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Analysis | What the Hong Kong Dollar Peg is and why it matters

Remark

Pegged to the US dollar since 1983, the Hong Kong dollar is mostly a boring currency. Except when it doesn’t, like this year. When the US Federal Reserve began raising interest rates in March to combat historically high inflation, fund outflows from the Hong Kong dollar market increased as investors chased higher yields. Consequently, interbank liquidity – the pool of Hong Kong dollars in the system – shrank rapidly as the city fought to maintain the peg, drawing market attention and raising concerns about the impact on the struggling local economy.

The Hong Kong Monetary Authority, the de facto central bank, has a mandate to keep currency trading at HK$7.75 to HK$7.85 per US dollar. The current bond was established in 2005 and has never been broken. If it gets too close to one side or the other, the HKMA steps in, buying or selling the city’s dollars. When HKMA uses its foreign exchange reserves to buy Hong Kong dollars from the commercial banks, the total balance of Hong Kong dollars in the banking system – interbank liquidity – falls accordingly. From May 11 through November, HKMA intervention shrank the balance by more than 70%. This tighter liquidity drives up local borrowing costs.

2. Why is it important to keep the pin?

First and foremost, it is considered an anchor for financial stability. A stable currency is important for an open economy like Hong Kong, where trade and logistics are important drivers. Investors park their money in Hong Kong because the currency is relatively safe and easily convertible — one of the reasons the city became a global financial center in the first place. Breaking the pin would upset that whole equation.

3. What does the Hong Kong dollar usually move?

Often that is when local borrowing costs don’t move with the US. For example, the gap between the Hong Kong Interbank Offered Rate (Hibor) and its US counterpart (dollar Libor) widened significantly after the Fed began aggressive rate hikes, as liquidity in Hong Kong was still very ample. (Hibor and Libor represent a daily average of what banks say they would ask to lend to each other.) That gap makes it attractive for traders to borrow in Hong Kong dollars to buy US dollars to earn the higher returns. That so-called carry trade could push the local currency to the weak end of HK$7.85, prompting the HKMA to intervene. That strategy became less attractive in the second half of 2022, as authorities’ purchases of local dollars propelled three-month Hibor higher than the U.S. equivalent.

4. What is the concern now?

Less liquidity as a result of defending the peg has led to higher borrowing costs for Hong Kong businesses and individuals this year at a time when strict Covid-19 restrictions, especially on travel, continue to weigh on the economy and hurt jobs . In addition, Hong Kong’s real estate sector is already under pressure from an exodus of Hong Kong residents, whether due to pandemic-related or political reasons after Beijing tightened its grip on the city in 2020. Higher mortgage payments don’t help.

5. Should people worry about the pin?

Hong Kong officials say no, but some hedge funds disagree. In November, Bill Ackman, the billionaire founder of hedge fund Pershing Square Capital Management LP, said he is betting against the Hong Kong dollar and its peg against the greenback. Boaz Weinstein, founder of Saba Capital Management, tweeted support for the trade, which he said had a payout of more than 200 to one. But officials repeatedly said there was no need to change the pin. In July, finance secretary Paul Chan said the city’s “massive” foreign exchange reserves — about $440 billion, equivalent to about 1.7 times the monetary base of the Hong Kong dollar — are enough to maintain the currency peg. A representative of the HKMA reiterated on November 24 that there is no plan or need to change the currency system.

6. Has the pen ever been pressurized before?

Sustained periods of outflow have previously occurred during previous periods of stress, such as the global financial crisis, the SARS epidemic, and during the tensions between the US and China under then-President Donald Trump. At the time, Chan noted that China’s central bank could also provide US dollars through a currency swap line, should Washington ever impose sanctions on the city. China has the world’s largest foreign exchange reserves at over $3 trillion. John Greenwood, the architect of the Hong Kong dollar peg and now an independent adviser to the International Monetary Monitor, said that because the city has a currency board charged solely with maintaining the peg, rather than a central bank that controls the domestic monetary policy, “speculation against the Hong Kong dollar always fails.”

6. Why not peg the Hong Kong dollar to the Chinese yuan?

There are several factors that support the status quo. The US dollar is fully convertible and can be freely traded in large quantities on foreign exchange markets. The yuan does not fit that bill for now. The US dollar also dominates as an international reserve currency, while the yuan has some way to go to increase its reserve status. Eddie Yue, the de facto head of Hong Kong’s central bank, said the peg has worked well for nearly 40 years and there are no plans to change it. However, Hong Kong has tended over the years to adopt currency regulations that facilitate cross-border trade with the mainland. Pegging the local dollar to the yuan “could be a long-term possibility” — if the yuan were used more in Hong Kong and internationally, Goldman Sachs Group economists, including Hui Shan and Andrew Tilton, wrote in May. Politics could be another driver if Hong Kong were to lose its semi-autonomous status and be integrated into the mainland. As George Magnus, an economist and fellow at Oxford University’s China Center, put it, “It’s China’s choice whether to keep the peg in place.”

–With help from Tania Chen.

More stories like this are available at bloomberg.com

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