Shanghai targets to be an international financial center (IFC) for China by 2020, aiming to lead the world in trading, pricing and settlement of yuan-denominated financial products by 2015. This ambition is worrying for Hong Kong in that its position could be replaced by Shanghai as China's IFC. However, this might simply be Hong Kong's unwarranted anxiety. Mainlanders continue to admire Hong Kong's world-class image, and international investors are still using Hong Kong as their headquarters for managing investment in the mainland.

Shanghai and Hong Kong are working on different parts of the yuan internationalization. The huge domestic financial demands surely qualify Shanghai as the top onshore yuan center, and Hong Kong's global connections help boost yuan liquidity worldwide. Shanghai's onshore yuan trading and pricing are essential for Hong Kong's offshore yuan promotion. Shanghai is expanding its non-forex turnover to $158.24 trillion (1,000 trillion yuan) with assets under management of $4.75 trillion (30 trillion yuan). With such capacity, the Shanghai Interbank Offered Rate (Shibor) and the yuan central parity rate are important references in pricing yuan assets and the yuan lending rate.

Before fully floating the yuan, the use of offshore yuan centers together with bilateral currency swap agreements are the most logical transitions. This reduces the unnecessary costs and risks of using the US dollar and euro as third currencies for direct trade settlements, foreign direct investment (FDI) and portfolio investment.

Hong Kong is working with Shenzhen's Qianhai to accelerate the backflows of overseas-acquired yuan into the mainland. This will reinforce the international investors' confidence in yuan assets and support the mainland private enterprises with low-cost yuan. The yuan deposit interest rate is 0.25 percent in Hong Kong, while the People's Bank of China (PBOC) gives 3 percent interest on yuan deposit and lends out yuan at 6 percent in the mainland. This move reduces borrowing costs and encourages cross-border swaps and other financial innovations.

Hong Kong has been a key IFC since early 1980s. Featuring efficient financial markets with global connections and free flow of capital, Hong Kong plays a key role in "attracting" overseas capital and talents, while helping mainland enterprises in "expanding" abroad. Therefore, Hong Kong is not being "marginalized". It focuses on international promotion and global operations. As a result, Shanghai is the top regional IFC while Hong Kong is a potential global IFC for China.

Shanghai is leading Hong Kong in GDP, GDP growth, stock market capitalization, stock market trade value, area size and population size. Hong Kong represents only 30.3 percent of Shanghai in population size, and 17.4 percent in area size. Hong Kong is tiny while Shanghai can freely expand to Suzhou, Wuxi, Nanjing, Hangzhou and Ningbo.

Shanghai's population growth has accelerated tremendously over the past three decades, with total population more than doubling to 23.02 million currently from around 11.86 million in 1982. Meanwhile, Hong Kong's population grew only 6.1 percent during the decade between 2000 and 2010.

However, having a big population has also brought big challenges to Shanghai's housing, health, transport and education. Almost 40 percent (9 million) are migrant workers and their families. This brings about a lower GDP per capita. Shanghai's per capita GDP is only 37.7 percent of Hong Kong's level. Meanwhile, 24.5 percent of Shanghai's population is over 60 years old. In Hong Kong, only 13 percent are aged 65 or above. Such unskilled and aged population won't help much in promoting Shanghai's financial innovations.

Further down the road in the future, international investors might vote for Hong Kong as China's global IFC. It is because Hong Kong could replicate Shanghai's onshore advantages as 2047 draws near, while Shanghai may still not allow a free flow of capital for national security reasons.

The author is a lecturer at Division of Commerce, Community College of City University. The views expressed here are entirely his own.

(HK Edition 07/31/2012 page2)