OK, internationalization.

Do we have a clear approach on the part of China as to how you can, how you internationalize the Renminbi? Well, there is a philosophy of crossing the river by feeling the stones. In other words, I don't actually, so far, detect a clear strategy as to what, you know, how you move forward in terms of liberalization. China is making use of the offshore Renminbi market in Hong Kong to conduct controlled experiments, But, you know, there is a lack, I think, a lack of a clear strategy. But it is developing in terms of the attitude towards the offshore market. I think China would need to accept that the offshore market is there, for the purpose of doing desirable things that for good reasons could not be actually done onshore in China. But there is a need to be careful that what I called the tail does not wag the dog, that the offshore market does not undermine financial safety and effectiveness of the monetary and financial policies onshore. But the two markets need to be connected to enable effective risk management, and the transmission of important market signals from offshore to onshore. But there are now emerging guiding principles in the internationalization of the Renminbi. You make use of the offshore market, but in the offshore market, there should be offshore rules. And onshore market you have onshore rules. OK? In the spirit of One Country, Two Systems. Linking the offshore market and the onshore market through this Renminbi settlement system. The settlement bank in Hong Kong is the Bank of China (Hong Kong), which is allowed to maintain a clearing account with the People's Bank of China in Shenzhen, so the two markets are actually linked up. There is a need to protect the integrity of the Mainland system, and this can be effected through writing into the settlement agreement between the People's Bank and the Bank of China (Hong Kong) certain conditions for providing settlement services. That's how it is being organized. This is the progress of internationalization. Interestingly it was something that I raised in November 2001, when I led a delegation of the

Hong Kong Association of Banks to Beijing. We visited the People's Bank of China, and in particular, the State Administration of Foreign Exchange. At that time, Guo Shuqing, formerly vice governor of the PBOC, he was Head of SAFE. And at that time I just felt that, wow, you know, if we want to sustain Hong Kong's position as an international financial center, we probably need to ensure that Hong Kong can handle international financial transactions denominated in the Renminbi. Now if we cannot even handle transactions denominated in the Renminbi, we can forget about Hong Kong as an international financial center because in the long run, the Renminbi will become an international currency, and an important reserve currency as well. So if Hong Kong is not in a position to handle financial transactions denominated in the Renminbi, how can we be an international financial center of China? So a start will need to be made. And at that time, in the year 2001, I raised the possibility of, you know, developing Renminbi business in Hong Kong. And interestingly, without the prior consultation with Guo Shuqing, his response was very favorable. And so we took, you know, a few years until about 2004, when we started, you know, developing banking business in, Renminbi banking business in Hong Kong. Remittances, credit cards, and conversion by Hong Kong residents between Renminbi and Hong Kong dollar or foreign assets. And there have been other developments since then, one after another. And significantly, in July 2009, trade settlement was introduced. And August 2010, selected institutions allowed access on to the Mainland and in the interbank bond market, etc, etc. And just now, in August 2012, there is now freedom to conduct Renminbi business for non-Hong Kong residents in the offshore market, because the offshore market should have offshore rules. We have no restriction as to who can operate a Renminbi bank account, so why should there be restrictions in Hong Kong for Mainland residents for operating Renminbi accounts in Hong Kong, or indeed any other non-resident operating a Renminbi account in Hong Kong ?

So that, once again, that was confirmed. But still, these initiatives appear to be, or give the impression, of being rather ad hoc in the development, or in the internationalization of the Renminbi. It does not suggest the existence of an elaborate strategy, or any sequence. Perhaps, you know, we can adopt we can continue to be guided by the philosophy of feeling the stones, etc. But I also feel that sometimes this is rather too political, because, you know, when we have put... I can still remember when I was Chief Executive of the HKMA, putting various proposals on the table for consideration by the People's Bank of China, and the response was actually quite favorable. Yes, we can do this, we can do that. And in the end, it was a political sign in the form of the Hong Kong and Macau Affairs Office, that determined the timing. You know, there would be people who would say, Hong Kong seems to be doing rather well recently. Why should we be taking out these goodies and giving it to Hong Kong? You know, there is a time for giving away these good things, which is actually a rather political way of looking at the internationalization of the Renminbi. That, to me, is a matter of national interest, whereas benefiting Hong Kong is obviously something good, but it should not override the national interest of Renminbi internationalization. It should not override the need to manage exchange rate risk for China. It should not override the need to manage credit risk for China as a whole, OK? So I think there is a need for an analytical framework to facilitate the development of a strategy. I was working on it. I was hoping that I can produce one for your consumption. Unfortunately I don't really have time to complete the work, but I can introduce to you that concept of an analytical framework. In fact, there are six dimensions when you look at, you know, internationalization and/or try to identify proposals that you can put forward. It's actually not that complicated. You are either talking about doing something onshore or offshore. You are either talking about Renminbi or foreign currencies. You are either talking about mobility of currency or conversion of currency. You are either talking about

current account or capital account. You are either talking about residents or non-residents of Mainland. You are either talking about individuals or corporations. Right? So there are in fact 64 possible combinations of those six dimensions. Let's say, you allow Hong Kong residents to convert 20,000 RMB a day, OK? So that is offshore conversion of Renminbi, between Renminbi and foreign currencies, a cross-currency conversion. It's either current account or capital account. It's by non-residents of the Mainland. Those are individuals. OK, that is possible. Then you ask the question as of why other non-residents cannot do that. How about foreigners? Shouldn't you also allow them to convert 20,000 a day? OK, there may be concerns of one sort or another, but at least this analytical framework can raise questions as to why something is done for a particular group of people and not the others, OK? So this is a framework that I was trying to develop, and I'm sure, you know, it can lead to somewhere. There are a number of examples that I want you to look at Let's take a look at Example (2). There is mobility of offshore Renminbi funds onshore, moving Renminbi from offshore to onshore, by non-residents which are Hong Kong residents. And those are individuals for investing onto the Mainland, and the limit is 80,000 a day. OK? That is one of the boxes of the 64 boxes that I have. Why should other non-residents and indeed residents of China not allowed such mobility? Let's say, if somebody from China holds a significant amount of Renminbi offshore, or onshore, why should you limit the mobility of such money between the Mainland and the offshore market? Why? And consider also another example. I think, you know, my Mainland colleagues can correct me if I'm wrong. I know that residents of China, individuals, can convert 50,000 US dollars, up to 50,000 US dollars a year. Isn't it? There is such a limit. OK? So that conversion is allowed.

Now, one can ask the question, if you allow residents in China to convert Renminbi into foreign currency to the tune of 50,000 US dollars a year, why should you be so worried about where they keep that US dollar? Why does it necessarily have to be kept on the Mainland? Since this is foreign currency already owned by the individual, why shouldn't you allow that individual to move that 50,000 US dollars to offshore, to Hong Kong, for example, so that they can achieve some return for that money? Let's say, invest that money in Hong Kong shares, or in Hong Kong property market, or whatever. Why, why should there be such a restriction? So you see, with this analytical framework, you can ask many questions and possibly lead to proposals being put onto the table. And if in the light of their impact on financial stability in China, the People's Bank feels comfortable about it, then we can go ahead more quickly in the internationalization of the Renminbi. There are other examples that I have given in these slides. So to conclude, actually, Renminbi internationalization is in the national interest of China, particularly in terms of risk management. I don't think China is aiming to take over the role as a reserve currency of the US dollar or the euro. It's only for the purpose of risk management and the stabilization of the international financial system. Realistically I think the US dollar will remain as a significant, or maybe, even the largest reserve currency. Interestingly, actually if you look back in history of reserve currencies, the pound sterling, the Spanish peseta, the Portuguese, whatever it is called, the Dutch guilder, for example, they have all served as reserve currencies of the world. They only lasted for 100 years. None of them, actually, lasted for more than 100 years, if you look back in history. And how long has the US dollar served as the reserve currency of the world? Almost 90 years now. Another 10 years to go, perhaps! But of course, this is just an interesting observation. But I mean, if you really look at the US economy now,

it's difficult not to feel concerned about, you know, not to feel lack of confidence in the currency. But realistically the US dollar would continue to be quite important and I don't think a breakup of the euro is likely. I hope that the Renminbi will become the third leg of a multi-polar international monetary system. And also, you know, we'll continue to pursue the road of the SDR, and the Renminbi is likely to be included in the SDR. Whether the SDR will become, you know, the currency, international currency of the world, because of the politics, it's doubtful. And I would consider, and not just for China, but for the rest of the world as well, whether or not there should be this new paradigm for the foreign exchange market. I hope that it will emerge, at least, you know. The foreign exchange market would serve better the global economy.