Thursday, April 7, 2011

Market Forces Slowly Alter China’s “One Country, Two Systems” Policy Towards Hong Kong

China has largely honored its promises to Hong Kong, spelled out in Hong Kong’s Basic Law, the territory’s mini-constitution, since it resumed sovereignty over the former British Crown colony on July 1, 1997.

Chapter V (Economy), Article 111 states “The Hong Kong dollar, as legal tender in the Hong Kong Special Administrative Region, shall continue to circulate.”  Subsequent paragraphs in Article 111 require that “the issue of Hong Kong currency must be backed by a 100 per cent reserve fund”...”with the object of maintaining the stability of the currency.”  So far, all Hong Kong currency is backed by several hundred percent holdings of foreign reserves, largely in dollars (but the Basic Law does not specify which currencies are required in Hong Kong’s foreign reserves).  The Hong Kong dollar is pegged to the U.S. dollar at a rate of US$1 = HK$7.80.

A dramatic change has taken place in customer deposits in Hong Kong banks in the past year.  Renminbi (RMB) deposits in January 2008 amounted to RMB 40.4 million, rising to RMB 54.4 million in January 2009, RMB 63.9 million in January 2010, and RMB 370.6 million in January 2011.  Year over year RMB deposits in Hong Kong banks in January 2011 grew 580%, of which time deposits rose 1,071% and demand deposits 309%.

RMB deposits as a share of Hong Kong dollar deposits have grown from a fraction of less than 1% to 15.3% (converting RMB into HK$), or 5.3% of all currencies (including HK$, US$, and non-US$ foreign currencies).  Given the expected appreciation of the RMB, this trend is likely to continue.  Perhaps in the short span of a few years, RMB yuan will displace Hong Kong dollars as the de facto currency of Hong Kong, even if it does not enjoy the legal tender status of the Hong Kong dollar.  As RMB deposits rise and the yuan become fully convertible, perhaps as soon as 2015, Hong Kong people will likely pressure the Hong Kong Monetary Authority to switch reserves from dollars to RMB.

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