Hong Kong’s HK$1.835 trillion reserve stockpile is so big, it’s actually hurting
Among the issues, it is time to ask both the government and the HKMA how much is needed in the Exchange Fund to defend Hong Kong’s linked currency system
Is Hong Kong’s government loaded? My answer is a definite yes.
According to recent data released by the Financial Services and Treasury Bureau, the fiscal reserves held by the Hong Kong government stood at HK$1.12 trillion in February 2018. If the accumulated surplus of the Exchange Fund, that amounted to HK$715 billion at end-2017, is added to the existing fiscal reserves, the government is now sitting on an overwhelming HK$1.835 trillion in total reserves.
From whichever angle we look at it, this amount of reserves is astronomical for a tiny island with roughly a population of 7.4 million people.
Unfortunately, the above calculation was questioned by the Financial Secretary, Paul Chan Mo-po at the Redefining Hong Kong debate organised by the South China Morning Post. Chan bluntly told the audience that the Exchange Fund’s accumulated surplus is intended for defending the Hong Kong dollar’s peg to the US currency. Therefore, this part of reserves is “untouchable”.
I agree with Chan that the creditability of the Linked Exchange Rate System (LERS) is related to the reserves held by the government. In this particular perspective, it appears that the higher the reserve is, the stronger is its credibility.
However, it is also important to consider the cost of holding excessive reserves, in particular, the LERS has already been substantially strengthened by the “seven technical measures’ that were implemented by the Hong Kong Monetary Authority (HKMA) in 1998.
As is well known to many financial market experts and participants, the LERS used to be vulnerable to massive capital outflows, which might lead to a larger than normal increase in the Hong Kong Interbank Offer Rate (Hibor). Consequently, the local asset markets would be adversely influenced. Nevertheless, the introduction of the “seven technical measures” has enlarged the monetary base, making it extremely difficult for Hibor to have a sudden surge.