Hong Kong's development into an offshore yuan center has made great leaps in the past year but each done deal and each under consideration must be viewed against the backdrop of the expectation that the Chinese currency is to appreciate.

The desire to hold something that you believe will gain value in future is certainly rational in a market-driven economy like Hong Kong.

According to official figures, yuan deposits rose fivefold in the preceding 12 months to May, reaching 544.8 billion yuan by the end of that month.

"Right now we see a lot of accumulation of yuan overseas, because overseas investors want to hold it, even though the interest rate is so low. That helps to some extent. But clearly that is not sustainable," said K.C. Chan.

The doubts about sustainability and their far-flung impact on Hong Kong are valid.

At a China Daily Asia Leadership Roundtable held in early June, Professor Fan Gang, former member of the Monetary Policy Committee of the People's Bank of China, warned that the yuan's upward momentum may be exhausted in 2 to 3 years, posing the risk of inverse capital flow when investors shy away from the currency.

For Hong Kong, does the yuan's projected path, which is rising to a plateau, indicate a fleeting boon or does it foreshadow strong headwinds?

Chan said though the expectation of yuan appreciation facilitates growth of the offshore yuan liquidity pool, some who might use yuan to settle their trade will not do so because they think yuan will cost more.

The logic is that such expectation has made traders more willing to accept the currency to settle exports, but reluctant to borrow the yuan to settle imports, leading to an imbalance in cross-border trade settlement.

"So the expectation is not totally beneficial to our development. Now we want a much more balanced situation where people do not have one-sided view on the exchange rate. So the people are more likely to switch to yuan for trade," said Chan, "and that is important, because the whole policy of yuan internationalization is to encourage import and export to be denominated in yuan."

If the yuan appreciation expectation moderated, "we got more trade, more people to borrow yuan, issue paper, so it may not be that bad," Chan said.

(HK Edition 07/15/2011 page4)