There may be some psychological effects on the market as the renminbi exchange rate passes through certain levels, but this does not indicate any increase in the probability of change in Hong Kong's exchange-rate policy, Monetary Authority Chief Executive Joseph Yam says.

In his latest Viewpoint article, Mr Yam noted there are levels in the renminbi exchange rate that the market is particularly sensitive about, for example, if the renminbi strengthens to beyond 8 against the US dollar and even more so if it strengthens further to 7.8.

"From a purely economic point of view, it is difficult to understand why the market should be particularly sensitive to these specific levels and not, even if less so, to levels nearby. Market psychology is, of course, sometimes difficult to explain and may not be supported by rational economic arguments," he added.

Integration, convergence

Mr Yam pointed out as the pace of reform and liberalisation on the Mainland picks up, and the Mainland's economy becomes increasingly integrated with the global economy, there will be a degree of convergence between price levels on the Mainland and in the rest of the world.

"This convergence will not be absolute; the price levels of many open economies still differ, given the different degrees of specialisation in production and trade, and the immobility of production factors such as land and labour. But there is likely to be significant convergence as the Mainland's economy becomes more open."

He said the Mainland has chosen to introduce flexibility to the nominal exchange rate to facilitate the important, but not necessarily smooth, process of integrating its economy with that of the rest of the world.

This has been accompanied by bold and well structured steps of capital-account liberalisation, such as Qualified Domestic Institutional Investors, which may ease some of the one-sided pressure on the exchange rate.

As there are more opportunities for domestic savings to earn higher investment returns overseas, there may be less need to save, causing the savings rate to fall and consumption to rise, the savings-investment gap to narrow and the current account surplus to decline.

Sensible strategy

"This seems to be a sensible strategy for reforming and liberalising the financial system, not only in terms of prudently managing the associated risks of financial instability, but also contributing to resolving the global imbalance, as opposed to the highly risky alternative of allowing the renminbi exchange rate to appreciate sharply, as some have called for," Mr Yam said.

In observing or even predicting the movements of the renminbi exchange rate, Mr Yam said people should consider these economic arguments. They should also note that, as long as the renminbi is not a freely convertible currency, the authorities are quite capable of steering the path for the exchange rate. Therefore, state leaders' views that there will not be unexpected steep changes in the exchange rate are highly credible.

"I understand, however, that the psychological levels of the renminbi exchange rate affect the Hong Kong dollar, leading to the questions about the long-term relationship between the renminbi and the Hong Kong dollar.

"Apart from reiterating that the Government has no intention to change the Linked Exchange Rate system, I would like to point out that the price convergence between the Mainland and the rest of the world, involving the appreciation of the renminbi against other currencies, applies to Hong Kong as well.

Psychological levels

"Given the proximity of Hong Kong to the Mainland and the extensiveness of the relationship between them, both the degree and pace of the convergence may be greater than for economies in other parts of the world. This convergence was one of the reasons for the period of deflation in Hong Kong and benign inflation rates elsewhere a few years ago. It will obviously be to our benefit if this continued convergence is facilitated by a gradual appreciation of the renminbi against the Hong Kong dollar.

"In other words, the psychological levels of the renminbi exchange rate are merely psychological; they do not indicate any increase in the probability of change in the exchange rate policy of Hong Kong," he added.