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There is a risk that perpetuating the Hong Kong dollar peg becomes an end in itself: the city’s economy becomes beholden to, rather than served by, the present arrangement. Photo: Reuters
Opinion
Macroscope
by Neal Kimberley
Macroscope
by Neal Kimberley

Is the dollar peg still in the Hong Kong economy’s best interest?

  • While linking the US and Hong Kong currencies has served the city well in the past, that is no guarantee it will always be the case
  • Given local economic conditions and growing geopolitical rivalry, Hong Kong needs to ask if following the US’ lead on monetary policy is still wise
Changing times require open minds, even among monetary policymakers who have long followed certain policy paths, and Hong Kong is no exception. The rigidities encased within its linked exchange rate system have served Hong Kong well for decades, but that doesn’t mean they should be regarded as sacrosanct. It is time for a fresh debate on these issues.
Hong Kong’s economy contracted in the first quarter of 2022. Yet, once the US Federal Reserve raised interest rates by half a percentage point on May 4, the Hong Kong Monetary Authority had to adjust the base rate upward by 50 basis points to 1.25 per cent “according to the established mechanism with immediate effect”.

Tightening monetary policy settings when the economy has shrunk might seem odd to anyone unfamiliar with the workings of the peg, under which the HKMA acts to ensure that the Hong Kong dollar remains “stable within a zone of 7.75 to 7.85” against the US dollar.

However, the HKMA’s response, its biggest single move since 2000, was administratively correct. Whether that decision was economically justified is a different matter.
In the United States, where the unemployment rate remains at a two-year low of 3.6 per cent, the Fed is fixated on curbing consumer price inflation (CPI) that reached 8.5 per cent year on year in March, its highest level since December 1981.

Tighter US monetary policy makes good sense, incorporating higher benchmark interest rates and, from next month, quantitative tightening. But if the HKMA’s commitment to the Hong Kong dollar peg did not oblige it to follow the Fed, tighter monetary policy might not necessarily be the best approach for the city’s economy right now.

Financial Secretary Paul Chan Mo-po noted last week that “the impact of the interest rate hike on the capital market, credit quality, local consumption and investment activities and economic sentiment, as well as the burden imposed on members of the public and small and medium-sized enterprises, are areas to watch over”.

Hong Kong’s CPI in March was a relatively benign 1.7 per cent, but the local unemployment rate for January to March hit 5 per cent. That was 0.5 percentage points up from the three months ending February and the worst figure since the 5.4 per cent for the rolling three-month period from April to June 2021.

Hong Kong’s inflation data is meaningless for helping poorer families

Nevertheless, as the HKMA reiterated last week, “the [peg] has continued to work well, having weathered many economic cycles in its nearly four decades of operation.”

But there is a risk that perpetuating the peg, as it is now constituted, becomes an end in itself: Hong Kong’s economy becomes beholden to, rather than served by, the present arrangement.

The dollar peg has indeed weathered many economic cycles in nearly 40 years, but it has never had to navigate the economic effects of efforts to contain a once-in-a-century pandemic. Neither has it had to deal with the very real prospect that years of increased economic engagement between the West and China – that has also benefited Hong Kong – could now see some degree of rollback.
Even leaving aside US tariffs on Chinese imports and the broader US-China geopolitical rivalry, pandemic-related disruption to China’s globally significant supply chain has prompted many Western policymakers to wonder if the West has become too reliant on goods imported from China.

Pandemic-derived global supply chain disruption has undoubtedly reignited a desire in the West to regain a greater degree of economic autarky. Throw in some discomfort in Western capitals at Beijing’s actions over Russia’s invasion of Ukraine and the argument that the West needs to partly disengage economically from China becomes even more persuasive to many.

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What is the Hong Kong Dollar Peg?

What is the Hong Kong Dollar Peg?
Additionally, while Western policymakers continue to recognise Hong Kong as a thriving entrepot, there have been increasing concerns about perceived mainlandisation of the city. For some in the West, the “special” in “special administrative region” is starting to mean less than it did in the past.

The HKMA continues to believe that the peg remains the right currency framework for Hong Kong. But when inflation in Hong Kong is relatively benign, the jobless rate is relatively high, the local economy shrank in the first quarter of 2022 and, perhaps crucially, the West might be moving to reduce its economic reliance on Chinese goods, it is not such an easy case to make.

It is time for a fresh debate on Hong Kong’s currency arrangement and the resultant requirement for the HKMA to mirror changes in US monetary policy regardless of local conditions.

Neal Kimberley is a commentator on macroeconomics and financial markets

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