Most years my Hong Kong sales colleagues take a long weekend at an offsite to build their strategy for the coming 12 months. On the past few occasions they have made the hour-long flight to China's tropical paradise, otherwise known as Hainan Island. In years gone by it was infamous for smuggling contraband, but has since been transformed into China's spa capital made famous through hosting the Miss World beauty pageant.

Loaded with wads of Hong Kong dollars, my colleagues landed to discover that, in contrast to previous visits, their once prized dollar was no longer the currency of choice. In fact restaurateurs and shopkeepers alike refused to take the pegged and internationally traded currency in preference to their own strengthening renminbi. How times have changed.

The Hong Kong dollar has followed the decline of the US dollar as a result of the currency peg that has been in place since 1983. In recent months international funds have flowed into Hong Kong's financial system both to participate in IPOs and also to buy up mainland companies already listed in Hong Kong.

Investors have continued to speculate on the expected valuation convergence between the shares of mainland companies listed in Hong Kong and their counterparts listed in China. As a result of these inflows, the Hong Kong Monetary Authority (HKMA) has acted to sell the Hong Kong dollar to maintain the exchange rate within its stated range. The most recently reported amount of selling was for HK$7.8bn (US$1bn, €680m, £488m) at the end of October. Comparisons have been made to 1998 when the then financial secretary and now chief executive of Hong Kong, Donald Tsang, spent $15bn to protect the peg and drive away speculators betting on a devaluation. However circumstances are radically different now and the HKMA is in a strong position to maintain stability.

Dollar weakness and significant international fund flows have been coincident with speculation of a possible stock through train that will allow mainland investors direct access to Hong Kong-listed companies. Much of the Hong Kong stock market's spectacular performance from the early days of August has been due to this speculation with the market rising by over 50 per cent at its peak since then.

However it is not just speculation and possible valuation convergence that is driving asset prices in Hong Kong. The discipline of the peg effectively cedes monetary policy to the US Federal Reserve. As such, local banks have little choice but to slavishly follow US interest rate movements. At times in the past this has imposed either a too austere or too liberal policy on the Hong Kong economy since it is not always perfectly synchronised with the US economy.

In the current cycle, the Hong Kong economy is more influenced by developments on the mainland where the economy is growing at a rapid 11 per cent this year at a time when the US economy is slowing. With inflation beginning to pick up, savers are likely to face the prospect of negative real interest rates again. Compounded by the weaker currency, this means that local assets are looking cheaper from an international perspective, and local savers are likely to be motivated to move their money out of deposit accounts. Typically in the past similar circumstances have been the cause of major stock market revaluation and rampant speculation in the property markets. Both are now on the verge of repeating historical patterns.

Recent investor doubts caused by the losses in the US financial sector and fears of a US slowdown have cautioned some investors, although the staggering interest in the November launch of China's e-commerce portal, Alibaba, indicates that the appetite to invest and speculate remains strong. This IPO raised $1.5bn on its Hong Kong debut and delivered an opening day profit of nearly 200 per cent. Chinese companies have raised $20bn on the Hong Kong stock exchange this year.

It seems as we approach the final stages of this year, global economic issues, uncertainty about the timing of the through train, and falls in China's A share market have combined to impede the progress of the Hong Kong market.

However with real economic growth at 11 per cent on the mainland and inflation at over 6 per cent, mainland companies should deliver a comfortable average 25 per cent earnings growth over the next 12 months, with many doing better. Convergence between the valuation of Hong Kong-listed Chinese companies and those listed in China will continue at a time when external factors, namely the weaker dollar and rising inflation, will provide another reason for asset prices to inflate further.

Whilst my sales colleagues have suffered a loss of face realising that their currency is no longer dominant in southern China, they have, no doubt, more than hedged their position through investment in the local property and stock markets.

Mark Konyn is the chief executive of RCM Asia Pacific

Copyright The Financial Times Limited 2007

Labels: Hong Kong

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