Hong Kong's International Financial Centre: Retrospect and Prospect

Kong’s role as a financial centre can be strengthened therefore depends on how one first
conceives the ultimate political objective. In this regard, external decisions seem lately to be
forcing choices.
In the financial sector, two such decisions stand out. The first was the decision by China’s
State Council on March 25, 2009 to affirm the goal of transforming Shanghai into an
international financial centre by 2020. The second is related, since there is no chance of even
getting close to such a goal without it. Chinese leaders decided gradually to relax exchange and
capital controls, to allow the emergence of offshore RMB markets, and eventually to make the
RMB a fully convertible currency. Skepticism is certainly warranted, since in the end such
moves are inconsistent with a system of central planning that still relies on the licensing,
monitoring, steering, and bailing-out of a full range of economic activities. The ability of the
Party at the core of the Chinese state to adapt to changing circumstances should not be
underestimated, for it lies at the core of the economic restructuring taking place before our eyes.
The challenge, however, is daunting.
A fully convertible currency would suggest fundamental change in the way China’s
economy is governed. Especially if it avoided recourse to a dual exchange-rate system (a
separate exchange rate for offshore RMB), intervention to guide capital flowing into and out of
the economy would become more difficult, more uncertain, and more costly. Today, all legal
foreign exchange transactions come through banks, typically one of the four state-owned banks
(Bank of China, Construction Bank, Commercial Bank, or Agricultural Bank), which must seek
specific authorization from the Foreign Exchange Department of the People’s Bank. Together
with interest rate controls on domestic loans and deposits, this system steers capital in the
direction desired by central planning authorities. If it were quickly liberalized, it would expose
China’s banks and their main clients to the full force of external markets. The well-known badloan
problem on the books of those banks would have to be solved quickly, and controls on
interest rates would be very difficult to maintain. The effects of being forced quickly to write off
bad loans and rapidly reduce reliance on hidden interest-rate subsidies would be particularly
problematic for state-owned enterprises not yet ready for open competition. The effects on
domestic wages and price levels would surely be dramatic and highly contentious. 32
For these very reasons, plans for gradualism are nothing new in this policy arena. The fact
is, however, that similar plans in other countries have often proved impossible to implement. At
a certain point, the pressure of freely moving capital forces the abandonment of rigid exchange
rate systems. Crisis ensues and typically leads to the rapid decontrol of capital markets. Of
course, nowhere in the world is capital entirely free to move, but the overall trend during the past
half century is evident. The most powerful industrial and industrializing countries came to realign
their politics and policies to accommodate open capital markets. Exceptions were made
32 See Victor Shih, Factions and Finance in China: Elite Conflict and Inflation, Cambridge: Cambridge University
Press, 2007. Also see Wendy Dobson, Gravity Shift, Toronto: University of Toronto Press, 2009, Ch. 3.
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