In an exclusive interview with Emerging Markets, Hong Kong Monetary Authority (HKMA) governor Joseph Yam rebuffed recent speculation about the Hong Kong dollar peg and asserted that the mainland’s boom complements rather than the threatens the city-state’s competitiveness.
“The US dollar continues to be the appropriate anchor for the Hong Kong dollar for the foreseeable future” he told Emerging Markets.
The governor has come under increasing pressure to adjust the 23-year old peg to reflect growing economic links with the mainland, and mitigate the weakness of the Hong Kong dollar resulting from the appreciation of the Chinese yuan. In January, the value of the Chinese yuan exceeded that of the Hong Kong dollar for the first time in 13 years, but Yam argued such depreciation pressures can be weathered.
“The fact that the Hong Kong (HK) dollar was not affected when the renminbi breached the psychological level of 7.80 against each US dollar proves that the technical arrangements of the Linked Exchange Rate system are sound,” argued Yam.
However, Craig Chan, Asia currency strategist with Lehman Brothers in Hong Kong, was less confident on the stability of the current system.
“The Hong Kong dollar is the most undervalued currency in Asia due to the US dollar peg, things are getting more expensive and inflation is up. The sustainability of the peg is clearly in doubt and an anchoring with the renminbi at some point is clearly on the cards,” Chan told Emerging Markets.
Chan recognized that a yuan peg was unfeasible at present, as the Chinese currency is not fully convertible and so would not meet the city-state’s foreign reserve requirements. Still, he saw potential for such a move if China continues the gradual relaxation of its capital account rules.
“Once the capital account is more liberalized and we see a significant improvement in China’s banking sector, a new currency arrangement for Hong Kong may be possible,” Chan concluded.
Inflation in Hong Kong reached 2.3% at year-end 2006, compared with 0.8% for 2005, but has since eased back toward 1.2% in May 2007. Against this backdrop, Yam reaffirmed his commitment to the dollar peg “given the correlation between the Hong Kong and US business cycles”. A recent study by researchers at HKMA showed that over five- and 10-year periods, around 60% of the city-state’s output variations and 45% of its price movements were due to changes in interest rates and GDP in the US.
Former Finance Secretary Antony Leung this month fuelled speculation that the peg could be dropped, after disclosing that he and former Hong Kong Special Administrative Region chief executive Tung Chee-Hwa considered such a move during the 2002 recession. On that occasion, the peg would most likely have been weakened to promote export competitiveness, rather than strengthened to fight inflation.
But Yam said that, given Hong Kong’s open capital account and its status as a financial hub, a fixed exchange rate policy is essential, and has proved stable.
“It has been tested several times including the world stock market crash in 1987, the ERM turmoil in 1992, the Mexican currency crisis in 1994/95 and the Asian financial crisis in 1997/98,” Yam told Emerging Markets.
This month marks the 10th anniversary since the UK relinquished control of the city-state to China. Some analysts have predicted that Hong Kong faces daunting challenges to fight off competition from the mainland, notably Shanghai, or face its regional significance fading away.
However, Yam argued that the city-state was providing China with an efficient financial intermediation platform “to support the sustainable growth of its large economy and avoid the payment and settlement risks associated with international financial activities in different time zones.” He also pointed to China Development Bank’s five billion yuan bond issue listed in Hong Kong this week as highly significant, as it is the first Chinese currency-denominated bond to be launched outside the mainland.
“Hong Kong is now the testing ground for the capital account convertibility of the renminbi and the increasing international use of the currency. And with the renminbi included alongside the Hong Kong dollar, the US dollar and the euro, as currencies our financial infrastructure is able to handle, it will also be possible for the equity channel to follow suit,” Yam told Emerging Markets.