China to Test Freer Yuan in Financial Zone

BI: China is Experimenting with a Truly International Currency
China Offshore: Central Bank Allows Chinese Businesses to Settle Trade Using the Rmb
FT: China to Create Special Currency Test Zone
Reuters: China to Experiment with Freer Yuan

On June 28, 2012, China announced plans to create a special financial test zone. The financial test zone is to be located in the city of Shenzhen on mainland China and will allow China to determine how easily Chinese currency can convert into gold and other foreign currencies. This new measure will allow Hong Kong banks to lend renminbi, the official currency of China, directly to companies on mainland China, particularly in the new economic zone of Shenzhen.

The currency experiment aims to increase the flow of the Yuan (the primary unit of the renminbi), between Hong Kong and mainland China. Prior to the announcement, Hong Kong banks could only lend to Chinese clients in Hong Kong, and if the Chinese clients wanted to bring that money into China, they needed approval from the foreign exchange regulator. The Chinese foreign exchange regulator limits the amount of renminbi that can leave and enter mainland China. The Chinese government also has regulations in place to ensure the renminbi cannot travel without restriction across the border for pure financial transactions, like loans. The currency experiment in Shenzhen allows renminbi held by bank lenders overseas to flow back to China because banks in Hong Kong can lend to Chinese clients in Hong Kong, but with the currency experiment, they can also lend to those on mainland China.

China’s currency experiment could prove important to the eventual undoing of capital controls in the country as well as increase the Yuan’s presence overseas. Capital controls are mechanisms the Chinese government uses to regulate the flow of Yuan in and out of the country. For instance, the Chinese government limits the amount of Yuan companies can take out of mainland China for trading and lending as well as the amount they can bring back in. The experiment follows a series of other steps taken by the Chinese government to make the renminbi a more globalized currency that could eventually compete with the U.S. dollar in global markets. A global currency refers to a currency in which the vast majority of international transactions like sales and trades take place, (e.g., the U.S. dollar and the Euro). China’s drive for financial reform includes the goal of making the Yuan convertible to foreign currencies as early as 2015.

Over the past two years, large amounts of Chinese currency have moved abroad for the first time because Chinese companies could settle their international trade in renminbi, rather than first exchanging renminbi to dollars prior to doing business with foreign companies. The allowance of settling international trade in renminbi meant the Chinese Central Bank allowed all businesses that trade with China to use the renminbi in their trade exchanges and in business transactions, such as sales, with each other. Thus, a Chinese company can now pay a European company in renminbi, allowing the outflow of Chinese currency to foreign hands. The Chinese government has also allowed foreign investing institutions a limited but growing selection of investment options for their renminbi holdings, which includes Hong Kong’s dim sum bond market. Hong Kong’s dim sum bond market is a market that sells bonds denominated, or valued, in Chinese Yuan.

Shenzhen, designated as the country’s first special economic zone in 1980, helped to bring foreign investment and free trade to China. This economic zone was the first city that experimented with China’s broader economic reforms that were later rolled out across the country and helped China on its way to becoming the world’s second-largest economy. If the Chinese government follows through with its announced plans in globalizing the Yuan, Chinese currency could be more easily convertible to foreign currencies very soon.

Tensions Rise Between Hong Kong and Mainland China

Sources:

BBC: Surge in Anti-China Sentiment in Hong Kong

FT: Hong Kong Rages at Wave of Pregnant Chinese

WSJ: Hong Kong-Mainland Tiffs Worry Beijing

Hong Kong residents are growing wary of the increasing numbers of mainland Chinese some of whom are travelling to the island for tourism, and some to take advantage of Hong Kong’s social programs. The number of mainland Chinese travelling to Hong Kong peaked at twenty-eight million in 2011—an amount four times the Hong Kong population of seven million—and anti-Chinese sentiment has culminated in a group of Hong Kong residents raising money to publish a full-page color advertisement in a Hong Kong paper depicting Chinese tourists as a locust overlooking the Hong Kong skyline. Moreover, the number of Hong Kong residents identifying themselves as Chinese fell to 16.6% in 2011—a twelve-year low—down from 38.6% in 2009.

Hong Kong passed from British colonial rule to Chinese control in 1997, and has been operated under a “one country, two systems” policy. Under this policy, Hong Kong is free to determine its own internal affairs, but Beijing controls Hong Kong’s foreign and defense policies. In 1997, Hong Kong residents mostly welcomed the transition as it ended 150 years of British rule and rescued Hong Kong’s struggling economy by opening its borders for increased trade with China. While Hong Kong still generally benefits from trade with China, travel to Hong Kong—primarily from some of mainland China’s wealthiest residents—has increased tension between the mainlanders and Hong Kong residents, as well as the Hong Kong government and Beijing.

Many mainlanders go to Hong Kong to shop for luxury goods because there is no sales tax. In many of Hong Kong’s shopping districts, the mainland Mandarin dialect is heard more often than the local Cantonese dialect, and Hong Kong residents are becoming resentful of seeing the conspicuous consumption of mainlanders who thirty years ago Hong Kong residents viewed as country folk. In January, this resentment came to a head when Hong Kong residents protested and forced a luxury store (Dolce & Gabanna) to close after hearing it permitted mainland tourists to take pictures in front of the store but not local residents.

This relatively minor episode highlights Hong Kong residents’ concerns that mainland Chinese are getting special treatment in Hong Kong in more important ways. Increased wealth, coupled with China’s one-child policy (which is not in effect in Hong Kong), has led a surge in birth tourism (mainland Chinese traveling to Hong Kong to give birth). If a child is born in Hong Kong, the child automatically receives the right to live and work in Hong Kong, carry a Hong Kong passport that eases international travel, access Hong Kong’s health-care system, and twelve years of free education. Over the past ten years, the number of newborns of mainland parents has risen from about 700 in 2000 to over 34,000 in 2011, or 38% of the newborns in the city.

Hong Kong residents complain that mainland Chinese are able to take advantage of the social programs that Hong Kong residents have built through hard work, without contributing to the funding of the social programs themselves. The Hong Kong government worries about access to schools and hospitals, and has already taken action to reduce the quota of hospital beds allocated to non-local mothers to 34,000 annually. In response, Chinese officials in Beijing have assured Hong Kong residents that it will ramp up its efforts to curb mothers travelling to Hong Kong to give birth by imposing heavy fines on those who skirt China’s one-child policy by travelling to Hong Kong.

These ongoing tensions between Hong Kong and Beijing will become more important in the coming years as Hong Kong braces for its first democratic election in 2017. If Hong Kong residents remain resentful of mainland China, it could boost a political party hostile to Beijing’s interests into power and threaten relations between Hong Kong and Beijing.