Banking and exchange rate relations between Hong Kong and mainland China in historical perspective 1965-1975

The ‘one country, two systems’ structure established to govern the relationship between Hong Kong SAR and Mainland China was an innovative and comprehensive solution to particular economic and political challenges posed by the return of Hong Kong to the PRC in 1997. At the time of the drafting of the Basic Law, the integration of the colony into the regional economy of Southeast China through outward FDI had already begun, and from the mid-1980s this process facilitated the transformation of the Hong Kong economy from a manufacturing base to one dominated by financial and commercial services. It was recognized on both sides of the negotiations that the territory’s viability and future prosperity relied on retaining independence over a range of key fundamentals, including a separate and independent currency and monetary system that was at the foundation of Hong Kong’s attraction as an international financial centre for the PRC and also for the rest of the Asian region. An important credibility mechanism for the HK$ (as for the inconvertible RMB at this time) was the exchange rate link to the US$. Since this was also the anchor for the RMB after 1997, the linked rate system kept the relationship between the RMB and the HK$ stable. While the rapid growth and development of the Mainland economy after 1999 outstripped many predictions, the relatively poor performance of Hong Kong from 1997 until 2003 has changed the context in which the one country two currencies system operates. The de-linking of the RMB from the US$ and subsequent appreciation from July 2005 has further complicated the monetary relations between Hong Kong SAR and the rest of China. Hong Kong’s interest rates and monetary policy are now arguably more closely aligned with those of the USA than those of its main trade partner. The increased use of RMB in banking and other transactions in Hong Kong SAR is further evidence of the erosion of the barriers between the two currencies. In February 2008, RMB deposits in Hong Kong had reached RMB47.8 billion, an increase of 92% over a year, although this still represented only 0.8% of total deposits in Hong Kong. Cross-border financial flows within the banking system have also accelerated with the accumulation of net liabilities in Hong Kong to banks on the Mainland since 1999. Once the RMB and the HK$ reached parity against the US$ in January 2007 there was a psychological shift in attitudes about the relative merits of each currency as well real concerns over the potential impact of the appreciation of the RMB on the cost of imports into Hong Kong from the Mainland.3 The potential for further appreciation of the RMB against the HK$ poses challenges as well as opportunities for Hong Kong consumers and producers and heightens public attention on the implications of separate currencies within a single country. The financial, monetary and banking relations between Hong Kong and Mainland China have a long and intimate history that should be borne in mind when assessing the challenges faced by the separate monetary systems operating today. As Chan’s chapter in this volume shows, due to the commercial integration of the region, the HK$ circulated widely in Southeast China both as a store of value and as a medium of exchange. This monetary integration increased during the collapse of China’s monetary system in the late 1940s.4 With the establishment of the PRC, HK$ were collected by the new government of China and their use in private transactions was prohibited in order to promote the new national Chinese currency. Banking relations between the two territories were never severed but they were put under severe strain by the nationalisation of banking and commerce in the early 1950s. Nevertheless, this article will emphasize that there was considerable continuity in the banking relations between Hong Kong and Mainland China and will explore the operations and implications of exchange rate dynamics in the 1960s and 1970s when the global fixed exchange rate system collapsed, destabilising the exchange rate between the HK$ and RMB. An important contribution is to present new data on the activities of Mainland Chinese banks operating in Hong Kong during this period, collected from official archives. This data confirm the extent of cross-border activities throughout the 1960s and early 1970s