Sep 06, 2022 07:53 PM

Opinion: Why Hong Kong Won’t Break Its U.S. Dollar Peg

Photo: VCG
Photo: VCG

From May to late August, the Hong Kong Monetary Authority (HKMA), the city’s de facto central bank, drained more than HK$170 billion ($21.7 billion) from the interbank market to maintain the currency’s peg to a strengthening U.S. dollar, leading its foreign exchange reserves to fall by $24 billion.

Such support has sparked concerns among market observers about the future of the HKMA’s mechanism for maintaining the value of the Hong Kong dollar (HKD) against the greenback — the Linked Exchange Rate System (LERS). However, in our view, the possibility that the peg will be broken remains a small one.

Recently, officials in Hong Kong have repeatedly stressed that the city has no need or intention of changing the system.

Hong Kong has been operating under the LERS since 1983. Under the system, the HKMA has to make sure that the local currency is always trading from HK$7.75 to HK$7.85 per U.S dollar. If the market pushes the HKD too close to either end of that band, the HKMA steps in by either buying or selling the currency to strengthen or weaken its value against the U.S. dollar.

These changes have an effect on the amount of cash in Hong Kong’s financial system. For example, when the HKMA spends its forex reserves to buy HKD, the city’s monetary base shrinks accordingly.

Due to this year’s interest rate hikes by the U.S. Federal Reserve, the interest rate spread between the U.S. dollar and the HKD has widened dramatically, creating an incentive for investors to move their money out of HKD assets and into ones denominated in U.S. dollars. The shift puts pressure on the HKD to depreciate against the American currency. In fact, after 2015, every time the HKD approaches the weak side of the currency band, it coincides with the Fed’s tightening cycle.

Despite market concerns, there are four reasons why it’s unlikely that the HKD peg will be broken. First, when the aggregate balance of Hong Kong’s banking system falls below HK$100 billion, it will have a greater impact on interbank market rates and encourage banks to raise their own lending rates, pushing them closer to rates in the U.S. As the two sets of rates converge, the depreciation pressure of the HKD will ease.

Second, Hong Kong’s monetary base is larger than it was during the 1997-1998 Asian financial crisis, which makes it a lot harder for international capital flows to drive up market interest rates in the city.

Third, Hong Kong’s large forex reserves, coupled with support from the Chinese mainland, can ensure the functioning of the currency peg.

Lastly, as a critical hub that connects the mainland’s financial system to the rest of the world, Hong Kong’s role as an international financial center requires the currency peg, which ensures that the local currency is fully convertible with the U.S. dollar.

Amid the HKD depreciation, we need to pay attention to two issues.

The first is the impact on Hong Kong’s economy. Rising interest rates are likely to trigger an increase of 25 basis points or more in local banks’ HKD prime lending rate. Hong Kong’s GDP has shrunk year-on-year for two straight quarters, so the economy is in much poorer shape than the last time local banks raised the prime lending rate in September 2018, which hurt economic growth. This year, Hong Kong’s unemployment rate has risen for several months. It was 4.7% in the April-June period, compared with a steady 2.8% from March 2018 to July 2019. If banks’ lending rates were to rise significantly now, it would take a much greater and much more visible toll on the economy, impacting key industries such as real estate, trade and logistics.

The second issue is the rising competition from Singapore over Hong Kong’s role as an international financial center. In 2017, the amount of global assets under management in Singapore surpassed that of Hong Kong. As Singapore’s global assets under management continue to grow, international capital will likely favor it over Hong Kong. If that trend persists, the diversion effect will slow the inflow of foreign capital into Hong Kong and have a medium- to long-term impact on the HKD’s exchange rate.

Zhong Zhengsheng is chief economist of Ping An Securities Co. Ltd. Zhang Lu is a macro analyst of Ping An Securities.

This article was originally published in China Newsweek.

This English version was translated by Zizan Wang, and has been edited for length and clarity.

Contact editor Michael Bellart (

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