9/18/2016 For 

how much longer can Hong Kong’s currency stay pegged to the dollar? – World Finance

 
For how much longer can  

Hong Kong’s currency stay

pegged to the dollar?
For over 30 years Hong Kong’s currency has
been pegged to the US dollar, but with the Fed
raising rates and China’s economic slowdown
applying downward pressure on property prices
and wages, it could be the end of the LERS

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Since the US Federal Reserve chose to lower interest 7. Sales and sins
rates in reaction to the economic turmoil that
followed the financial crisis, China’s economy
http://www.worldfinance.com/banking/for­how­much­longer­can­hong­kongs­currency­stay­pegged­to­the­dollar has 1/8
9/18/2016 For how much longer can Hong Kong’s currency stay pegged to the dollar? – World Finance

followed the financial crisis, China’s economy has 8. Paying for parking
gone from strength to strength, with the country
boasting impressive annual GDP growth statistics
year-on-year. All this combined to create an
extremely favourable environment in Hong Kong for
the past decade, but now the city-state looks likely to
face some serious challenges.

The influx of cheap money since the US adopted a

monetary easing policy in the wake of the 2008
financial crisis has served to increase capital inflows
for investment in the city, with depressed rates
helping to raise Hong Kong’s aggregate banking
balance by more than HK$300bn ($384bn). At the
same time, historically low interest rates led to
investors looking for a more profitable haven, Hong
Kong being among them. It was no surprise then that
the head of the Hong Kong Monetary Authority
(HKMA), Norman Chan Tak-Lam, expressed
concern over a US rate hike and the impact it would
have on the capital outflows and the general
economic prosperity of the city-state.

Braced for repercussions

However, prior to the rate hike, bankers in Hong
Kong were more concerned about the impact of
policy decisions emanating from Beijing, with the
CEO of Christfund Securities telling South China
Morning Post that investors were prepared for a rise
in US interest rates, but that a devaluation of the
renminbi is the real worry.

“I do not think it will shock the market even if the

Fed will decide to increase the interest rate this week”,
Cheung had said. “The devaluation of the yuan, as
well as whether Beijing has enough measures and
policies to rescue the weak stock markets in the
mainland, may have a bigger impact to the Hong
Kong stock market outlook than the US rate rise.”
Interestingly, when the US finally did raise its base
interest rate by 0.25 percentage points in mid-
December, Hong Kong’s economy was buffered
against the hike by the mainland’s decision to
cheapen its currency, but only slightly.

“We had the best of all worlds for years — we had

very low US rates and a boom in China”, said Frederic
Neumann, co-head of Asian economic research
http://www.worldfinance.com/banking/for­how­much­longer­can­hong­kongs­currency­stay­pegged­to­the­dollar at 2/8
9/18/2016 For how much longer can Hong Kong’s currency stay pegged to the dollar? – World Finance

Neumann, co-head of Asian economic research at

HSBC in an interview with The Financial Times.
 rates,
“Now China is slowing and the Fed is raising  so  
we get a double whammy for Hong Kong.”

The temporary cushion that the renminbi

SEARCH
devaluation provided from rising US interest rates is
the result of the territory’s currency being pegged to
the dollar, while its economic future is becoming
increasingly tied to Chinese mainland. As this trend
continues, with China choosing to expand its trade
links with the special administrative region (SAR), the
question of whether or not the HK dollar should
break away from the US and peg itself to the Chinese
renminbi will be increasingly raised.

“
Stick or twist
Since the handover of Hong
Kong from the UK to China, Since the
the city-state has gradually handover of
become more and more Hong Kong from
integrated with the economy the UK to China,
of the mainland, with more
than half of all exports
the city-state has
coming out of Hong Kong gradually become
finding their way to China. more and more
integrated with
What is more, the tourism the economy of
and retail sectors in Hong the mainland

”
Kong, which account for
roughly a 10th of its GDP,
are bolstered by the special
relationship it has with the People’s Republic. In fact,
just by looking at the substantial increase in the
amount of trade and the financial flows between the
SAR and the mainland it is clear that China now
plays an increasingly dominant role in determining
Hong Kong’s economic future.

“Hong Kong is more integrated with China now and

so its economy could be dragged by China’s
slowdown”, Mole Hau, a Hong Kong-based
economist at France’s largest bank, told Bloomberg
Business. “On the other hand, Hong Kong’s
monetary policy has to follow that of the US – that’s
quite a dis-coordination for the city”.

After the Fed raised its base rate for the first time
http://www.worldfinance.com/banking/for­how­much­longer­can­hong­kongs­currency­stay­pegged­to­the­dollar 3/8
9/18/2016 For how much longer can Hong Kong’s currency stay pegged to the dollar? – World Finance

After the Fed raised its base rate for the first time
since the financial crisis, the HKMA followed suit –
 to
raising its key rate by 0.25 percentage points 0.75  
percent. This decision was taken during a period
when emerging markets and advanced economies the
world over have to adjust to a slowdown in China.
SEARCH The combination of raised rates and increased levels
of volatility emanating from the mainland has put the
world, and, in particular Hong Kong, under renewed
levels of pressure at a time when it needs it least.

“Closer integration with mainland China has

delivered several benefits to Hong Kong SAR,
particularly by way of an appreciable boost to tourism
and financial services, and the offshore RMB business
in the last five years”, the IMF said in a report. “Hong
Kong SAR remains well placed to act as the leading
platform to intermediate two-way flows in and out of
the Mainland as it opens its capital account.

“At the same time, the deepening linkages through

tourism, cross-border bank lending, issuance of RMB
and USD securities in Hong Kong SAR by Mainland
entities, and equity market connect schemes also
create more channels for transmitting shocks from
the Mainland.”

Dollar allegiance
The Linked Exchange Rate System (LERS), which is
the mechanism that forces the HKMA to adjust the
city’s monetary policy in line with the Fed, was
originally implemented in response to the Black
Saturday crisis in 1983 in order to provide greater
stability between the HKD and the USD. Since then,
and with the recent rise in rates – combined with the
increased levels of economic integration between the
city and the mainland – some commentators suggest
that it is now time for Hong Kong to start
considering a new exchange rate regime.

“Over the next decade it would make sense for the

Hong Kong dollar if it is pegged to anything, to be
pegged to the renminbi”, said Michael Hasenstab,
Chief Investment Officer of Templeton Global Macro
at Franklin Templeton Investments in an interview
with CNBC.

Because the LERS forces the HKMA to adjust

http://www.worldfinance.com/banking/for­how­much­longer­can­hong­kongs­currency­stay­pegged­to­the­dollar its 4/8
9/18/2016 For how much longer can Hong Kong’s currency stay pegged to the dollar? – World Finance

Because the LERS forces the HKMA to adjust its

interest rate in line with the Fed, it prevents Hong
Kong from being able to adequately deal with   
inflation and other economic challenges it may face.
This has naturally led some to blame the LERS for
the overheating of city’s property market, which been
SEARCH rising year-on-year for the last decade, as increased
demand has been forced to compete with decreased
supply.

This ongoing trend means that Hong Kong homes by

square foot are the most expensive in the world. In
fact, according to CBRE’s recent Global Living
Report: A City by City Guide, homeowners in Hong
Kong are paying around $1,416 per square foot,
while Londoners come in at a close second, paying
$1,025, and New Yorkers a mere $842.

With sky-high property prices and wages stagnating

in the city, there is likely to be a renewed debate over
whether or not the government should switch to a
floating exchange rate regime, or even peg it to the
renminibi. But, despite the fact that Hong Kong has
been handed back to China and the mainland has
embarked on an unprecedented and prolonged period
of economic growth, along with the increased
acceleration of renminbi internationalisation, the
conditions are still not yet right for Hong Kong to
peg its currency to the yuan.

“The Hong Kong economy is too small to adapt to a

free float”, said Wilson Chan Fung-Cheung, a senior
consultant at the Hong Kong Institute of Bankers in
an interview with the South China Morning Post. “A
currency-basket system lacks transparency. A peg
with the yuan will not happen in the near future as
the currency is not yet freely convertible.”

Another reason for why the peg is unlikely to change

anytime soon is that Hong Kong relies on it as a
means of providing increased levels of credibility
among western investors. This is due to the relatively
smooth manner in which the LERS functions, which
is a characteristic that stems from the strong
institutional, legal and policy framework that exists in
Hong Kong.

Not only that, but there are considerable levels

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9/18/2016 For how much longer can Hong Kong’s currency stay pegged to the dollar? – World Finance

Not only that, but there are considerable levels of

fiscal reserves to draw upon, which are capable of
 
softening the city’s landing should its economy face  
any unfavourable shocks from outside. Therefore, for
the time being at least, it appears that the LERS is the
best option for Hong Kong, as it provides a decent
SEARCH anchor, giving the city-state a level of stability that it
requires at a time when global market volatility is
high.

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