Mainland tourists and multinational corporations alike will find their money goes further in Hong Kong, thanks to the revaluation of the Chinese currency

After keeping the yuan pegged firmly at 8.2765 to the US dollar for a decade, Beijing announced on July 21 that it was allowing the currency to revalue by 2.1 per cent to 8.11 to the US dollar, and repegging it to an unspecified basket of foreign currencies, representing a major milestone in the country's economic development.

The currency, also known as the renminbi (RMB), is now allowed to move by 0.3 per cent either side of a reference rate set each day by the People's Bank of China. That in theory could allow the currency to appreciate much further in coming months since the initial move. The currency has since moved to a high of 8.098, a further appreciation of 0.15 during trading in Shanghai. That doesn't sound much but it is much bigger than the imperceptible moves allowed under the peg regime, and could hint at larger moves on China's tightly controlled currency market later as traders and the central People's Bank of China get used to the new system.

Even the initial 2.1 per cent move higher for the yuan will be enough to provide a shot in the arm for Hong Kong, says fund manager Brook McConnell of South Ocean Management. "There will be higher spending power on the part of mainlanders, that is obvious. The local economy is going to get a boost," he said.

HK dollar buys more

The yuan now buys 2.1 per cent more in US dollar terms - and also in Hong Kong dollar terms. Hong Kong has maintained its currency board system which keeps the Hong Kong dollar within a tight range around a reference rate of 7.8 per US dollar. The relatively cheaper Hong Kong dollar in yuan terms means that the millions of mainland tourists who flock to the city -- making up 56 per cent of Hong Kong's tourist total last year -- will be able buy that bit more, even with the same spending budget in yuan terms.

"Hong Kong's hotels, meals, transportation and entertainment would become cheaper for mainland tourists in RMB terms," said Joe Lo, an economist with Citigroup. "The prices of mainland tourists' favourite items, such as electronics, jewellery, fashion and watches, would also decline in RMB terms."

Mainlanders will also be increasingly attracted to buy Hong Kong property with a heftier yuan in their pockets, along with other investments like stocks listed on Hong Kong's market.

Indeed, Macquarie Research raised its year-end target for the Hang Seng Index from 15,500 to 17,550 in response to Beijing's move and said: "RMB is another significant positive for Hong Kong." Investors agreed with the Hang Seng Index rising by more than 5 per cent since the currency regime change on July 21.

The yuan's appreciation has allowed other Asian currencies to rise. Regional central banks have worked in recent years to keep their currencies at competitive rates against the yuan or risk losing export orders to China. With the Chinese currency's move higher, other Asian central banks have felt they too can relax their grip slightly and let their currencies move higher against the US dollar.

"It starts the ball rolling for all the Asian currencies over time," Mr McConnell said.

Attractive regional hub

Against the backdrop of potential further rises in Asian currencies, Hong Kong will also become more attractive on a cost basis for multinationals considering where to position regional offices.

One of the downsides of China's stronger currency is that exports will lose a little of their competitiveness - that is precisely the impact that US and European politicians were looking for while putting Beijing under tremendous pressure to engineer a revaluation in recent months.

But the impact on Hong Kong's vital trade sector should not be too severe, says Citigroup's Mr Lo. "(Chinese) exporters should be able to offset the increase in costs through higher productivity or reducing profit margins. Hong Kong's transportation and exports, therefore, should only suffer only modestly from a gradual RMB appreciation," he said.

But Mr McConnell points out that some exporters are already operating on wafer thin profit margins, so even the yuan's modest rise will hurt.

"Some exporters are going to be affected more than others. It will have to be looked at on a case by case basis," he said. "The guys with 2 per cent margins selling DVD players to Wal Mart are going to have a tough time."

Looking from Hong Kong outwards, the yuan appreciation is going to help push up inflation in the city. It will now take slightly more Hong Kong dollars to buy the same goods from China, raising prices. A little bit more inflation is not necessarily a bad thing for Hong Kong given it only just emerging from years of deflation induced by the Asian financial crisis. Inflation measured by Hong Kong's consumer price index (CPI) was a relatively modest 1.2 per cent higher year on year in June.

Economic fillip

"The renminbi appreciation will intensify Hong Kong's imported inflation, particularly via food prices which make up 27 per cent of the CPI basket of goods and services," said regional stock brokerage Kim Eng Securities. Higher inflation should also push up wages and help strengthen Hong Kong's economic upcycle as it completes its lengthy recovery process from the Asia financial crisis.

Financial markets are speculating that the yuan will be higher to reach its fair against the US dollar and other currencies. If it does, it will amplify the boost to Hong Kong's economy. Kim Eng believes the year-end fair value for the currency is 4 per cent higher at 7.787 against the US dollar, or near parity with the Hong Kong dollar. Macquarie Research believes the yuan could move another 6 per cent higher in the next six months.

At any rate it is going to be fascinating to watch the yuan story unfold as China takes major economic steps forward - and to gauge the impact it has on Hong Kong's economy.

Related links
The reform of the Renminbi exchange rate regime