More recently, the current issue of speculation surrounding the renminbi - and one which is far more grounded in reality - is the question of whether its exchange rate will be given greater flexibility in the near future. This revives the old question of how far the Hong Kong dollar will be affected by movements in the renminbi, which has some connection with China’s prospective WTO accession, and it is therefore worth examining the rationale behind it, and the implications. First, however, since there is some confusion on this point, it is helpful to clarify the difference between flexibility and convertibility. Convertibility means the ability of a currency to be freely exchanged into foreign currencies, either for trade (current account convertibility) or for investment (capital account convertibility). The renminbi enjoys current account convertibility but is not freely convertible for capital account transactions. Flexibility means the degree to which the exchange rate is allowed to fluctuate before there is intervention by the central bank. At present, there is flexibility in the exchange rate of the renminbi, in that the exchange rate is determined by “market” supply and demand, although the central bank remains the ultimate banker in the market. The renminbi has indeed been trading within a very narrow band in the past few years. The narrowness I think reflects China having acted responsibly, against the background of financial turmoil in Asia, in not allowing greater flexibility in the renminbi exchange rate to add destabilising volatility to Asian currencies.
These processes have positive implications for domestic banks incorporated in the mainland and for foreign banks, including banks incorporated in Hong Kong. For the domestic banks, expanding business and the challenge of foreign competition provide an impetus for reform and innovation. The banking reforms currently in progress in China are proceeding well. These include, among other things, the establishment of asset management companies to carve out the bad assets inherited from the days of policy lending. They also include the full introduction of commercial principles and market-based credit policies, and improvements in accounting standards. There will also be a profound impact on the governance and culture of the commercial banks, in terms of much better transparency and accountability, especially if these banks are to be floated as intended. To meet foreign competition, they will also put much more emphasis on recruiting good people, including those studying abroad, and giving them proper training. A good example is the recent joint venture between Qinghua University and Harvard Business School to provide extensive training for bank managers in the mainland. They will also need a much clearer business and IT strategy, which could include the need for consolidation. WTO entry will mean a phased opening of China’s banking market to foreign banks. Restrictions on foreign banks’ operations, in terms of the scope of business, 3  BIS Review 68/2000  clients and geographical coverage, will be gradually relaxed.