Hong Kong has been well served by pegged exchange rate for 35 years
Andy Xie argues that Hong Kong dollar interest rates being below US dollar rates is “not how the peg is supposed to work” and the Monetary Authority (HKMA) should “hug the US dollar interest rate” (“Raise rates to soften blow of looming property crunch”, April 27).
Investors are normally highly sensitive to even small differentials between Hong Kong and US dollar interest rates. The exchange rate peg therefore forces Hong Kong dollar rates to converge to US rates. But in the current circumstances, in which Hong Kong dollar holders are hesitant to switch into US dollars, despite the interest rate advantage in doing so, this mechanism is weakened.
One is therefore tempted to ask the HKMA to “raise” interest rates. But under the peg, there is no scope for such an activist interest rate policy – interest rates only rise if an outflow pushes the exchange rate to the weak edge of the band, triggering HKMA intervention, which reduces liquidity and pushes up interest rates.
Indeed, Hong Kong dollar interest rate can only be “raised” by the authority intervening inside the 7.75-7.85 HK$/US$ band. But that would entail an effective narrowing of the band and constitute a fundamental change of the pegged regime.
In such a system, with objectives for both the exchange rate and interest rate differentials, there is always the risk of a conflict between the two aims. For instance, what should the authority do if the exchange rate was weak but Hong Kong interest rates were high relative to US rates?
Such policy conflicts are often the root causes of spectacular monetary policy mistakes. The pegged exchange rate has served Hong Kong well.
Its longevity – 35 years this year – is largely due to the HKMA’s complete commitment to act according to the rules of the game. This is not time to muddy the waters by adopting a second interest rate objective.
Stefan Gerlach, chief economist, EFG Bank, Zurich, and former executive director, HKMA