Hong Kong Suffers for Its Devotion to the Peg
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Hong Kong has pegged the value of its dollar to the greenback since 1983. The peg was meant to ensure financial stability as the city embarked on the long process of re-integrating with China. Since then its currency has been one of the most stable in the region. To lock the HK dollar’s trading range against the greenback into a narrow band, about 7.75 to the US dollar, the Hong Kong Monetary Authority (HKMA) buys and sells the two currencies. Whenever the Federal Reserve raises or lowers interest rates, Hong Kong follows suit.
That means Hong Kong is caught between tightening monetary policy in the US and the economic slump of its main trading partner, China. If the Fed moves on the rate soon, Hong Kong will have to raise interest rates even as the mainland’s slowdown puts pressure on the city’s wages and property prices. “It’s a double whammy,” says BNP Paribas economist Mole Hau.
“Nobody was in the mood to buy an apartment”
China’s surprise devaluation of the yuan last month helped trigger currency declines worldwide and increased speculation about Hong Kong’s willingness to keep putting up with such pain. In the options market, bets on an end to the peg jumped to their highest in more than a decade. On his blog in late August, Hong Kong Financial Secretary John Tsang warned that the economy may slow from the 2.6 per cent growth rate it managed in the first half of the year. “Hong Kong still needs to face the challenges brought by the fluctuating financial markets, weak foreign trade, and slower tourism,” he wrote.
“Hong Kong still needs to face the challenges brought by the fluctuating financial markets, weak foreign trade, and slower tourism,”
Hurt by the Chinese devaluation as well as low prices for oil and other commodities, regional currencies have declined an average 6.4 per cent against the US dollar in the past six months. That’s making the prices at the city’s stores more expensive for visitors, including the Chinese.
As tourist arrivals from China fell 9.8 per cent in July compared with a year earlier, the Hong Kong retail industry’s sales for the month fell 2.8 per cent to HK$37.6 billion ($4.85 billion). That was the fifth consecutive month of declines, and much worse than the 1.2 per cent contraction economists surveyed by Bloomberg had predicted.
Home prices in Hong Kong have increased 60 per cent since 2010, fuelled by strong demand from the mainland and low interest rates. But Hong Kong in August had the weakest home sales in 17 months. With the stock market plummeting, “nobody was in the mood to buy an apartment,” says Louis Chan, chief executive officer of the residential unit of Centaline Property Agency, one of the city’s two largest brokers. Home prices may start falling as much as 10 per cent a year starting in 2016, says Cusson Leung, an analyst with JPMorgan Chase.
Investors and economists have been talking about the peg’s demise since China regained control of the city in 1997. There’s always the possibility of the HKMA pegging the HK dollar to the yuan instead of the greenback. Zhang Yichen, chairman and CEO of Citic Capital, the Chinese investment bank, says that won’t occur soon. Speaking at the World Economic Forum in the Chinese city of Dalian on 9 September, Zhang said the Hong Kong government will be hard-pressed to end the peg until the yuan becomes a truly convertible currency, meaning that it must be exchangeable for foreign currencies in unlimited amounts.
Questions & Answers
Q.Why is Hong Kong's monetary policy so closely linked to the Federal Reserve's actions?
Why is Hong Kong's monetary policy so closely linked to the Federal Reserve's actions?
The Hong Kong Monetary Authority pegs the HK dollar to the US dollar within a narrow trading band. To maintain this peg, the HKMA buys and sells the two currencies, meaning it must follow the Federal Reserve's interest rate changes.
Q.What impact is the current economic situation having on Hong Kong's retail sector?
What impact is the current economic situation having on Hong Kong's retail sector?
The retail industry experienced a 2.8 per cent sales drop in July, its fifth consecutive monthly decline. This was influenced by the Chinese devaluation, lower commodity prices, and a 9.8 per cent fall in Chinese tourist arrivals.
Q.What is preventing Hong Kong from potentially pegging its currency to the yuan instead of the US dollar?
What is preventing Hong Kong from potentially pegging its currency to the yuan instead of the US dollar?
According to Zhang Yichen of Citic Capital, the Hong Kong government will struggle to end the current peg until the yuan becomes a truly convertible currency. This means it must be exchangeable for foreign currencies without limits.
Q.How have property prices in Hong Kong been affected by recent economic pressures?
How have property prices in Hong Kong been affected by recent economic pressures?
Home prices have risen significantly since 2010, but August saw the weakest home sales in 17 months. Forecasts suggest prices could begin falling by as much as 10 per cent annually from 2016.
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