Yuan ‘Seismic Change’ Far Off for Architect of Hong Kong Peg

A free-trade zone opened by China last year is unlikely to be a major step toward making the yuan fully convertible and suitable as a Hong Kong dollar peg, the architect of the city’s 30-year-old currency regime said.

The area, started in Shanghai last September as a testing ground for liberalizing interest rates and yuan usage, is “not likely to be a seismic change” for the nation because firms still face too many restrictions, John Greenwood, chief economist at Invesco Asset Management, said in an April 28 interview. HSBC Holdings Plc Chief Executive Stuart Gulliver said last month that the yuan will be fully convertible by 2017.

China’s policy makers started the zone as they seek to shift from an export-led economy to a consumption-driven model. Banks in the zone are allowed to conduct cross-border yuan settlement for direct investment, while companies can borrow from overseas for operations and project construction. The yuan completed a fourth monthly drop today, its longest losing streak in at least seven years, on concern an economic slump has deepened and as the central bank lowered the currency’s daily fixing.

“It doesn’t seem to me that it’s a huge, major step,” as the rules are only a widening of exemptions to a ban on capital flows, said Greenwood, who has previously maintained that the yuan needs “many years” to become fully convertible. “We will still have a lot of regulations as to which firms are permitted to register, etc. There will continue to be the large, long negative list.”

Interest Rates

Greenwood said the U.K. couldn’t be considered to have shifted to full convertibility of its currency until 1979 and Japan in 1981, at times when their economies were far more advanced than China’s. Policy makers need to allow companies to fail and liberalize interest rates to overhaul the economy, which will struggle to grow faster than 8 percent amid a slowdown in global trade, he said.

Hong Kong linked its exchange rate to the U.S. dollar in October 1983, when negotiations between China and the U.K. over the city’s return to Chinese rule spurred capital outflows. The currency has been kept at around HK$7.8 per dollar since then. In 2005, policy makers committed to limiting the currency’s declines to HK$7.85 per dollar and capping gains at HK$7.75. The Hong Kong dollar was little changed at HK$7.7531 today.

Renminbi Proxy

A currency peg means Hong Kong’s monetary policy is dictated by the Federal Reserve’s, and calls to review the system have mounted since 2008 as near-zero U.S. interest rates fueled a surge in property prices and living costs. Greenwood says he sees little risk of a rapid increase in U.S. Treasury yields triggering a slump in the housing market.

“I don’t see anything specific that would cause the Hong Kong administration to want to change something that has been operating for 30 years,” Greenwood said. “There were episodes when people tried to use the Hong Kong dollar as a proxy for the renminbi. I’m glad to say that those kind of views have been squashed.”

The yuan depreciated 0.7 percent this month and 0.02 percent today to close at 6.2593 per dollar in Shanghai, China Foreign Exchange Trading System prices show. It has slumped 3.3 percent in four months, the longest run of losses in CFETS records dating back to 2007. Local financial markets will be closed May 1 and 2 for holidays.

A repeg to the Chinese currency will only be feasible when “the yuan is fully and irreversibly convertible,” Greenwood said.

“China would have to have a huge amount of domestic liberalization before it’s ready for full external convertibility,” he said. “They are still many years away.”

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