The afternoon of March 25, Hong Kong. Mr. Huang, a Taiwanese owner of a Hong Kong-based company that processes food in China, rushes out of Sheung Wan subway station on his way to Cleverly Street, to see a broker dealing in renminbi.

"Mr. Huang, the money you remitted from Shenzhen has been confirmed. Should I change it into U.S. dollars and transfer it to your Hong Kong account?" asks the currency broker's manager in a tone suggesting complete familiarity with the process.

"No, no. Directly give me renminbi. Right now, how could I possibly take U.S. dollars?" Huang says.

Cleverly Street may be less than 500 meters long, but it is the nerve center of Hong Kong's quasi-legal renminbi trade, home to more than 10 currency brokers. Because the currency of China, the renminbi (also known as the yuan), is still not fully convertible and Hong Kong banks are barred from handling renminbi remittances for corporate clients, the door has been left open for the brokers, who help small- and medium-sized enterprises like Huang's skirt China's currency regulations on renminbi transactions by shuttling cash between Hong Kong and China proper.

Already, the renminbi's impact is being felt throughout the region as it begins to surpass the U.S. dollar in importance. On the same day Huang made his renminbi transaction, the headline of a Hong Kong newspaper read: "After Renminbi Fully Convertible, HK Dollar's Greenback Peg May End: Hong Kong Chief Executive." Such a development, which would allow Hong Kong's dollar to move in closer alignment with the renminbi, would have huge implications for Taiwanese businesses based in Hong Kong and China.

Renminbi In, Dollar Out

The renminbi's rise poses a challenge to exporters like flat panel manufacturer AU Optronics. The flat panel industry has traditionally priced its products in U.S. dollars, but with Chinese consumer electronics vendors accounting for a growing share of panel makers' sales in recent months, they have begun to insist that panel exporters quote their products in renminbi, rather than the greenback.

  "We've seen a trend since the beginning of the year where the renminbi is replacing the U.S. dollar," AU Optronics' new chief financial officer Andy Yang tells CommonWealth Magazine. "In the future, the supply chains of Taiwanese companies will be using two currencies simultaneously, especially those supplying China's domestic market. The demand for renminbi management will rise sharply."

Taiwan's financial sector is also concerned about the trend. If the renminbi business becomes Hong Kong banks' main profit generator, Taiwan's financial institutions will also want in on the opportunity. Taiwan and China are expected to sign a memorandum of understanding (MOU) on cross-strait financial cooperation and discuss a currency settlement mechanism in June, and the next step, bankers hope, will be to allow the renminbi's use in foreign trade settlement, which would lower the currency risk of China-based Taiwanese businesses. Once the cross-Taiwan Strait financial framework is normalized, the Taiwanese financial industry will move aggressively to capture a share of the renminbi business.

In a sign of the anticipation, Taiwan's financial shares soared the week ending April 3 after news surfaced that Taiwan and China would sign the financial MOU. The spike was also driven by news that Hong Kong will allow trade settlement in renminbi, an unmistakable indication of the Chinese currency's muscle in the Greater China economic region.

As a result of the renminbi's dominance, might the Hong Kong dollar be one day phased out? Could Taiwan, similar to Hong Kong in that China is its biggest trading partner, be next?

Renminbi Internationalization

The internationalization of the renminbi will be driven by China's foreign trade. As soon as Beijing allows Hong Kong to officially engage in renminbi trade settlement on a trial basis, the huge underground influx of renminbi will be brought to the surface and provide Hong Kong's financial sector with a lucrative opportunity.

The term "international trade settlement" refers to how companies price and pay for imports or exports. When Chinese or foreign companies in Hong Kong conduct trade with areas outside its borders, be it importing raw materials or exporting products, and payments are made by bank remittance or other means, if the two parties to the transaction agree, and "renminbi trade settlement" is allowed, payment can be made in renminbi through a bank, avoiding the U.S. dollar and exchange rate risk.

Trade between China and Hong Kong totaled US$356.56 billion in 2008, accounting for 47.5 percent of Hong Kong's foreign trade activity. But China's government to date has only allowed Hong Kong financial institutions to handle individual renminbi deposits and remittances, not renminbi trade settlement business. That has left businesses reliant on Chinese brokerage "stores" and the Hong Kong currency brokers like the ones on Cleverly Street to change money.

Neither China's government nor the Hong Kong Monetary Authority has been able to estimate the total volume of renminbi transactions through these underground moneychangers.

Daiwa SB Investments (HK) Limited Deputy Managing Director and Regional CIO Ambrose C.K. Chang, cited unofficial statistics in estimating that more than Rmb500 billion was in circulation in Shenzhen, where the foreign currency brokers operate. The numbers reveal at least indirectly the magnitude of the renminbi exchange business, as the volume of renminbi circulating in Shenzhen city was one-third of China's total, while Shenzhen's GDP accounted for only one-eighth of the country's total.

Hong Kong Banks' Magic Elixir

Hong Kong financial institutions hope that the underground renminbi exchange and settlement business will be made legal and serve as the magic elixir that gets them through the global financial crisis. Their anticipation has brought intrigue to Hong Kong's financial sector, as banks vie for a license to launch renminbi operations.

"The Hong Kong financial sector in fact needs the renminbi business," says a composed Song Yun Zhao, the deputy general manager of Bank of China (Hong Kong) Ltd.'s Economics and Strategic Planning Department. Song's bank, well known for its landmark BOC Tower, is currently the only financial institution in Hong Kong allowed to engage in renminbi settlement operations.

Song says Hong Kong's banks are unable to develop their renminbi deposits into a viable business primarily because of regulatory constraints and a lack of applicable tools and investment. Hong Kong banks cannot use renminbi for more profitable lending or corporate client business and therefore are forced to turn over renminbi deposits to the Bank of China (Hong Kong) and then on to China's central bank, the People's Bank of China, to get back Hong Kong dollars.

"After going through two procedures, the interest rates that banks can offer on (renminbi) deposits are not attractive, and making a profit is out of the question," Song says.

"In the future when renminbi can be used to settle trade accounts, services related to renminbi financing will emerge, such as L/C negotiation, factoring, bills clearing, and others. Renminbi capital will be on its way," he adds.

As part of the international trade settlement plan that has been proposed, Hong Kong banks will be allowed to engage in interbank lending with their Chinese counterparts and to use currency swap schemes to get cash infusions from the People's Bank of China. These maneuvers will allow for far greater levels of renminbi circulation in Hong Kong.

Nicholas Kwan, regional head of research for Asia at Standard Chartered Bank (Hong Kong) Limited – the bank that prints Hong Kong's banknotes – predicts that the liberalization of renminbi business will soon be accelerated. 

Hong Kong and China signed a Closer Economic Partnership Arrangement in 2004, and soon after Hong Kong financial institutions were allowed to handle individual deposits and remittances. Kwan says that was the Chinese government's first step in trying to push its currency out into the world, and if those same banks are allowed this year to engage in renminbi trade settlement transactions and renminbi interbank lending, it will be a crucial second step.

"It will have taken a full five years to go from the first step to the second step, but the international situation is quite different today. Liberalizing (renminbi-denominated business) would be making a significant statement," Kwan says.   

The third step, Kwan says, would be to allow Hong Kong banks to get involved in renminbi financing and allow the currency to be freely convertible internationally. When these services become reality, renminbi-denominated business will emerge as a key engine of profitability.

This magic elixir could also revamp Hong Kong's financial sector.

Fubon Bank (Hong Kong) managing director and CEO Jin-Yi Lee observes that Hong Kong's financial sector, which is "gearing up for renminbi business," is facing internal and external pressures.

Internally, the question remains whether Hong Kong banks, when authorized to engage in the renminbi trade settlement business, will be treated equally or whether Chinese banks will be given preferential treatment.

Externally, Hong Kong still needs to confront the challenge posed by its longtime competitor Shanghai. At the end of March, China's State Affairs Council announced that Shanghai will become an international financial center commensurate with China's economic power and the renminbi's international status by 2020.

Hong Kong's financial circles interpreted the announcement as signaling that the Special Administrative Region (SAR) would no longer be the exclusive test location for renminbi trade settlement and would soon be joined by Shanghai.

Hong Kong Dollar Must Not Disappear

The financial sector accounts for over 20 percent of Hong Kong's GDP, and for Hong Kong, the renminbi battle is a silent struggle for survival. The former British territory's residents also have mixed feelings about the Chinese currency.

"Our next generation could very possibly no longer have Hong Kong dollars," says Daiwa's Ambrose C.K. Chang, a native Hongkonger. "The public can now exchange Rmb20,000 a day. A lot of my friends and I have opened several accounts in which we deposit Rmb20,000 every day."

Ultimately, the Hong Kong dollar and the renminbi may coexist and circulate side by side in Hong Kong in the future.

Susie Chiang, currently chairwoman of the CS Culture Foundation and formerly the Taiwanese Government Information Office's representative in Hong Kong, who is active within political and economic circles in Greater China, offers a view that reflects to a certain extent the sentiments of Hong Kong's elite: "Hong Kong needs the renminbi, but the Hong Kong dollar will not and cannot disappear."

Chiang believes that to people living in Hong Kong, the local currency not only serves as the SAR's legal tender, but also remains an important symbol of Hong Kong's independent and autonomous status relative to China. "China promised that Hong Kong would not change for 50 years. If after only 10 years the Hong Kong dollar no longer exists, does Hong Kong have any autonomy left?" Chiang wonders.

For a long time Taiwan's central bank, from its governor Perng Fai-nan to the heads of every department, has closely monitored the impact of the renminbi's liberalization on Hong Kong and the Hong Kong dollar.

In a report published in the Taiwanese central bank's International Monetary Reference Materials, central bank senior analyst Lu Shih-hsun predicted that the Hong Kong dollar will retain its independent status for the next 10 years, but will likely gradually delink itself from the U.S. dollar to lower the risk of a major greenback depreciation. In its place, the report predicts, the Hong Kong dollar will tie itself to a basket of currencies that includes the renminbi. Only after the renminbi becomes readily convertible internationally will the Hong Kong dollar move in step with the Chinese currency.

A Potential Future Challenge for Taiwan

Once the Hong Kong dollar and the renminbi both circulate in Hong Kong, and the Chinese currency grows in regional strength, Taiwan may be forced to make a choice between economic interest and economic sovereignty. The dual use of the U.S. dollar and local currencies in some Latin American countries, for example, has shown that the concurrent use of two currencies is bound to interfere with the monetary policy of a country's central bank.

Yet, because the impact of the financial crisis on Taiwan has been similar to its effect on Hong Kong, creating investment deficits, a bleak outlook for wealth management, and loan obligations that are hidden time bombs, Taiwan's financial sector needs a new business line that would bring it new vitality.

Though it is too early to talk about Taiwanese banks handling renminbi-denominated business, one Hong Kong investment bank executive says a number of Taiwanese financial institutions, in partnership with international banks with presences in Taiwan and China, are already targeting familiar China-based Taiwanese businesses through services such as "borrowing in China, paying off loans in Taiwan," or vice-versa. These cross-border renminbi-denominated operations have already earned Taiwanese banks considerable fee income.

As soon as cross-strait financial commerce is normalized, renminbi business will be aggressively pursued by Taiwanese companies.

Without a doubt, the renminbi's international journey has begun. In the near future, the Hong Kong dollar is likely to be tugged in different directions, trying to survive as a symbol of the SAR's autonomy against the onslaught of the renminbi. Taiwan's financial sector may also one day face the dilemmas posed by the renminbi's rise, and how it copes will have important implications for its future.

Translated from the Chinese by Luke Sabatier