Can Hong Kong's linked exchange rate system withstand shocks amid trade war?

Source:Global Times Published: 2019/9/13 10:17:58

Illustration: Xia Qing/GT

With the yuan's rate breaching the psychologically important 7 threshold against the US dollar in August, the Hong Kong dollar's exchange rate has also been affected. Many market participants are worried about whether or not Hong Kong's financial market can maintain stability and if Hong Kong's linked exchange rate system can withstand the impact.

From the perspective of the size and quality of Hong Kong's foreign exchange reserves, the government of the Hong Kong Special Administrative Region (HKSAR) and financial regulators can cope with short-term shocks and ensure the stability of Hong Kong's linked exchange rate system. Data showed that, as of the end of June 2019, the size of Hong Kong's Exchange Fund reached HK$4.14 trillion. Due to fluctuations in the global market, the investment income of the Exchange Fund may see a decline, but overall it can still make profits each year. If calculated in the form of assets and US dollars, Hong Kong's Exchange Fund holds about $41.8 billion in cash and about $392.6 billion in convertible securities. With this much liquidity and cash reserve, Hong Kong should be able to cope with any short-term attack by speculative capital on the Hong Kong dollar.

But in the long run, the ultra-low interest rate of Hong Kong dollar-denominated assets is actually one of the reasons why the Hong Kong dollar has been attacked repeatedly. Since 2017, due to the low interest rate, the Hong Kong dollar has been under the constant pressure of depreciation. The Hong Kong Monetary Authority (HKMA) has tightened liquidity to stabilize the exchange rate since last year. In 2018, the HKMA reportedly purchased about HK$103.5 billion to ease the downward pressure on the Hong Kong dollar's exchange rate. It also followed the US Federal Reserve to raise the interest rate, but the move led to an increase in Hong Kong's residential mortgage rates, directly suppressing housing prices. It can be said that the bubble in the real estate market in Hong Kong is one of the factors undermining Hong Kong's financial stability and causing exchange rate fluctuations.

After the Fed's latest announcement of interest rate cut, the Hong Kong dollar overnight interbank interest rate came down, which somewhat eased the pressure on the Hong Kong dollar exchange rate. However, the continued fermentation of social problems in Hong Kong will continue to impact the financial and real estate markets. 

The sluggish economy of Hong Kong as a whole will inevitably impact the linked exchange rate system. Hong Kong's GDP in the second quarter of this year rose by 0.5 percent year-on-year. After seasonal adjustment, the GDP in the second quarter declined by 0.4 percent on a quarterly basis. The year-on-year GDP growth in the first half of the year is 0.5 percent, its weakest since the recession in 2009. Many institutions believe that the Hong Kong economy will continue to face significant downward pressure. 

With the escalation of the China-US trade war, Hong Kong has suffered greatly as the "eye of the storm." The outside world is also concerned about whether the trade war will impact Hong Kong's linked exchange rate system. Paul Chan Mo-po, financial secretary of the government of HKSAR, recently stressed that the SAR government has no intention to decouple this system. However, Hong Kong's economy has seen both internal and external problems. Therefore, although the outflow of funds from Hong Kong is not serious, the pace of recovery in the future may be more difficult than in the financial tsunami in 2009.

Historically, Hong Kong's linked exchange rate system has withstood many shocks and tests. In the case of financial market fluctuation, Hong Kong has the experience, strength and confidence to safeguard this system. However, at present, Hong Kong is already at the "storm center" of the China-US trade and financial war. Its economy, politics and society are all under pressure, and various problems intertwine to make the situation more complicated and severe. Under such circumstances, safeguarding the linked exchange rate system as the cornerstone of Hong Kong's economic and financial stability requires significant attention and adequate preparation.

The article was compiled based on a report by Beijing-based private strategic think tank Anbound.

blog comments powered by Disqus