‘Hasty’ to reject ex-HKMA chief’s calls to end dollar peg

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Markets and officials were quick to reject a proposal from Joseph Yam, former head of the Hong Kong Monetary Authority (HKMA), that the city should consider abandoning the HKD’s peg to the US dollar, but it could be premature to dismiss the appeal.

Yam, who as chief executive of the HKMA nursed the peg through two financial crises until his retirement in 2009, says the currency regime has served Hong Kong well for nearly 30 years since its introduction in 1983. However, writing in the Institute of Global Economics and Finance, Yam says it is time for a review of the peg, which the HKMA has enforced “to the point, some would say, of obsession or even paranoid”. Yam says it is now time to consider whether the stability afforded by the stable peg to the US dollar is worth the asset bubbles it created in Hong Kong and the ensuing unsettling effects of rising inflation that came along with the city’s involuntary adoption of US monetary policy. Indeed, those effects could intensify if the Federal Reserve implements a further round of quantitative easing at its policy meeting next week. “The question then becomes one of whether, even accepting that a fixed exchange rate serves Hong Kong well, the currency anchor should not be, in the fullness of time, the renminbi instead of the US dollar,” says Yam. Yam’s views were quickly rebuked by the current administration, with HKMA chief executive Norman Chan and financial secretary John Tsang issuing a joint statement reiterating that the government was fully committed to the dollar peg. Leung Chun-ying, Hong Kong chief executive elect, also says there are no plans to change the peg. Markets also took a similar view, with USDHKD spot and forwards remaining comfortably within the HKMA’s $7.75 to $7.85 trading band, while the price of USDHKD calls minus the price of puts – an inverse indicator of appreciation bets – also remained broadly stable.

Price of USDHKD call minus price of put - perceived pressure on peg

Source: Bloomberg, RBS 
Erik Lueth, strategist at RBS, says Yam’s comments were significant given his former role and the fact he helped create and defend the peg for better part of his professional life. However, Lueth contends that the peg will not be abandoned during the next seven to 10 years, and Yam’s comments should be read as the views of “a man that misses the limelight”. Lueth argues that one of the central tenets of those who question the peg is not true, namely that Hong Kong’s economy is more closely aligned with the Chinese business cycle than with the US cycle. “Yes, mainland Chinese come in droves to shop, including for property, but Hong Kong is also a global financial and trans-shipment centre,” he says. “As a result, Hong Kong’s GDP growth is much more correlated with the global and US business cycle than with the mainland cycle.”

HKD not "terribly" undervalued

 Source: CEIC, RBS
Furthermore, Lueth argues that inflation and credit growth in Hong Kong are easing, while the HKD is not terribly undervalued on a real effective exchange rate basis or a nominal effective exchange rate basis. Moreover, Yam’s critics argue that, with CNY fairly valued against the US dollar, HKD should not depreciate further against the CNY, eliminating the need for a re-peg. However, James Malcolm, strategist at Deutsche Bank, says the market’s reaction has been “way too hasty”, and that Yam’s comments should not be dismissed so easily. He says Yam’s paper rewards close reading and breaks new ground, providing a glimpse into official calculus and decision-making, and laying bare the mechanics of any change. According to Malcolm, Yam breaks with Hong Kong officials’ insider tradition of dismissing anything other than the continuation of a hard currency board, playing up the advantages of a more discretionary approach: a wider band, Singapore-style monetary tightening or even outright float and rates-based inflation-targeting. Malcolm says, though Yam holds back from firmly proposing anything other than a technical change, the whole exercise serves to underline how much behind-the-scenes policy-thinking has differed – and continues to differ – from the requisite public presentation of unwavering support for the current framework. “It should raise the medium-term risk premium on a de-peg or re-peg, though it may well not since the market is heavily conditioned to fade such things,” says Malcolm. “It seems clearer than ever a move would involve switching to CNH or CNY as the new anchor, probably at a rate of 1:1, but with wider bands.”