Expanding Yuan Role Is Biggest Boost to Hong Kong Since 2003

Chinese Vice Premier Li Keqiang
Chinese Vice Premier Li Keqiang speaks at a government seminar in Hong Kong. Photographer: Jerome Favre/Bloomberg

Chinese Vice Premier Li Keqiang unveiled the biggest package of measures supporting Hong Kong’s economy since the 2003 SARS epidemic, allowing more two-way investment in shares and sparking a rally in brokerage stocks.

China will start an exchange-traded fund based on Hong Kong equities, Li, the front-runner to replace Wen Jiabao as premier in 2013, said at a forum in the city today. He also pledged a 20 billion yuan ($3.1 billion) quota for qualified companies to invest in domestic Chinese securities and said sales of yuan bonds in the city will be expanded.

The plans relax restrictions on investment flows, bolstering the city’s role as a financial hub and aiding an economy that shrank in the second quarter for the first time since 2009. China Everbright Ltd. rose 8.2 percent, the most in 19 months, as financial services companies surged on speculation they may benefit from the quota.

“Today’s announcements should enhance Hong Kong’s exposure to mainland growth momentum, giving the territory more cushioning against rising global economic headwinds,” said Donna Kwok, an economist at HSBC Holdings Plc in Hong Kong.

Haitong International Securities Group Ltd. shares closed 8.6 percent higher and Guotai Junan International Holdings Ltd. climbed 10 percent.

‘Piece of Candy’

Today’s measures echo the government’s assistance after the deadly disease epidemic, when a loosening of visa restrictions spurred spending by Chinese tourists. At that time, China and Hong Kong also signed a free-trade agreement, the Closer Economic Partnership Arrangement.

“It seems to be the biggest piece of candy offered by Beijing since the one they gave to Hong Kong after SARS,” said Raymond Yeung, a Hong Kong-based economist at Australia & New Zealand Banking Group Ltd.

Making the announcements in person, with the heads of the central bank and commerce ministry, was “a symbolic demonstration of Beijing’s commitment to Hong Kong,” said Kwok. The quota for qualified foreign institutional investors is a yuan-settled version of an existing program settled in dollars, she said.

China will expand its companies’ offshore bond sales and support the use of yuan for foreign direct investment in the nation, Li said. The city’s status as a financial center “is crucial for Hong Kong’s development,” he said.

Financial Center

The pledge for an exchange-traded fund comes after the government scrapped in January 2010 a plan to allow Chinese nationals to buy equities directly. The so-called “through-train” program for direct purchases, unveiled by regulators in August 2007, had helped push the Hang Seng Index to a record high in October that year.

“All these moves will help enhance Hong Kong as a leading financial center,” said Danny Yan, Hong Kong-based portfolio manager at Haitong International Asset Management, which oversees $600 million. “The impact on the Hong Kong market will be more long-term than short-term.”

Qualified foreign institutional investors “will be allowed to invest in mainland securities markets with an initial size of 20 billion yuan,” Li said. “Pilot projects for foreign banks to replenish capital with renminbi will be launched and support will be given to Hong Kong enterprises in making direct investment on the mainland in renminbi.”

Zhou’s Cooperation

Central bank Governor Zhou Xiaochuan told the same forum that Hong Kong and China would continue to “deepen their cooperation” to protect the stability of financial markets amid global volatility.

Hong Kong’s economy is sinking into a recession that is likely to last for at least a year, according to Daiwa Capital Markets economist Kevin Lai, who had the closest estimate in a Bloomberg News survey on second-quarter gross domestic product.

Li swept through Hong Kong’s financial district yesterday on his arrival, with police blocking footbridges between the world’s fifth-biggest stock exchange and the Asian headquarters of JPMorgan Chase & Co. when his cavalcade of more than 18 vehicles passed beneath. A helicopter flew overhead with a banner by Industrial & Commercial Bank of China Ltd. for today’s 20 billion yuan sale of bonds by China’s Ministry of Finance.

Li is one of nine members of the Communist Party’s ruling Politburo Standing Committee and is mentioned by political analysts such as Li Cheng of Washington’s Brookings Institution as being a likely successor to Premier Wen Jiabao.

Badges of Success

While the skyscrapers and fundraising are badges of Hong Kong’s success, Li also toured a public housing estate in a city where a growing wealth gap is stoking discontent. Chief Executive Donald Tsang has failed to win backing from a majority of the public for more than a year, according to the latest findings in a University of Hong Kong survey tracking his popularity.

The city lost its place this year as the world’s biggest center for initial public offerings as the flow of multibillion-dollar sales by Chinese state-owned companies dried up. Hong Kong IPOs raised $15 billion this year, while the U.S. had $36 billion worth, according to data compiled by Bloomberg.

In a sign of the rising role of the Chinese currency, yuan deposits in Hong Kong totaled a record 554 billion yuan at the end of June, more than six times the level of a year earlier, according to the city’s de facto central bank. The Chinese finance ministry’s sale of “dim sum bonds” is its third and largest issue of yuan-denominated debt in Hong Kong.

Yields in China

Price differences for securities suggest investors using the yuan QFII may look to invest in bonds rather than equities. Yuan-denominated bonds in Hong Kong yield less than those on the mainland because offshore investors have fewer options to invest using China’s currency and seek to profit from appreciation.

Chinese government notes maturing in December 2020 yield 2.48 percent in Hong Kong and 4.05 percent in Shanghai, according to data compiled by Bloomberg. The yuan will strengthen 5.6 percent to 6.05 per dollar by the end of next year, based on the median forecast in a Bloomberg survey.

All of the 70 companies that have stock listings in both China and Hong Kong trade at a premium on the mainland, according to data compiled by Bloomberg. Luoyang Glass Co. has the biggest gap in valuations, with its Shanghai price of 9.93 yuan more than five times the HK$2.29 commanded in Hong Kong.

China is also boosting the currency’s international role to curb dependence on the dollar, which may weaken as the U.S. Federal Reserve pledges to keep interest rates at record lows through mid-2013.

“China wants the yuan to be one of the new currency anchors in the long-run, thus it will be less affected by the increasingly volatile and weaker U.S. dollar,” said Yao Wei, a Hong Kong-based economist with Societe Generale SA. “Hong Kong will continue to be a test ground for China’s capital account opening-up and currency internationalization.”

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