For decades Hong Kong’s currency has been pegged to the US dollar, Tim Yu looks at whether that is now about to change.
Currency volatility and the devaluation of the Renminbi (RMB) in the midst of China’s economic downturn, rising interest rates in the United States, and uncertain global markets have revived a 32-year-old question: how much longer will Hong Kong maintain its currency peg to the US dollar?
Since 2012, the Hong Kong Monetary Authority (HKMA) – Hong Kong’s de facto central bank – has intervened on a number of occasions to defend the dollar peg, having already spent HK $227.15 billion this year alone to prevent the Hong Kong dollar (HKD) from trading beyond the range of HK $7.75 to 7.85 to the USD. In January 2016, the HKD suffered from a four-year low of HK $7.77886 to 1 USD raising concerns over the long-term viability of the dollar peg due to Hong Kong’s weakening currency and capital outflows. Another previous round of intervention of HK $155.66 billion in August 2015 was due to a weakening Chinese economy and the People’s Bank of China’s decision to delink from the USD, which set off speculation over whether Hong Kong may be the next in line.
Sandwiched between monetary tightening from the US Federal Reserve and a slowing Chinese economy, Hong Kong is now facing downward pressure on property prices and wages with capital outflows. Because of the dollar peg, Hong Kong’s business cycles are determined by those of the United States – leaving the city-state with limited discretion over its monetary policies. At a moment when Hong Kong should arguably be pursuing more expansionary monetary policies, the HKMA was forced to raise its interest rates in line with Washington.
Hong Kong is one of the rare successful cases of an advanced economy that operates under a currency board system. After an unsuccessful period with a floating exchange rate regime between 1974 and 1983, the HKMA adopted an emergency Linked Exchange Rate System (LERS) in response to the Black Friday Crisis in 1983 that saw an inflation spike and investor concerns over the uncertainty of Hong Kong’s handover status from the United Kingdom to China. Over the past three decades, Hong Kong’s LERS has maintained low inflation and currency stability and managed to navigate through a series of financial volatilities including the Asian and Global Financial Crises and the SARS epidemic.
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To date, the HKMA has resisted calls to move away from its dollar peg. After the HKMA reaffirmed its commitment to defending the peg until 2020, the imminent de-pegging – or the demise of the currency peg itself – remains highly unlikely. Given Hong Kong’s $358.8 billion war chest in foreign-exchange reserves, current account surpluses, and large fiscal reserves, the HKMA arguably still has enough policy freedom and resources to defend the peg. Yet with stagnating wages and escalating property prices, dollar-peg sceptics have questioned whether Hong Kong can realistically commit to the same monetary policies as Washington when its economic future is becoming increasingly tied to Beijing.
Making the switch to the RMB would not be without its challenges. The primary obstacle is that the RMB is still not fully convertible, and capital accounts have yet to be fully liberalised. As the first designated International Renminbi Offshore Hub to have launched in 2004, Hong Kong has played a crucial role in building China’s offshore market while processing 72.5 per cent of all overseas Renminbi transactions. However, the lack of convertibility poses problems for a financial centre that is highly dependent on free flows of capital. Estimates suggest that if the HKD were to be pegged to the RMB, Hong Kong would need over 2 trillion yuan in assets to replace the HKMA’s US$340 billion in foreign reserves – an amount that exceeds its existing RMB assets in its offshore market.
The question is more over the long-term. While widening the trading range of the HKD/USD remains another possibility, Hong Kong’s growing financial linkages with the Chinese economy would suggest that a switch to pegging against the RMB may become an eventual possibility down the road.
But there are several factors that will need to be addressed for this to happen. The current instability of the RMB – combined with the need to minimise foreign exchange risks for HKD users – is one concern. The other is arguably more political than it is economic. Until Beijing determines that China’s capital accounts are to be completely liberalised, and the RMB becomes fully convertible, Hong Kong’s dollar peg is here to stay – at least for the time being.