One has to bear in mind that since RMB is the mainland currency, its exchange rate should be adjusted to the need of the mainland economy. RMB's exchange rate should not be responsible for the trade imbalance of other countries, such as the US. Washington is running a huge trade deficit with Beijing and that implies US imports more products from the mainland than it exports to it. The mainland has also been the most important destination in Asia for foreign direct investment. Its foreign reserves have been accumulating at a rapid pace.

Some people are using these arguments to push for a greater appreciation of RMB. When we examine the growth rate of the mainland's foreign reserves, we'll see that half of its foreign reserve has accumulated since 2003. That means the mainland's international reserves could also be lost rapidly if things were to go wrong. The mainland has also been investing its foreign reserves in US Government securities. In other words, the mainland has been financing the US Government to bridge its budget deficit.

We all understand that the US has to solve its twin-deficit problem at the end. But would a higher appreciation of RMB help ease the US trade deficit? The RMB appreciation will make mainland products more expensive and force Americans to buy less products imported from the mainland and more of those made in the US. This way, it could generate more jobs in the manufacturing sectors of the US. As a matter of fact, the RMB appreciation could actually help ease the trade deficit between the US and China. But even a higher RMB appreciation would not ease the overall trade deficit because US customers could easily supplement Chinese products with imports from other developing countries.

The immediate impact of the 2 per cent RMB appreciation on the Hong Kong economy would be small . The negative side is that we are going to pay more for mainland products. This will create inflationary pressure on Hong Kong and may affect its external trade because of the decline in overseas demand for mainland products. The 2 per cent RMB appreciation may have cost implication on smaller manufacturers, who could not pass on the cost increase to customers because of competition. The labour-intensive industries will have to bear most of the brunt. The positive side, however, is that mainland tourists will now have higher purchasing power. This will also attract more investment to Hong Kong from the mainland.

Will this change affect the exchange rate system of the Hong Kong dollar? In my view there's no immediate need for changing the Hong Kong dollar's peg to the greenback. The currency board system has been serving Hong Kong well for the past two decades, hence, I do not think there's an urgent need for any substantial change. Moreover, the Hong Kong Monetary Authority has recently introduced measures to make the Hong Kong exchange rate system more flexible. My prediction is that the Hong Kong dollar will not be linked to RMB in the nearest future.

As Hong Kong and the mainland economies get closer, the relationship between the Hong Kong dollar and RMB will become closer too. That means the Hong Kong dollar will eventually become a collector's item. But this won't happen under some conditions. First, RMB is not an international convertible currency. Second, the capital account of the mainland is not fully convertible. Further reform of RMB will take time.

There's another reason for the HK dollar not to be fixed to RMB, which could either appreciate or depreciate against the Hong Kong dollar. Though the US dollar is still a major component in the currencies' basket that determines RMB's exchange rate, the rate between the Hong Kong dollar and RMB could fluctuate. The US dollar, I think, will depreciate further because of its deficits' problem. Thus, the HK dollar could further lose its value against RMB. This explains why the people of Hong Kong are rushing for RMB deposits. The accumulation of RMB deposits in Hong Kong's banking system suggests RMB is playing a greater role in Hong Kong's financial system. As an international financial centre in the region, Hong Kong can play a more active role in the mainland's financial market reform.

Hong Kong's equity market has been active in raising capital for mainland companies. Amd now Hong Kong's bond market will be allowed to raise funds for the mainland companies. For further reform, the central government may consider introducing derivative investments in RMB for hedging purposes. At present, there is no hedging contract in RMB. I hope the central government could make use of this opportunity to develop a derivatives market for RMB. Hong Kong has a lot of experience in developing the derivatives market and the central government could consider it as a testing ground for the development of RMB's derivatives instruments.

The RMB reform caters to the need of the mainland's economy and is also critical for its future economic growth. We should take a step-by-step approach towards further reforms because it will affect the welfare and well-being of 1.3 billion people.