Recent volatility aside, Hong Kong’s dollar peg is here to stay
Aidan Yao says Hong Kong has plenty of ammunition to defend the peg, if necessary, and there are currently no real alternatives that are compatible with its status as a financial hub
Even though market interventions by the HKMA are not uncommon historically, previous interventions, in 2008-09, 2012, and 2014-2015 were all in response to excessive currency strength, requiring the HKMA to sell Hong Kong dollars.
Being one of the few remaining fixed-exchange regimes in the world, these developments have created renewed chatter about the vulnerability of Hong Kong’s peg.
Before we go into regime sustainability, here’s some background on how the Hong Kong dollar peg works.
The key reason for this sluggish adjustment is abundant liquidity in the financial system, caused by a number of factors.
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All these factors have kept Hong Kong’s financial system flush with liquidity, which held back the convergence between Hong Kong and US interest rates and created incentives to sell Hong Kong dollars for US dollars. This is the cause of the recent Hong Kong dollar depreciation.
To ease that pressure, the HKMA has started actively draining liquidity via foreign interventions. The new market equilibrium should be reached fairly quickly, provided the extreme expectations for the Hong Kong dollar de-peg do not become mainstream.
Despite weak Hong Kong dollar, city’s assets remain strong, thanks to HKMA intervention
But if the market is serious about breaking the peg, can the HKMA defend it?
But is there any chance that Hong Kong won’t defend its currency?
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Free-floating the currency is not an option as the Hong Kong government has always thrived so as to minimise foreign exchange risks for users of Hong Kong’s financial and trade services. Plus, floating the currency would mean the HKMA, instead of the Fed, would manage Hong Kong’s monetary policy, creating some technical and credibility issues that may not be easy to adapt to in the short term.
Pegging the Hong Kong dollar to the renminbi is another option. But that would expose Hong Kong to one fatal problem: the renminbi is not yet fully convertible, and having the Hong Kong dollar linked to a non-convertible currency would expose Hong Kong to the same degree of capital control as the mainland. A lack of free capital flows would be detrimental to Hong Kong as a financial centre.
Hence, there’s no chance that the authorities, in Hong Kong or Beijing, will let go of the currency any time soon.
Aidan Yao is senior emerging Asia economist at AXA Investment Managers