrangement was introduced in 1987 to neutralize the clearing balance in the banking system. A negative interest rate was provided in 1989 to counteract speculative revaluation pressure. They are intended for more-effective market intervention if necessary. The yuan was pegged to the US dollar in 1996, and a tripartite currency alliance was established in the advent of the 1997 return of Hong Kong to China. It also helped pave way for China’s entry into the World Trade Organization in the new millennium. The Chinese currency reform of 2005 was another landmark on the road to internationalization. The yuan was depegged from the US dollar and priced against a designated foreign-currency basket.

With partial relaxation of exchange controls, the offshore yuan market flourished in Hong Kong. In recognition of its hub, the offshore yuan was designated CNH (Chinese yuan in Hong Kong) in the global exchange market to differentiate it from onshore yuan (CNY).

In the course of internationalization, the yuan would need an offshore payment and clearing hub as a buffer to external shocks on domestic financial market. The London offshore banking, known as the eurodollar market, for instance, is such a buffer for the US dollar. Similarly, banking in the SAR is not subject to mainland jurisdiction under “one country, two systems”, and this is the chosen hub of offshore yuan. Hong Kong and the mainland are entering into a fresh financial partnership.

When the yuan is fully convertible and internationalized, Hong Kong will be the de facto global hub for offshore banking in the yuan. Like the eurodollar, the exchange rate of offshore yuan will align with onshore yuan, as the US dollar does. Notwithstanding, the Hong Kong SAR will remain the global source of exchange and pricing of offshore yuan, as London is for the eurodollar. The Hong Kong interbank interest rate of offshore yuan would be a global benchmark, like Libor (London inter-bank offered rate) or the eurodollar.

China’s Belt and Road Initiative is a mega-project of assistance in development across the globe in the decades ahead. The 18th and 19th National People’s Congresses have further promoted national and regional integration and development. Apparently, the yuan is the working currency by default to develop an international exchange zone in parallel with the US dollar in the region and the globe. The offshore banking market of Hong Kong will be crucial to specialized banks and funds like the Asia Infrastructure and Investment Bank in payment, financing and funding. Pilot free-trade zones in selected Chinese ports where offshore yuan might be used along with foreign exchange, for instance, are rehearsals.

That the Hong Kong dollar is derivative of Chinese currencies has bonded the two economies together for almost 180 years. The past 70 years has witnessed an even closer partnership, with Hong Kong evolving from foreign exchange conduit to offshore currency center. The Hong Kong dollar used to be the exchange intermediary of the yuan but is nowadays tantamount to offshore yuan by heritage. The Hong Kong SAR and Hong Kong dollar, by virtue of “one country, two systems”, will play a significant role in China’s emergence as a global financial power in the coming 70 years. 

Victor Zheng, the co-author, is research director of the Hong Kong Institute of Asia-Pacific Studies and co-convener of the Global China Research Programme of the Chinese University of Hong Kong. 

Roger Luk, the co-author is a retired banker, honorary research fellow of the Hong Kong Institute of Asia-Pacific Studies, and an adjunct professor of business studies.


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