Right on cue, the peg’s detractors in markets and the Western financial media have renewed their attacks on the Hong Kong dollar. Their criticisms are the same. Maintaining a currency board in a city whose financial conditions are tied to those of the US but whose economy is increasingly dependent on China’s is ultimately doomed to fail, they claim.
The peg’s critics have seized on the sharp fall in the aggregate balance, a gauge of interbank liquidity. In the past two months, it has halved to HK$165 billion (US$21 billion) because of the Hong Kong Monetary Authority’s purchase of HK$172 billion since May 11
to shore up the currency.
Pressure on the Hong Kong dollar is attributable to “ carry trade
” behaviour. Sufficient liquidity has prevented local interbank rates from rising to fully match their US equivalents. This has made it attractive for traders to borrow in Hong Kong dollars to put money into the higher-yielding US dollar and pocket the difference.
Yet, the carry trade would not have come about in the first place if investors did not have confidence in the peg, as Financial Secretary Paul Chan Mo-po pointed out in an interview
with the Post
on July 26. Moreover, as the HKMA buys up local currency and causes domestic interbank rates to rise, the carry trade becomes less profitable, easing pressure on the peg.
Higher funding costs put Hong Kong’s property market under further strain by encouraging banks to lift their prime rates
. However, prices for second-hand homes in the world’s least-affordable housing market are still only around 6 per cent below their all-time high in August 2021. Furthermore, the share of private residential stock with mortgages has fallen from more than 50 per cent in the early 2000s to 34 per cent, according to JPMorgan data.
Yet, the two main reasons the peg is secure are the credible commitment to maintaining it and, just as importantly, its special significance to Hong Kong and Beijing.
First, maintaining fixed exchange rate regimes
requires a lot of discipline. The pressure often proves too much, as it did with the pound sterling, whose collapse in 1992 forced Britain out of the European Exchange Rate Mechanism.
The credibility the Hong Kong dollar has built up in the past four decades is unmatched, though. Its resilience in the face of successive speculative attacks
and crises – the dramatic increase in the one-month Hong Kong Interbank Offered Rate to more than 20 per cent in August 1998 puts this year’s rise to 1.3 per cent in perspective – makes the peg a powerful anchor for financial stability.
The International Monetary Fund has commended Hong Kong for the transparency and institutional credibility of its currency board. In a report published in March, it said the peg was backed by “ample fiscal and [foreign exchange liquidity] buffers, strong financial regulation and a prudent fiscal framework”.
Second, the peg serves the interests of both Hong Kong and Beijing. It is a key underpinning of the “one country, two systems”
framework that, if anything, has become more valuable to the city and China in the past two years.
For Hong Kong, the peg helps preserve the city’s status as a global financial centre
at a time when the mainland is tightening its grip over the city’s institutions. Just as investors betting on the dissolution of the euro zone underestimated the amount of political capital invested in safeguarding the integrity of the bloc, those betting on the peg’s demise fail to appreciate its political and economic importance to Hong Kong.
For Beijing, keeping the city as the dominant offshore Hong Kong dollar funding centre in Asia is still hugely beneficial to mainland firms and banks. As long as China maintains capital controls and continues to be cautious in opening up its financial sector to foreign investment, the peg is secure.
While Hong Kong faces acute challenges – the two biggest ones are reopening its economy to the rest of the world and coping with the sharp economic downturn
in China – its currency is not one of them. Betting against the peg is another widow-maker trade.
Nicholas Spiro is a partner at Lauressa Advisory