Hong Kong's peg to the US dollar has become a hindrance to its economy, according to Lehman Brothers. It urged further debate on the linked exchange-rate system, saying it had increasingly become a burden on the domestic economy. Although the peg had served Hong Kong well for the past 19 years, it did have drawbacks especially when Hong Kong was in a deflationary spiral, the investment bank said. 'The consequences of targeting a fixed exchange rate are that Hong Kong has relinquished control over its monetary policy to the United States, while its domestic costs and prices have had to bear the full brunt of adjustment to external shocks,' the bank said. 'These limitations have become more obvious over the past five years, particularly in the current economic cycle, in which Hong Kong is the laggard in the region.' The opinion echoes comments in a BOCI Research report published in August, which said the peg had a finite lifespan. The report said it was unlikely the government would abandon the peg but said de-coupling the currencies sooner rather than later promised less pain. Lehman Brothers said persistent deflation would have a negative impact on the real economy. Also, deflation had pushed up the real burden of domestic debt, squeezing profit margins and encouraging consumers to postpone spending on the expectation of cheaper goods tomorrow. 'These economic difficulties are creating a vicious cycle, whereby depressed domestic demand is adding to the deflationary pressure, thereby keeping real interest rates high,' the report said. 'The longer that price deflation persists, the greater the negative effect on the real economy.' The bank also attributed the high jobless rate to deflation as the downward adjustment of consumer prices outpaced the adjustment in nominal wages, putting pressure on the demand for labour. The unemployment rate stood at 7.6 per cent in August. 'Hong Kong's weak labour market is a particular example of the negative real effects of downward cost rigidity,' it said. Lehman Brothers said the Hong Kong Monetary Authority could stay with the peg or readjust it to a more competitive level - but both measures carried risk. Meanwhile, ABN Amro reiterated that alternatives to the peg remained elusive although it had long been blamed for the SAR's deflation problems. In a report published last week, the bank said the technical problems of a floating exchange-rate system, such as monetary growth and interest-rate volatility, remained unsolved. 'It is commonly stated in the investment community that Hong Kong should de-peg, that is, that it should adopt a floating exchange-rate system. But it is easier said than done,' the report said. The bank also argued a floating system might adversely affect the economy with excessive volatility in exchange rates, given its nature as a small and open economy. 'Even if all technical problems are resolved, we still need to ask if a floating exchange-rate system would serve Hong Kong better than the currency-board system, given that the SAR is a small, open economy and a financial centre,' it said.