HKMA intervention once again prompts debate on US dollar peg
Bets of a re-peg of the Hong Kong dollar have resurfaced in the currency markets as the Hong Kong Monetary Authority (HKMA) intervened to inject dollar liquidity to the tune of $9.86 billion several times since July 1 on the back of large inflows into Hong Kong during the past few months.
The HKMA’s stated reasons for the recent surge in capital inflows range from dividend payments of more than HK$200 billion by H-share companies to Hong Kong shareholders, large cross-border acquisitions – for example, Oversea-Chinese Banking Corporation’s acquisition of Wing Hang Bank – and concerns about Fed tapering.
Market participants also believe a large part of the capital inflow is a result of Russian corporates and individuals parking funds in Hong Kong to escape US sanctions in response to the conflict in Ukraine.
Under the linked exchange rate system (LERS), which has been in place since 1983, the HKMA intervenes to ensure the Hong Kong dollar remains between 7.75 to 7.85 to the US dollar convertibility undertaking. This peg to the US dollar has come under regular speculation as Hong Kong’s economy has become more closely linked with the Chinese economy.
In 2011, Bill Ackman, portfolio manager at Pershing, a US-based hedge fund, publicly bet that the Hong Kong dollar will appreciate on the back of an inevitable removal of the US dollar peg to avoid importing “the US’s ultra-accommodative monetary policy, despite [Hong Kong’s] much stronger economy”.
I don't think Hong Kong’s chief executive has enough
political capital to make such a big change at the moment
This idea received further endorsement from Joseph Yam, former chief executive of the HKMA, in 2012 when he wrote a lengthy treatise arguing the peg with the US dollar had run its course. By linking its exchange rate to the US dollar, Hong Kong has received high inflation and increasing asset prices during the past few years on the back of the Fed’s quantitative-easing programme.
Ashley Davies, FX strategist and senior economist at Commerzbank in Singapore, says a viable alternative to the LERS or the peg to the US dollar was not available to the HKMA just yet.
If Hong Kong was to move to another system of exchange management – Singapore’s managed float regime against a trade-weighted basket of currencies, for example – it would still be outsourcing its monetary policy to other countries, he says.
“Singapore’s short-term interest rates look very similar to Hong Kong’s,” says Davies.
Linking the HK dollar to the RMB has been a common refrain. However, Philip Wee, currency strategist and senior economist at DBS in Singapore, doesn’t think the RMB is a suitable replacement for the US dollar.
“Ultimately, Hong Kong is an international financial centre and it needs a strong anchor currency,” he says. “The US dollar is still the most dominant currency in terms of international transactions.”
However, as the RMB moves towards full convertibility and up in importance in trade and investments globally, market participants believe it might become a credible choice for a change in the peg.
Xia Le, chief economist at BBVA Research in Hong Kong, expects full convertibility of the RMB to be achieved within seven years.
“By that time, Hong Kong will have more options and can choose to peg to the RMB,” he says. “But that is a long-run thing.”
Further, Le says the pro-democracy protests and general anti-Beijing mood will make it harder for Hong Kong’s political authorities to endorse a change in the peg.
“I don't think Hong Kong’s chief executive has enough political capital to make such a big change at the moment,” he says.
The HKMA seems to be taking comfort in the knowledge the volatility in capital into Hong Kong is not structural and, more importantly, driven by real economic needs rather than speculation on the currency, as it steadfastly refuses to change its stance on its peg.
Raymond Yeung, senior economist at ANZ in Hong Kong, explains that any change in Hong Kong’s exchange rate regime, including suggestions to expand the trading range, will cost the HKMA its credibility among currency traders.
“Credibility is the common currency in central bank economics,” he says. “Once you change your band or the allowable trading range, you are inviting people to speculate that you will change your policy again.”
Kay Van-Petersen, Asia macro-strategist at Saxo Bank in Singapore, further adds that any change in the exchange-rate regime should have huge structural implications for the economy, considering all the business and trade that depends on having a stable fiscal and monetary environment with minimal FX risk against the US dollar.
“It is also a huge advantage for China to have a jurisdiction that they can control that is linked to the US dollar and implicitly to US dollar monetary policy,” he says. “This is greater optionality for them, and optionality by definition is always more valuable than no optionality.”