What the Hong Kong Dollar Peg Is and Why It Matters

Comment

Anchored to the US dollar since 1983, the Hong Kong dollar is generally a dull currency. Except when it’s not, like this year. When the US Federal Reserve began raising interest rates in March to combat historically high inflation, outflows from the Hong Kong dollar market intensified as investors sought higher yields. As a result, interbank liquidity – the pool of Hong Kong dollars in the system – rapidly declined as the city struggled to maintain peg, attracting market attention and concern over the impact on the struggling local economy.

The Hong Kong Monetary Authority, the de facto central bank, has a mandate to keep currency trading between HK$7.75 and 7.85 per US dollar. The current group was created in 2005 and has never been broken up. When it gets too close to either end, the HKMA steps in, either buying or selling the city’s dollars. When HKMA uses its foreign exchange reserves to buy Hong Kong dollars from commercial banks, the overall balance of Hong Kong dollars in the banking system – interbank liquidity – decreases accordingly. From May 11 to the end of July, the HKMA bought a total of HK$172 billion ($22 billion), cutting the balance by more than half. This tighter liquidity drives up local borrowing costs.

2. Why is it important to keep the ankle?

First and foremost, it is seen as an anchor for financial stability. A stable currency is important for an open economy like Hong Kong, where trade and logistics are key drivers. Investors put their money in Hong Kong because the currency is relatively safe and easily convertible – one of the reasons the city became a global financial center in the first place. Breaking the ankle would upset this whole equation.

3. What usually moves the Hong Kong dollar?

This is often when local borrowing costs do not move in tandem with the United States. For example, the spread between the Hong Kong interbank offered rate (Hibor) and its US counterpart (dollar Libor) widened significantly after the Fed began its aggressive rate hikes, as liquidity in Hong Kong was still very abundant. (Hibor and Libor represent a daily average of what banks say they would charge to lend to each other.) This spread makes it attractive for traders to borrow Hong Kong dollars to buy US dollars in order to get the highest yield. This so-called carry trade may push the local currency towards its low end of HK$7.85, prompting the HKMA to intervene.

4. What’s the problem now?

Lower liquidity resulting from the peg defense has led to higher borrowing costs this year for businesses and individuals in Hong Kong at a time of tight Covid-19 restrictions, particularly regarding travel, continue to weigh on the economy and hurt employment. Moreover, Hong Kong’s real estate sector is already under pressure from an exodus of Hong Kong residents, whether for pandemic-related or political reasons after Beijing tightened its grip on the city in 2020. higher mortgage costs won’t help.

5. Should people be worried about the ankle?

Hong Kong officials say no. Finance Secretary Paul Chan said in July that the city’s “enormous” foreign exchange reserves – around $440 billion, or around 1.7 times the monetary base of the Hong Kong dollar – are enough to sustain the currency peg. Prolonged periods of capital outflows have already occurred during previous stressful times such as the global financial crisis, the SARS outbreak, and during US-China tensions under then-President Donald Trump. At that time, Chan noted that China’s central bank could also provide US dollars through a currency swap line if ever Washington imposed sanctions on the city. China has the largest foreign exchange reserves in the world with more than 3,000 billion dollars. John Greenwood, the architect of Hong Kong’s dollar peg and now an independent consultant to the International Monetary Monitor, said that because the city has a currency board charged solely with maintaining the peg, rather than a central bank that conducts domestic monetary policy, “speculation against the Hong Kong dollar always fails.

6. Why not peg the Hong Kong dollar to the Chinese yuan instead?

Various factors support the status quo. The US dollar is fully convertible and can be traded freely in large quantities on the foreign exchange markets. The yuan does not fit this bill at this time. The US dollar also dominates as an international reserve currency, while the yuan still has some way to go to strengthen its reserve status. Hong Kong’s de facto central bank chief Eddie Yue said the peg had worked well for nearly 40 years and there were no plans to change it. However, Hong Kong has tended over the years to adopt monetary arrangements that facilitate cross-border trade with the mainland. Pegging the local dollar to the yuan “could be a long-term possibility” – if the yuan were used more in Hong Kong and abroad, Goldman Sachs Group economists, including Hui Shan and Andrew Tilton, wrote in May. . Politics could be another driver, should Hong Kong lose its semi-autonomous status and be integrated into the mainland. As George Magnus, an economist and associate at the University of Oxford China Centre, put it: “It’s up to China to decide if they want to keep the peg in place.”

More stories like this are available at bloomberg.com

Comments are closed.