PRC TO ALLOW RMB INVESTMENT IN HONG KONG MARKET,

UNCLAS SECTION 01 OF 02 HONG KONG 002183 SIPDIS SIPDIS STATE FOR EAP/CM AND EEB/OMA, TREASURY FOR OASIA, NSC FOR WILDER, TONG E.O. 12958: N/A TAGS: EFIN ECON HK CH SUBJECT: PRC TO ALLOW RMB INVESTMENT IN HONG KONG MARKET, HANG SENG JUMPS ¶1. The Chinese State Administration of Foreign Exchange (SAFE) announced August 20 that it would allow mainland Chinese citizens to invest in the Hong Kong Stock Market. Chinese investors will be required to open a special account through the Bank of China (BOC),Tianjin, but will then be able to purchase Hong Kong stocks with either Renminbi (RMB) or foreign exchange deposits. A SAFE spokesman said the new policy would remove the yearly investment cap of USD 50,000 and would not require Qualified Domestic International Investor (QDII) designation. ¶2. The Hang Seng Index moved sharply higher on reaction to the U.S. Federal Reserve's announcement of a cut in the discount rate, news that Hong Kong Shanghai Bank (HSBC) is in discussions to acquire Korea Exchange Bank, and the SAFE announcement, jumping 5.93% on August 20 - the highest one day increase since May 1998. Optimism continued to reign at the Hang Seng's opening on August 21, with the Hang Seng Index shooting up 1000 points in the first thirty minutes of trading. The Index eventually hit 22,616, up an additional 4.6% before slipping back as traders took profits in the afternoon and the rumors of an impending People's Bank of China (PBOC) interest rate hike hit the market. (NOTE: At 6:00pm August 21, PBOC announced that effective August 22nd it would raise the 1-year benchmark deposit rate by 27 basis points and the 1-year lending rate by 18 basis points. END NOTE.) The Hang Seng Index finished up 0.62% at 21,729.35 on a near record volume of HKD 116.8 billion. Chinese company stocks (H Shares) gained strongly as investors speculated Chinese companies would be more attractive to Chinese investors. The Hang Seng Chinese Enterprises Index rose by 8.74% on August 20 and an additional 2.84% on August 21. ¶3. Credit Suisse Managing Director Dong Tao said the SAFE policy is basically a "closed door experiment" that will function as a swap between BOC, Tianjin and BOC, International. The money will not need to move across the border except when settlement in needed for gains or losses. Tao added that he believes this experiment could help to relieve the appreciation pressure on the RMB. He characterized the move as a landmark in Chinese deregulation of capital controls with significant implications for the Hong Kong stock market now and eventually the rest of the world. This limited opening allows Chinese residents to participate in overseas markets without SAFE losing control of the foreign exchange market and gives SAFE the chance to suspend the scheme if it feels necessary. ¶4. BOC Executive Vice President Xie Yonghai on August 21 told the Sing Tao Daily that mainland investors would not be allowed to withdraw their revenues in Hong Kong after they sell their Hong Kong stocks. Instead, they could either keep the money in the BOC International accounts or remit it to their BOC, Tianjin accounts. He noted that this is how the PRC can ensure that mainland capital is not allocated to "other uses." Xie added that the program would not be limited to residents of Tianjin Binhai, but that mainland investors in other provinces and municipalities would be able to open accounts at BOC, Tianjin via their local BOC branches to buy Hong Kong stocks. ¶5. Cable TV Hong Kong reported from Tianjin early on the morning of August 21 that BOC, Tianjin Binhai branch was not allowing Tianjin residents to open special accounts at that time because the branch had not yet received final approval from the China Banking Regulatory Commission (CBRC). A spokesman for the bank branch insisted that the bank is technically prepared to implement the new policy. ¶6. The Hong Kong government (HKG) claimed credit for successfully lobbying mainland officials to make use of Hong Kong as a Chinese financial intermediation center to facilitate the orderly outflow of capital from China. A press release issued August 20 by the Hong Kong government said, "the Tianjin pilot scheme announced by SAFE is a concrete response to the HKG's recommendation. The Hong Kong Monetary Authority (HKMA) has been in discussions with the People's Bank of China and SAFE on the operation details of the "free-walk scheme." (Note: the "free-walk scheme" allows individuals to invest their own foreign currency funds offshore without being designated under QDII. ¶7. Hong Kong Financial Secretary John Tsang and HKMA Chief Executive Joseph Yam, both just returned from meetings in Beijing, praised the SAFE announcement. Tsang said, "the use of Hong Kong's financial platform for mainland individuals to HONG KONG 00002183 002 OF 002 invest offshore is a clear demonstration of the mutually-assisting, complementary and interactive relationship between the financial systems of the mainland and Hong Kong. It will help to enhance the status of Hong Kong as an international financial center." Yam added that, "the HKMA will continue to work with the PBOC, SAFE, and other mainland authorities on measures to strengthen the links and interaction of the financial markets in the two places, thereby increasing their overall size and efficiency." ¶8. Foreign banks in Hong Kong are bullish about the SAFE scheme. Jing Ulrich, Managing Director at JP Morgan said the pilot program "should produce an upward revaluation of Hong Kong shares." A Morgan Stanley report estimated that up to 800 billion RMB could enter the Hong Kong market if only 10% of the Shanghai A Share market capitalization is permitted to invest in Hong Kong stocks. UBS expects transaction on the Hong Kong market could increase by as much as 20%. Merrill Lynch recommended investors buy shares of BOC, Hong Kong which is expected to benefit from the scheme. The share price of the Hong Kong Stock Exchange rose by 6% on August 21 on investor optimism about its new business proposal. Cunningham