In defense of HK’s currency peg

Akrur Barua argues that Hong Kong’s linked exchange rate system has served the SAR well and any change in the HKD -USD peg will lead to great volatility

As economies across the world ride the ebb and flow of business cycles, fixed exchange rate regimes sometimes come under immense pressure, mostly due to the limited ability of their central banks to respond to these cycles.

Given Hong Kong’s strong economic links to the mainland, the Hong Kong dollar-US dollar peg recently came under pressure due to an economic slowdown on the mainland and losses in equity markets there. The devaluation of renminbi in August 2015 also did not help the matters. The resultant capital outflow from the mainland, in turn, pushed up the difference between onshore (mainland) and offshore (Hong Kong) renminbi values, thereby posing challenges for policymakers. Moreover, Hong Kong itself is bracing itself against a property downturn and declining trade revenues. In such a scenario, concerns about existing policies, including the HKD-USD peg, are natural. However, breaking the peg is not the ideal response.

Hong Kong’s external sector has played a key part in its economic success. In 2015, for example, exports amounted to 202 percent of the territory’s GDP; total trade was 401 percent of GDP. While liberal economic and trade policies — along with history — have aided Hong Kong’s trade, currency stability through the HKD-USD peg has also played a major role. Policymakers would be wrong to change that, especially at a time when international trade faces headwinds from a slowing world economy. The peg also makes sense since a large volume of global trade is priced in US dollars, as is evident from the predominance of the greenback in global financial transactions.

Hong Kong is also one of the world’s leading financial centers, competing with the likes of New York and London. By the end of 2015, Hong Kong had a net investment position of HK$7.6 trillion ($1 trillion). This amounted to about 317 percent of GDP, much higher than Singapore (210 percent of GDP) — the other major financial center in Asia. Hong Kong’s capital flows — both assets and liabilities — are also higher than those of Singapore. Any change in the HKD-USD peg will therefore create large volatility in currency returns, especially for the territory’s financial institutions whose assets are mostly denominated in US dollars.

Hong Kong’s strong economic links to the Chinese mainland raise valid concerns about the future of the HKDUSD peg. In 2015, the mainland had shares of 49 percent in Hong Kong’s imports and 54 percent in its exports; it also accounts for a sizable amount of Hong Kong’s external claims and liabilities. This raises questions about a possible change in the HKD-USD peg to a HKD-RMB peg, a peg to a basket, or even a managed float in future. However, it would not be prudent to do so in the short to medium term. First, there is still great disparity between the economies of Hong Kong and the mainland. The gap has to be brought down before any change in Hong Kong’s exchange rate policy. Second, a peg to the renminbi in the short term does not make sense, given that the renminbi itself is heavily managed with respect to the US dollar. Third, the renminbi is not freely convertible and its offshore liquidity is low.

The recent decline in property prices in Hong Kong has put pressure on the Hong Kong Monetary Authority (HKMA) once again. Ideally, in such a scenario, monetary easing helps to revive demand. However, due to the currency peg, the HKMA has to mirror the US Federal Reserve, which instead is seeking to raise interest rates this year. In 2013, there were similar pressures on the HKD-USD peg when the peg prevented monetary tightening to counter the rising cost of living — the Fed was on an easing spree then. As worrying as it might seem at first reading, a breaking of the peg — and hence independent monetary policy — will not necessarily help Hong Kong’s real estate sector. Given the level of Hong Kong’s property prices (prior to declining late last year), a correction was always on the cards. For example, between November 2008 (the last major trough) and Sep- The author is economist and manager at Deloitte Research, Deloitte Services LP.

As worrying as it might seem at first reading, a breaking of the peg — and hence independent monetary policy — will not necessarily help Hong Kong’s real estate sector.”

tember 2015 (the last peak), property prices had gone up an astounding 184 percent before heading down. In fact, declining house prices might help stoke demand in the medium term by increasing affordability. Also, monetary policy interventions to deal with asset bubbles have not always been successful — as the Fed would vouch, given its experience in 2007-08. The answer, as central banks are learning, is more macroprudential measures, even in fixed exchange rate regimes.

Changing from a fixed exchange rate to something like a managed float would have made sense for a large economy trying to liberalize and shore up competitiveness. A good example is India, which has reaped the benefits of a managed float when it adopted liberalization in the early 1990s. Often, abandoning a currency peg is also suggested for commoditydependent countries trying to diversify their economies. Saudi Arabia, which is under pressure from declining oil revenues, is an example. None of the above arguments, however, makes sense for Hong Kong. The territory is not commodity-rich, has a vibrant private sector, is highly competitive, and is one of the world’s most liberalized economies. To top it all, it has a healthy current account and is armed with about $360 billion worth of foreign exchange reserves. And the HKD-USD peg, which is now about 33 years old, has been one of the key reasons for this economic success. It has helped propel Hong Kong as Asia’s premier trade and financial services hub. That equilibrium shouldn’t be disturbed.