Integration of the Chinese currency will further boost Hong Kong, consistently voted the world’s freest economy, as an international financial centre

Hong Kong is moving closer towards integrating its economy with China – a process which is helping to lay the foundation for the city’s long-term future.

Soon, Hong Kong companies and foreign firms based in Hong Kong will be able to settle bills for imports from China in the mainland’s currency the renminbi (RMB) or yuan.

In addition, Chinese financial institutions will be allowed to issue bonds in Hong Kong denominated in yuan. The moves were announced as Hong Kong celebrated the ninth anniversary of its handover to China.

“This is a major policy initiated by the Central Government in support of the consolidation and development of Hong Kong's status as an international financial centre,” said Hong Kong’s Chief Executive Donald Tsang.

The State Council in Beijing is putting the finishing touches to the legal framework for the initiatives before they get underway.

Cost savings

The payment of imports in yuan will be particularly useful for companies based in Hong Kong which are already receiving revenues in the currency, allowing them to save on foreign exchange costs.

“A lot of people in Hong Kong already accept yuan notes and coins, and this makes the yuan more useful in Hong Kong if you want to retain yuan here,” said Paul Tang, Chief Economist of Hong Kong-based Bank of East Asia.

Banks in Hong Kong have already been allowed to take yuan deposits even though Beijing does not allow the currency to be freely traded like other units such as the US dollar and the Hong Kong dollar. There is now about 22.9 billion yuan (US$2.9 billion) sitting in deposit accounts in Hong Kong, Mr Tang said.

The issuance of yuan-denominated bonds by mainland institutions will be a boon to the banks, giving them a means of usefully investing the yuan they are holding as deposits.

The two new steps follow hard on the heels of an announcement in April that China will set up a qualified domestic institutional investor (QDII) scheme allowing corporations and individuals to send money abroad for the first time. Hong Kong is expected to be a prime beneficiary of the billions of yuan which are expected to eventually flow out of China under the QDII seeking higher investment returns than are available domestically. Hong Kong has the status of a Special Administrative Region within China, preserving the economic freedom it enjoyed as a British colony until 1997.

World’s freest economy

Hong Kong has consistently won the title of the freest economy in the world in annual surveys by the Cato Institute, a US-based public policy research foundation. Without compromising that freedom, Hong Kong has been slowly integrating its economy with that of fast-growing China, which is moving away from a central command model towards a free market.

The policy initiatives are allowing companies based in Hong Kong, including foreign-invested enterprises, to enjoy the city’s free flows of capital and information and the rule of law, while getting special access to China.

Hong Kong and China introduced their Closer Economic Partnership Arrangement (Cepa) in 2003 which gives companies in Hong Kong privileges when doing business in the mainland. Each year since, new concessions have been added to Cepa.

Cepa has also allowed Chinese individuals to visit Hong Kong, reforming requirements they be in group tours. The result has been 13 million mainlanders coming to Hong Kong under the Individual Visitors Scheme, giving a substantial boost to the city’s retail and tourism sectors.

Cepa will still be helping Hong Kong even after China opens up its markets to foreign businesses later this year as part of its pact to join the WTO. China may go a few steps further in its concessions to Hong Kong companies than foreign companies will receive under the WTO agreement, said Bank of East Asia's Mr Tang.

The efforts to integrate with China have played a part in helping Hong Kong rebound strongly from its restructuring in the wake of the Asian financial crisis of 1997-98. The city’s economy grew at a stunning 8.2 per cent in the first quarter this year compared to the same period in 2005. That was even faster than the 7.3 per cent pace in 2005.

The buzz is back

“In a reflating economy the feel-good factor comes back. There is that buzz back in Hong Kong again,” said Tim Condon an economist with Dutch bank ING.

The moves made so far towards integration have already had a major impact on the Hong Kong economy but the biggest benefits may lie ahead as systems are slowly put in place for the yuan to become more freely traded in Hong Kong.

“More and more Chinese yuan will circulate in Hong Kong. If you want to have legitimate economic activity then you want to put it in a formal financial infrastructure,” Mr Tang said.

“Hong Kong wants to position itself not just as an international financial centre but as a services centre for China.”