Online Extra: Will a Renminbi Revaluation Rock Hong Kong?

Financial Secretary Henry Tang says he expects a reasonable movement that probably won't harm the territory's economy too much

Two years into the job, Hong Kong Financial Secretary Henry Tang has presided over Hong Kong's economic recovery. But now he faces new challenges linked to uncertainty over the Chinese currency revaluation and the inflow of hot money pushing up Hong Kong's asset prices.

He recently discussed his strategy to keep the Hong Kong economy ticking with Frederik Balfour, BusinessWeek Asia correspondent. Edited excerpts of their conversation follow:

Q: Do you think there's a consensus in China's state council about a revaluation?

A:

I'm sure considerations are very diverse and wide. They have to put domestic issues and the nation's interests first. Their current account is nearly balanced, so a revaluation will have significant implications for imports and exports. It will not happen just because the U.S. is putting pressure on them. I think that the time you might want to be more careful is when the Americans go quiet.

Q: What contingency plans to do you have if China does revalue the renminbi (RMB)?

A:

We're obviously reviewing the situation very closely. Any movement will have implications and impact on our currency and will affect our competitiveness.

The mainland is our largest trading partner, and we employ 10 million or 11 million workers in the Pearl River Delta alone. But the impact may not be as large as we fear.... Even a reasonable movement won't put us into a different league, so to speak.

Q: What's reasonable?

A:

That's anybody's guess. There has been a lot of speculation and rumors of when they will move and how they will move, so we have different scenarios in mind, but it's very hard to say.

Q: So you have different contingency plans for different scenarios?

A:

Yes. But I can't tell you them.

Q: What happens to Hong Kong if China's economic engine falls off the track?

A:

That's a very hypothetical question. I don't believe the current leadership will change the course of reform they see as necessary. The engine may speed up or slow down, but the track is laid, and the direction is clear.

Q: Are you concerned about Hong Kong's peg and the large amount of liquidity coming into the system as people speculate on an RMB revaluation?

A:

The peg has served us very well for more than 21 years and given us the stability we needed over the Asian financial crisis. It's a concern of ours recently because so much foreign capital has flowed into Hong Kong that it has kept the interest rate disparity between Hong Kong and the U.S. at a fairly sizable level.

The ideal situation is that we closely track U.S. interest rates.

Q: What about the growing problems of air quality in Hong Kong?

A:

It's a price we pay for being so geographically close to China, [with its] rapid industrial development. When the north wind blows, we suffer with the whole of Southern China. We can continue to [work] with them and map a regional solution

But there are things we can do domestically. The buses are now using Euro 3 and move onto Euro 5 [emissions standards]. On power, we are moving ahead, but companies need to consider investments and control schemes.

Q: Are you concerned Hong Kong will lose its competitive edge as costs go up?

A:

Hong Kong will never be cheap. In the whole of China, it's probably one of the most expensive places to operate. But how competitive Hong Kong is depends on more than just cost factors.

Looking at the report [the World Competitiveness Report, which in May ranked Hong Kong No. 2 in the world], where we performed strongest is [on the] low and simple tax system [and] transparency in our regulatory regimes. Once we commit ourselves to a fiscal discipline, we do carry it out. And we're committed to a rule of law. We remain committed to those factors that gave us a strong rating. Whether we will catch the U.S. at No. 1 is another question, but we want to remain No. 2.

Q: Do you still assume a balanced budget by 2008?

A:

Yes, because the economy has performed better than we predicted, so our figures are better than anticipated from taxation sources and stamp duty.

Q: There was $34 billion in direct investment last year into Hong Kong. Where did it all go?

A:

A lot of people use the combination of basing their hub in Hong Kong and investing in the mainland because of the [territory's] rule of law and system they're familiar with, the ease of doing business, the convertibility of the currency -- all those things we can recite in our sleep. They use Hong Kong as a base and invest in the mainland.

Q: As Shanghai's financial sector develops, how will Hong Kong hold its dominance?

A:

Going forward while we have a clear edge in being China's financial center, I believe additional business in RMB will be a key strategic direction to pursue. [Last year, Beijing allowed Hong Kong banks to accept a maximum of $256 dollars per day worth of RMB deposits from Hong Kong residents.]

If we want to further lengthen our lead and edge, I set three directions in my budget to allow diversification of RMB assets and liabilities of Hong Kong banks, particularly on the liability side: To allow nonresidents and companies to deposit RMB in Hong Kong banks, to allow banks to provide RMB services for trade and other current account transactions, and to set up RMB debt issuance in Hong Kong, such as letters of credit. This is a wish list we're discussing with the mainland.

Edited by Patricia O'Connell

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