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Hong Kong Monetary Authority (HKMA)

Peg shift would mean pay cuts, deflation: Chan

Too early to consider linking with the yuan as preconditions do not exist, HKMA chief says

PUBLISHED : Tuesday, 15 October, 2013, 12:00am
UPDATED : Friday, 26 January, 2018, 4:12pm

Pay cuts and deflation would sweep across Hong Kong if the peg to the US dollar was abandoned and switched to the yuan, Hong Kong Monetary Authority chief executive Norman Chan Tak-lam said.

"If the Hong Kong dollar were pegged to the [yuan], Hong Kong's exports and the overall competitiveness of the economy would substantially weaken," Chan wrote in an article in the South China Morning Post today analysing the peg's 30 years of operation. "We would have to go through the pain of pay cuts and deflation before our competitiveness could be restored."

The frank assessment of the competitiveness risks posed to Hong Kong by a potential end to the peg offers a rare glimpse into the analysis the city's monetary authorities have conducted into the economic impact of a change in the value of the currency.

HKMA officials say it is the first time such a detailed analysis of the competitive risks involved in a change to the linked exchange rate system has been publicly disclosed.

The authority estimates that Hong Kong's labour productivity has grown at an average annual rate of 3 to 4 per cent over the past 10 years, while the mainland has achieved a rate close to 10 per cent. And it expects the mainland to deliver relatively high rates of productivity growth for a prolonged period of time.

The loss of competitiveness by a shift in the peg would effectively plunge Hong Kong businesses back into the misery they experienced during the depths of the 1997-98 Asian financial crisis.

Back then, the city's peg to the dollar delivered foreign exchange stability as a financial storm swept through the region, but the battering dished out to Hong Kong's neighbours saw the city struggle for years to adjust as currencies in surrounding countries became dramatically cheaper and more competitive.

The competitiveness angle opens a fresh window on the debate about the likely timing of a future shift in the peg regime.

Chan insists the preconditions for a peg to the yuan still do not exist.

An anchor currency must be totally and freely convertible and it must have a sufficient quantity of assets in circulation to back the Hong Kong dollar.

About 2 trillion yuan's (HK$2.5 trillion) worth of assets would be needed to replace the US$300 billion or so of mainly US dollar assets that currently sat in Hong Kong's official reserves, a sum that "far exceeds" the amount of offshore yuan assets now in existence, Chan said.

"It is too early to consider the use of the [yuan] as our anchor currency while it is not yet freely convertible and the capital account of the mainland is still not fully liberalised," Chan wrote.

Not that the HKMA was considering any such move, he said. "There is neither the need nor the intention to change the [linked exchange rate system]."