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Hong Kong currency peg under mounting pressure

Hong Kong currency peg under mounting pressure

(29 September 2019 – Hong Kong) Fund managers are wagering that the Hong Kong dollar’s peg to the US dollar is under threat as ongoing protests drag on economic sentiment threatening recession.

The Hong Kong Monetary Authority (HKMA) and bankers disagree however and view a move in the status quo as unlikely.

Hong Kong has seen escalating violence against the now withdrawn extradition bill. The protests, now approaching their 20th consecutive week, have morphed into a wider movement for greater democratic freedom, with protesters calling on the government to address issues such as unaffordable housing and income inequality.

The HKMA has outlaid HK$125.6 billion since April 2018 to bid up the Hong Kong dollar to prevent it from falling below the bottom range of the peg. As a result, the aggregate balance (a measure of liquidity in the local banking sector) fell from HK$176 billion in Q2 2018 to HK$54 billion in Q2 2019 when the HKMA last intervened to support the currency.

A HKMA spokesman said that recent statistics indicate that there has not been any noticeable outflow of funds from Hong Kong, and even if it happens, HKMA’s sound and prudent banking system can cope. He added that the HK$1.1 trillion of Exchange Fund Bills and Notes could turn into banking liquidity at any given moment.

Fitch has downgraded Hong Kong to 'AA' from 'AA+', outlook negative after months of persistent conflict and violence testing the strength of the "one country, two systems" framework that governs Hong Kong's relationship with mainland China.

Fitch expects the "one country, two systems" framework to remain intact, but the gradual rise in Hong Kong's economic, financial, and socio-political linkages with the mainland implies its continued integration into China's national governance system, which will present greater institutional and regulatory challenges over time. In Fitch's view, these developments are consistent with a narrowing of the sovereign rating differential between Hong Kong and mainland China (A+/Stable).

“When there is a recession, the government cuts interest rates to help companies and individual borrowers to cope with a poor economy. However, under the currency board system, the HKMA will need to drive the interest rate up to defend the peg whenever it trades at the weak end” said Trium Capital portfolio manager Thomas Roderick which manages US$700 million at the British boutique fund.

Roderick said that the peg is designed in such a way so that the Hong Kong dollar’s exchange rate can be defended and that it remains stable even when overseas markets are in the midst of serious crisis like the Asian financial crisis in 1997 and the global financial crisis in 2009.

“When we are facing a recession, the government would need to maintain the peg to add confidence to the financial market” said Bank of East Asia senior adviser Ignatius Chan Tze-ching, believing that the government will not change the peg and has the ability to defend it.

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