One popular bet in the market, for fun or for real money, is on when the renminbi exchange rate against the US dollar will touch 7.80, or when the rate against the Hong Kong dollar will reach one to one. There are now charts of all sorts prepared by financial institutions, to facilitate their own position-taking or advise their clients, on the so-called "first-hit probability", in other words, the probability of the renminbi exchange rate hitting 7.80 within, say, three, six or twelve months. Most of these charts are based on past trends of the renminbi spot exchange rate as well as those of forward contracts, deliverable on the Mainland or non-deliverable outside the Mainland.

While these largely statistical exercises are interesting, I hope these bets on the renminbi exchange rate breaching certain psychological levels are merely for entertainment, like picking the winner in a horse race or the Mark Six numbers. The renminbi exchange rate of 7.80 against the US dollar is perhaps a psychological level to some people, although when that level is reached is much more than just a statistical phenomenon. There are, of course, underlying economic fundamentals of the Mainland relative to those of the rest of the world, notably the United States, against whose currency the exchange rate of other currencies is measured. There is so much uncertainty surrounding the global economy, particularly the US economy, that sharp exchange rate movements among the major freely convertible currencies are a distinct possibility. The large global imbalance continues to exist and exchange rates are at their current levels mostly because of the large interest rate differentials between currencies, a notable example being that of around five percentage points between the US dollar and the Japanese yen. And exchange rate levels, regrettably, have been very much politicised, affecting market sentiment.

Interestingly though, Premier Wen has said in no uncertain terms that there will be no further one-off moves (of the type seen on 21 July 2005) in the renminbi exchange rate. Indeed, no such move is called for given the economic and structural circumstances of the Mainland and the declared exchange rate policy of a managed float while pursuing capital account convertibility for the currency. It seems to me, as a keen observer, that further opening up the capital account is clearly preferable to allowing the currency to appreciate as a way to achieve greater balance in the international payments account and financial liberalisation, if indeed there is a choice. Holding the largest, and still increasing, foreign reserves in the world presents difficulties in monetary management, resulting in excessive liquidity in the financial system. In the meantime, a lack of avenues for mobilising savings results in a low rate of return on those savings. This means that people have to save more to achieve a given amount of return, feeding back into the already high savings rate and discouraging consumption. Capital account liberalisation is clearly a desirable approach to address these challenges.

The pace of capital account liberalisation and the sequence of individual steps towards it affect the exchange rate. As currently structured, the QDII schemes are unlikely to provide significant relief from upward pressure on the renminbi. I hope that many restrictions in these schemes will be relaxed and the volumes allowed enlarged in time. There is of course a need to be cautious. Financial stability is very important to economic growth and development. But there is ample scope for imaginative financial liberalisation on the Mainland, without being imprudent. How about giving freedom to investors with their own foreign-currency holdings and the ability to protect themselves, to invest overseas and enjoy more attractive returns? This would provide the incentive to pursue, and be consistent with, the declared policy of "storing foreign exchange with the people". Let us have a "free walk" (自由行) for investors with foreign exchange along with the "free walk" for tourists (the Individual Visit Scheme).

Meanwhile, by all means have a bet, just for entertainment, on the timing of the renminbi exchange rate hitting 7.80. Based on our internal statistical analysis (undertaken as part of our work, not for book-making purposes), the odds quoted within the HKMA are two to one, or a 50-50 chance for a first hit within six months. Don’t bet your bottom dollar on it though.

Joseph Yam
5 October 2006

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