Will The HKD / USD Peg Last??

Credits: Reuters

24 April 2023

HONG KONG, April 24 (Reuters Breakingviews) - Hong Kong’s currency peg to the greenback is stuck between a rock and a hard place.

The wide yield spread between U.S. government debt and the Asian hub’s equivalent has forced the monetary authority in the special administrative region of China to repeatedly intervene to prevent the currency from crossing the weak end of its official trading band of between 7.75 and 7.85 per dollar. In the short term that’s manageable, but it highlights investors’ deeper concerns about the city’s economic future.

In the process of maintaining the defence, the Hong Kong Monetary Authority’s aggregate balance – a key gauge of cash in the banking system - has plunged from HK$458 billion ($58 billion) to below HK$50 billion since September. That is the lowest level since 2008, and the steepness of the slope is striking; the last comparable decline took nearly four years. In the past 12 months, the de-facto central bank has stepped in to buy Hong Kong dollars from the market roughly 40 times.

Some foreign financiers, including Pershing Square boss Bill Ackman, argue Hong Kong’s financial system can’t sustain the peg and question its rationale. The system, in place since 1983, effectively links local interest rates to American monetary conditions, so Hong Kong was forced to hike even as its China-facing economy contracted for four consecutive quarters in 2022.

Relief is on the way, but it’s not clear how much. Predictions that the end of draconian pandemic controls in China would lead to a massive influx of mainland capital into Hong Kong dollars, buttressing the exchange rate, have yet to be realised. The Hang Seng Index (HSI.) is treading water; up barely over 1% this year, it’s one of the world’s worst-performing major stock exchanges, Refinitiv data shows. Private equity interest in China has plunged and cumulative northbound flows through the Stock Connect equity trading scheme cooled in April. Both are bad news for the Asian financial entrepôt, which benefits from channelling money into the People’s Republic. Officials have financial tools to maintain ample liquidity in the system. Meanwhile, business activity is reviving, and if the Fed decides to stop raising rates, a lot of pressure will come off the city’s currency.

But in the long run, demand for Hong Kong dollars depends on confidence in its economic strategy. Its population is shrinking, mostly thanks to aging but also emigration, and it is unclear whether it can attract enough immigrants to offset the decline. Chief Executive John Lee has removed onerous Covid-19 measures that choked growth, but the city remains on the receiving end of geopolitical tensions between Washington and Beijing that are dampening capital flows, while key industries including trade, retail and technology look stagnant.

Hong Kong’s peg is durable enough for now, but its future is in doubt nevertheless.