After 40 years of stability, Hong Kong’s US dollar peg is here to stay

The cornerstone of monetary and financial stability in Hong Kong, the linked exchange rate system is transparent, resilient and has helped the city weather many shocks and crises

Eddie Yue Wai-man

Published: 12:01am, 17 Oct 2023

Why you can trust SCMP

The biggest headline 40 years ago was that Hong Kong had introduced the linked exchange rate system, pegging Hong Kong’s currency to the US dollar. For the past 30 years or so, my work at the Hong Kong Monetary Authority (and its predecessor the Office of the Exchange Fund) has involved this linked system, directly or indirectly. It is fair to say I have established a long-lasting and strong relationship with this important part of Hong Kong’s financial regime.

The linked exchange rate system is a good one. It is the cornerstone of monetary and financial stability in Hong Kong, providing a stable environment for the development of our economy and community. It has helped Hong Kong weather shocks and crises, which have highlighted the system’s resilience and robustness.

The system’s success rests on its robust design, in line with market disciplines, and its highly transparent and rule-based mode of operation, as well as our abundant foreign reserves, strong fiscal position and dynamic economy.

It is characterised by the currency board arrangement, which restricts the Monetary Authority’s discretion. We introduced the seven technical measures in 1998 and the three refinements in 2005, making the system more rule-based and aligned with our policy intent.

More importantly, the market has seen the system function in strict adherence to its design. Since 2005, the “strong-side convertibility undertaking” has been triggered 321 times, with the HKMA buying US dollars equivalent to nearly HK$1.45 trillion (US$185 billion) to keep the Hong Kong dollar below the higher limit of the trading band.

The “weak-side convertibility undertaking”, which keeps the Hong Kong dollar from weakening too much, has been triggered 84 times, resulting in the selling of US dollars equivalent to nearly HK$420 billion. These inflows and outflows worked like clockwork.

There are two keys to the system’s high degree of transparency that underpins market confidence: the openness that is a feature of the system’s design, and the timely and accurate disclosure of crucial data. Whenever we entered the market to fulfil the obligations imposed by the convertibility undertakings, we promptly let the market and the public know, by publishing related transaction data.

We regularly publish the latest Exchange Fund balance sheet data, currency board accounts and other information about the linked exchange rate system, and communicate about the system to the market and the public through appropriate channels.

Confidence in the system has been tested countless times, such as the shocks triggered by the many financial crises, the severe challenges facing Hong Kong in recent years and the resulting tremendous pressure on the financial system, and the numerous market rumours over the years, be they intentional, unintentional or even malicious. The system sailed through them all.

No exchange rate regime is perfect. Policymakers in every economy must take into account its unique circumstances and historical factors in deciding what arrangements best suit its needs, to obtain the biggest advantages for the lowest costs. The exchange rate regime is an important and serious matter. Once decided, it should not be changed lightly.

Recently, higher-for-longer US interest rates and a strong US dollar have triggered discussions about the implications for the local economy and livelihoods as a result of the linked exchange rate system.

06:10

Underprivileged class bearing the brunt of Hong Kong’s rising inflation

As the Hong Kong dollar strengthens, people often say it becomes cheaper to travel overseas, while tourists visiting Hong Kong become more cautious in spending. The exchange rate can be part of the reason. But there may also be cyclical and structural factors, such as Hong Kong people’s keenness to travel after the reopening of the border, or visitors seeking “in-depth experiences” instead of sheer consumption during their stay here.

As Hong Kong is highly dependent on imports to meet our daily and production needs, a stronger Hong Kong dollar helps reduce import costs and ease some inflationary pressure. Indeed, many other advanced economies are battling persistent inflationary pressures, too. The strengthening and weakening of any currency is cyclical. A stronger or weaker Hong Kong dollar each has its pros and cons.

The linked exchange rate system means that Hong Kong dollar rates track their US dollar counterparts, while also being subject to the supply and demand of Hong Kong dollar funding in the local market. With the Hong Kong dollar interbank offered rates (HIBORs) having gradually risen alongside their US dollar counterparts, the high interest-rate environment is likely to persist for some time.

01:43

What is the Hong Kong Dollar Peg?

Of note, though, is that many other economies and financial centres are also feeling the pain of high interest rates, even those that do not adopt a fixed exchange rate. Whether Hong Kong implements the linked exchange rate system does not seem the most critical factor.

Moreover, local interest rates have not risen too sharply. The composite interest rate, a measure of banks’ funding cost, has increased from 0.24 per cent at the end of March last year to 2.55 per cent at the end of August this year. Since March last year, the local best lending rates, or prime rates, have increased moderately by less than one percentage point, against the cumulative increase of 5.25 percentage points by the US Federal Reserve.

Change is constant. That is even truer of the financial markets, and the implications are more far-reaching. The HKMA must always be well prepared to embrace change. But we must also bear in mind the value of keeping a good system – not for the sake of keeping it, but because we have thought things through carefully to reach an informed decision.

As we have said many times, we have no intention and we see no need to change the linked exchange rate system.

Eddie Yue Wai-man is chief executive of the Hong Kong Monetary Authority

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