The Hong Kong government could re-peg the city’s currency to the Chinese renminbi before the end of next year, a packed conference hall was forewarned yesterday.
Peter Redward, head of emerging Asia research at Barclays Capital, made the bold claim at a panel discussion on the likely impact of RMB liberalisation on foreign exchange markets. He also forecast that the renminbi could appreciate by 10% against the US dollar over the next year.
Redward spoke at a seminar on the internationalisation of the renminbi organised in Hong Kong by AsianInvestor and FinanceAsia.
Asked by audience member Charles Han, Hong Kong-based head of FX trading at Newedge Financial, what might be the catalyst for Hong Kong’s de facto central bank to re-peg to the renminbi, Redward argued there was a good economic case for switching already.
He noted that deflation dynamics, commodity prices and adjustments going on in Hong Kong were all being driven by the RMB, negating the historic justification for a US dollar peg.
“I think it is going to be a case of the frog in the boiling water,” he added. “Over time, the deposit base of RMB here [Hong Kong] is going to grow, the number of small businesses pricing product and transacting in RMB is going to grow, and the heat is slowly going to get ratcheted up."
“It could happen sooner than people think given the rapid rise in the circulation of the currency,” he said.
An earlier panel discussion at the event had revealed that RMB deposits in Hong Kong had surged from Rmb100 billion to Rmb130 billion in just two months.
Redward was happy to go out on a limb and predict a 12- to 24-month time horizon for repegging to the renminbi. “Probably not less than 12 months,” he said.
But ING Group's chief Asia economist Tim Condon subsequently put forward five-to-10 years as a more realistic time-frame. "As I understand it, the [Hong Kong] Basic Law requires that the Hong Kong dollar has to be linked to a convertible currency," he stated. "That requires that the yuan become convertible, and I think that one-to-two years seems to be a little bit on the quick side."
Redward further noted that long-dated FX-volatility in Hong Kong is between 1% and 2%, meaning the market is still pricing in the probability that there will be no change to the peg.
“If the HKMA [the Hong Kong Monetary Authority] steps back and lets the Hong Kong dollar die, that’s fine,” he said. “But if they re-peg it to the RMB, you could potentially see a very significant appreciation in the value of the Hong Kong dollar against the US dollar and that is absolutely not priced into the market now.”
(The power to change Hong Kong's currency arrangement is actually with the finance secretary, not the HKMA, as was pointed out by other panellists.)
This, he suggested, was something for companies with long-dated cashflows to think about. “When the volatility starts moving, that is the markets telling you something is going on. At the moment it is not moving, but watch that space.”
In terms of likely renminbi appreciation against the US dollar, Redward is forecasting up to 10% over the next year, although his co-panellist Dennis Tan, Asia FX strategist at Deutsche Bank, made a more restrained 5% call.
The renminbi has appreciated at an annualised pace of about 7.5% since the June 19 liberalisation announcement. By BarCap calculations, if the effective exchange rate had remained stable since mid-June [it has fallen by 3%], the RMB would have been trading at around Rmb6.23 to the US dollar.
“Given that we need to see RMB appreciation in effective terms, not just against the dollar, if you price in a weaker dollar coupled with a stable-to-strengthening effective exchange rate, then I think that we could easily see the RMB appreciate by anything up to 10% over the next year,” said Redward.
Tan was more circumspect. He noted that an appreciating currency is consistent with Beijing’s policy to move to a more domestic consumption-driven economy as opposed to an export-driven one.
“But as a caveat I would caution about being overly optimistic on RMB appreciation,” he said. “Besides a structural shift [to domestic consumption] in the five-year plan of China, there is another component, which is to increase household income as a proportion of national income, so that supports the view that China may be trying to engineer wage increases.
“We can see minimum wages in some cities doubling in five years’ time, so maybe they [Beijing] think appreciation in the real exchange rate can be done through a weight adjustment and a price adjustment rather than nominal appreciation of the exchange rate itself.”
He pointed out that the nominal exchange rate has been on a downward trend since June. “The accelerated move in dollar-China may have been a way to forestall protectionist measures from the US,” he added.
In terms of the likely impact of renminbi appreciation on other currency markets in Asia, Redward likened it to the “snake system of exchange rate adjustments” in Europe in the 1970s.
“The dollar-China comes lower because the dollar is weakening, then the dollar-yen moves lower, the Thai baht and the Malaysian ringgit move lower and these all interact with each other through their effective exchange rates,” he said.
However, he advised against betting on cross-rate trades, given an environment in which currency movements are based more on the willingness of policymakers to allow adjustment than on fundamentals.
“It makes these cross-strait trades extremely difficult because you are actually trading the decision-making processes of the central banks,” said Redward. “Unless you know what they’re doing, the probability of losing money is very high.”
He recommends keeping things simple: the dollar is going to continue to fall, so stay short dollars – given QE2 [additional quantitative easing], the US's massive and rising current account deficit and $900 billion in funding requirements.
For his part, Tan noted that 90% of Asian trade is carried out in US dollars, and given that direct trade from the US is on the decline from most Asian countries and that a lot of trade is now going through China, there's plenty of room for the offshore RMB settlement market to grow.
“You will find that a lot of financial centres – Singapore, Seoul, Taipei – will try to come in and you will find that the development of RMB offshore settlement will spread, Chinese authorities allowing.”
Redward suggested that Singapore will probably develop a derivatives market based around non-deliverable forwards and RMB-cross rates.