2023-06-16 06:42:00
Hong Kong (iStock)
Economy
Rising US interest rates are beginning to hamper many economies
Hong Kong’s currency is facing its biggest test since the 2008 global financial crisis, as it still pegs the value of its money to the US dollar. It’s an arrangement that dates back nearly four decades and has long been considered a guarantee of financial stability and prosperity.
But in recent months, the Chinese city’s de facto central bank has had to spend a significant portion of cash buying Hong Kong dollars to maintain the currency’s peg to the US currency.
Traders take advantage of the uncertainty regarding Hong Kong’s future as an international financial center and the interest rate differences between the city and the United States. Geopolitical tensions and Beijing’s tightening grip, in particular, are undermining its long-term prospects as a global financial centre.
The data indicates that Hong Kong’s total balance, a measure of liquidity levels in the banking system, has declined rapidly over the past year, falling by more than 90% from its peak in 2021. It fell to HK$44.76 billion ($5.7 billion), the lowest level. Since November 2008.
The sharp drop is a sign that investors are abandoning the Hong Kong dollar. While the city still has ample foreign reserves that can be used to prop up the currency, according to officials, this has not allayed market concerns. Some analysts are urging the city to drop the US dollar peg altogether.
According to CNN, independent economist Andy Shi says, “Hong Kong’s currency peg to the US dollar is not sustainable… The city risks increasingly leading US monetary policy… With the growth of global demand for the yuan, the shift to that The currency will enhance the financial fortunes of Hong Kong.”
For Logan Wright, Partner and Head of China Market Research at Rhodium Group, the risks to Hong Kong’s dollar peg come mainly from market uncertainty regarding Beijing’s intentions with regard to the currency. He added that fears that money might leak out of China – despite tough capital controls – via Hong Kong might prompt Beijing to act if liquidity flight intensified.
Meanwhile, some hedge funds, such as billionaire Bill Ackman’s Pershing Square Capital Management, have taken large positions once morest the Hong Kong dollar. “The most likely alternative to maintaining the peg to the US dollar is to peg the currency to the Chinese yuan,” Wright said.
When did the link to the dollar begin?
Previously, Hong Kong had to contend with large capital outflows. About 40 years ago, global investors panicked during negotiations between Britain and China over the city’s future, which led to a sharp drop in the value of the Hong Kong dollar. The drop was so sudden and severe that officials decided to impose the most powerful form of fixed exchange rate regime, a currency board.
But that system has served Hong Kong well since then, helping the city navigate the Asian financial crisis, the severe acute respiratory syndrome outbreak in 2003, the collapse of investment bank Lehman Brothers in 2008 and the COVID-19 pandemic in 2020.
The Hong Kong Monetary Authority is committed to maintaining its currency between 7.75 and 7.85 to the dollar. When the currency reaches either end of the range, the authority will step in and defend the peg, by buying or selling Hong Kong dollars in the currency market.
By selling US dollars to buy Hong Kong dollars, the financial authorities siphon cash from the banking system, reducing the city’s overall balance and driving up interest rates. This enhances the strength of the Hong Kong dollar, enabling it to remain within the trading range. The same applies on the contrary.
But at the same time, pressure is building on the Hong Kong dollar. Since last May, the US dollar has touched 7.85 HK dollars, prompting the authorities to buy nearly 289 billion HK dollars ($37 billion) from banks to boost their value.
The recession began in early 2021, when there was a decline in investment flows from mainland China into Hong Kong stocks as Beijing cracked down on the country’s internet giants and education firms, many of which are listed in the city. But in the past 18 months, US interest rates have been the main driver of pressure on Hong Kong’s currency.
Huge interest rate hikes by the US Federal Reserve encouraged traders to engage in borrowing HK dollars and use them to buy higher interest US dollar assets.
Chi Lu, chief market strategist for Asia-Pacific at BNP Paribas Asset Management, says the main force behind the capital outflows is the fact that Hong Kong banks have lagged behind US banks in raising market rates. Fixed rates with the Fed.
Where are the concerns headed?
But rising US interest rates are starting to hamper Hong Kong’s economy as it tries to recover from severe Covid-19 restrictions. The high rates also add to the headwinds affecting the city’s real estate market, which was already facing pressure from an exodus of people and capital due to the political unrest. Beijing has tightened its grip on Hong Kong in recent years, sparking mass protests and global criticism. It imposed a sweeping national security law in 2020 that critics fear facilitates a crackdown on free speech and dissent.
And the economic and social costs of maintaining Hong Kong’s currency peg to the dollar have become unbearable, according to some investors. “Hong Kong’s best days are behind this,” says Richard Cookson, head of research and fund manager at Rubicon Fund Management. “Chinese political interference has increased… The number of workers, especially high-earners in finance, is shrinking.”
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