Goldman Sachs outlines Hong Kong's RMB future

It won't be long before residents in Hong Kong will be transacting as much in renminbi as in Hong Kong dollars, says Enoch Fung, executive director and Asia economist at Goldman Sachs.

Last week, he addressed an audience at a conference organised by SunGard, in which he outlined Hong Kong's future as a platform for internationalising the Chinese yuan.

Prime minister Wen Jiabao's administration has outlined its vision of Hong Kong as a financial centre to include the following roles: to expand RMB-denominated business offshore; to expand RMB-denominated bond issuance offshore; to encourage mainland companies to list offshore; and to collaborate in the development of Shanghai as a domestic financial centre.

China needs to diversify its $2.4 trillion of foreign reserves away from the US dollar by creating conditions to have exporters and importers transact and settle in renminbi. Today, all such activity takes place in foreign currencies because the renminbi is constrained by capital controls and a closed currency account.

Hong Kong is a natural stage for such an ambition. Fung likens its potential to London's becoming the global centre for dollar-based transactions. By establishing the Eurodollar market in the 1960s, the UK showed that it's possible, and even desirable, to separate country risk from currency risk.

In the next decade, Hong Kong will be able to maintain a separate legal system, which will allow it to foster an environment in which the renminbi is allowed to circulate freely. As Hong Kong develops an RMB-denominated bond market, this will lead to an RMB interbank market similar to Libor. Brokers will begin to do RMB business, and insurers will introduce RMB-denominated policies. Ultimately, Fung predicts companies will even list on the Hong Kong stock exchange -- in renminbi terms.

All this will serve as the lead-up to Hong Kong re-pegging its dollar to the renminbi, Fung says, at which point the Hong Kong dollar will become obsolete. He likens this future to Macau today, where taxi drivers transact in patacas, Hong Kong dollars and renminbi.

Fung says the scepticism towards China today and fears among many investors that it is in an asset bubble are misplaced. Although he acknowledges that China's official GDP growth figures are unreliable, he says Goldman Sachs' proprietary index of Chinese economic activity suggests GDP has actually been under-reported. Fung says it could be running at 15%, and that the country needs to continue tightening and will likely need to raise interest rates.

The government is being criticised for its easy credit policies of 2008-2009, designed to combat the credit crunch and the economic crisis in the West. However, Fung argues there is no credit bubble today in China. He calculates the growth in lending is less than the growth in GDP. Current lending reflects pent-up demand because of insufficient investment in the past.