Foreign exchange: Is the Hong Kong peg to the dollar unsustainable?

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By:
Hamish Risk
Published on:

Inflation at 16-year high; Wealth gap widens

The Hong Kong currency peg, in its present form, has existed since 1983. However, some Hong Kong observers have begun to question whether the HK dollar’s link to the US dollar is relevant and in the best interests of an economy facing runaway inflation and an ever-widening wealth gap.

The justification for the peg has been based on Hong Kong’s close economic links to the US economy, rather than to its neighbours. That is now being called into question. China is the key driver of the Hong Kong economy, analysts argue, and by remaining pegged to the US dollar the Hong Kong economy falls prey to economic distortions. Essentially, Hong Kong operates Chinese levels of growth within a US monetary policy framework. It is a bad combination.

Hong Kong’s inflation rate

Hong Kong’s inflation rate

As a result, inflation is now running at a 16-year high, which is fostering a widening wealth gap in the country. In a population of 7.2 million, a record 1.26 million Hong Kong residents were living in poverty as of mid-2010, according to the Hong Kong Council of Social Service. In the past year, public housing rents have risen more than 3,000%.

"The peg is becoming ever more difficult to sustain, because of this combination of the Fed being on hold till 2013, and inflation in Hong Kong remaining at these elevated levels," says Ilan Solot, an emerging markets strategist at Brown Brothers Harriman Investor Services in London.

Although the future of the peg has yet to force itself to the top of the political debate ahead of elections next year, Hong Kong’s biggest opposition party, the Democratic Party, last month conducted a survey that found that 60% of people thought the government should reconsider the peg with the dollar in order to fight inflation.

This has been exacerbated by the continued appreciation of Asian currencies. Since 1983 the Hong Kong dollar has lost two-thirds of its value against the Singapore dollar, which operates a crawling-peg basket. In the past five years, the currency has lost one-third of its value against the Chinese renminbi, whose appreciation continues to gather momentum.

"The more the Chinese currency appreciates the harder it is to maintain the peg, because it creates this situation by which Hong Kong gets cheaper and cheaper for the Chinese mainlander," adds Solot.

Not all analysts hold to this view, however. Some argue that Hong Kong’s inflation problem is a not uncommon ailment of Asian economies, although Hong Kong’s rate is the highest in Asia, with the exception of Pakistan.

Bert Gochet, an interest rate strategist at JPMorgan in Hong Kong, says the widening wealth gap is more the result of the constant influx of people from mainland China into Hong Kong who can do jobs at relatively low wage rates. This has kept minimum wages low. "No one in Hong Kong believes that the widening of the wealth gap is anything to do with the peg, so no one is going to demand politicians reset it," he argues.

Indeed, if JPMorgan’s US economists are accurate in their prediction of a 40% to 50% chance of a double-dip recession, much of that inflationary pressure will dissipate. "Money will flow out of Hong Kong, property prices and stock markets will go down, and the economy will slow," Gochet says.

Meantime, the Hong Kong Monetary Authority is standing firm on the peg. Norman Chan, the head of the HKMA, last month rejected suggestions of a link to the renminbi, or any form of peg to a basket of currencies.

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