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Wednesday, August 19, 1998 Published at 19:00 GMT 20:00 UK

Business: The Economy

The next domino?

China is trying to modernise its economy and avoid devaluation

The past year has seen a massive currency crisis sweep through Asia and hit other emerging markets like Russia. But one region has remained untouched: China and its territory of Hong Kong, have not devalued their currencies. BBC News Online's Steve Schifferes looks at the rumours that they could be the next to suffer.

Both China and Hong Kong have huge currency reserves which they say they will not hesitate to use to defend their currencies, the Hong Kong dollar and the renminbi, or yuan.

The Hong Kong authorities, which operate a separate monetary system as a Special Administrative Region, recently spent more than $3bn propping up the stock market from its $100bn war chest, while the Chinese central bank sits on $140bn in reserves - more than any other country except Japan.

But analysts and currency dealers are wondering whether, despite such reserves, it will still be possible to maintain their fixed link to the dollar.

The Chinese and Hong Kong authorities say they are determined to maintain that link - providing stability in a sea of chaos.

Any devaluation of the yuan could set off another round of the Asian crisis - with further devaluations across Asia and falls in world stock markets.

Costly link

As other currencies continue to decline, the costs of maintaining a currency peg have been rising, and the social costs may prove too high.

[ image: Hong Kong has seen its stock market collapse]
Hong Kong has seen its stock market collapse
In August financial markets began testing the degree of support for the currency.

The Hong Kong dollar - which has been fixed since 1982 at HK $7.82 to the US dollar - was the first to come under pressure.

The Hong Kong Monetary Authority - the equivalent of the central bank - intervened several times to protect the currency.

This has involved raising interest rates which now stand at nearly 11%.

And in August the authorities began intervening directly in the stock market, buying top company shares in an attempt to deter speculators from profiting from the market falls.

But the cost of defending the currency has been high.

For Hong Kong, high interest rates have been a signficant drag on the economy and growth has turned negative.

Unemployment has risen to 4.8%, its highest for 15 years.

Chinese economy slows

[ image: Traders in Shanghai didn't stay happy]
Traders in Shanghai didn't stay happy
The Chinese are in the process of modernising their economy. That process will involve them closing many inefficient state factories and making workers redundant.

The government has been counting on fast economic growth led by exports to absorb the unemployed.

But the strength of the Chinese currency has hit exports and reduced the rapid pace of economic growth. In the first half of the year, China grew by less than 7%, below its 8% target for the year.

The Chinese authorities have repeatedly said they would not devalue.

But observers say that if other Asian currencies continue to slide, the government will have to consider devaluation which would trigger the nightmare scenario of another round of competitive devaluations.

Foreign currency holdings held by Chinese individuals have been increasing sharply as expectations of a possible devaluation have risen.

About $700m more was deposited in Shanghai banks in the first half of the year, but it is believed that many more dollars are being held in under-the-counter transactions.

The informal exchange rate in Shanghai is around RMB8.7 to the dollar, as opposed to the official exchange rate of RMB8.28.

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