Profiting from the peg
Monetary Authority chief Joseph Yam Chi-kwong gave a characteristically robust defence of the Hong Kong dollar peg in his speech last week. Currently, he is on something of a roll. As a consequence of the surge of speculative inflows, which has kept the exchange rate on the strong side of 7.8, banks have been selling US dollars to the authority, which it has invested to earn interest. Meanwhile, however, the authority pays no interest on the Hong Kong dollars which, in exchange, it credits to the banks' accounts. Profits resulting from this are well over HK$1 million a day. And, on present figuring, the authority can expect an exchange gain of about HK$250 million, if and when the market exchange rate eventually returns to 7.8.
Mr Yam indicated that he is happy to carry on buying US dollars in this way if the pressure of inflows persists; after all, it is part of the classical adjustment process under the currency board, and it is potentially profitable. Ultimately, those who are sitting on piles of Hong Kong dollars, effectively speculating on a formal revaluation, are likely to become so fed up with earning no interest, that they will give up - but evidently not yet.
Mr Yam mused over two possible variants to his present stance. One would be to hasten the adjustment by using his powers to impose negative interest charges on the banks' balances at the authority. Some might regard this as unnecessarily interventionist and counter to the 'automaticity' concept of the currency board. But it would bear a certain symmetry to the discretion which the authority already exercises over the interest it charges if banks have to borrow when they are short of Hong Kong dollars. No, the objection to negative interest is not so much a philosophical one, as a fear of adverse publicity for banks or officials if banks, in turn, were to apply negative interest to their depositors, in a more explicit manner than is already practised, in effect, through monthly fees and the like.
The other variant would be to issue additional Exchange Fund bills to the banks to mop up their surplus Hong Kong dollar balances. But it is far from clear how this would help steer the market exchange rate back to 7.8. Indeed, to give banks the opportunity to hold securities which can be immediately sold back to the authority in time of need and which, in order to be worth buying, must pay some interest, would be tantamount to simply offering interest on part of the banks' surplus balances. This would, if anything, exacerbate the situation by enticing renewed inflows.
So, somewhat incongruously, the two variants involve, on the one hand, exacting negative interest from the banks' balances and, on the other, paying positive interest on them. Add to this the possibility of establishing a formal convertibility rate on the strong side, to mirror 7.8 on the weak side, and we can see that Mr Yam is certainly keeping all his options open. Yet he made it very clear that for the moment, he will not be pursuing any of these.
But all this is at the technical and operational level of detail. The message on the big picture was unambiguous: the peg is staying put, and it will do so regardless of anything that may happen to the yuan.
Despite these reaffirmations about the 7.8 policy, and the seemingly widespread popular support for it, there must nevertheless be a sizeable contingent in the financial markets who cling to the prospect of a revaluation against the US dollar; it is this sentiment which keeps the market rate obstinately at around 7.77. But this is in no sense a very fragile or dangerous situation; and since it is one that is profitable for the Monetary Authority, I doubt that Mr Yam is losing any sleep over it.
Tony Latter is a visiting professor at the University of Hong Kong
