Hong Kong's Currency Inflicts Plenty of Pain

Its peg to the U.S. dollar gives the city no way to raise interest rates

In Hong Kong, a city notorious for the gyrations of its markets, the local currency is always worth about the same as the U.S. dollar. To ensure stability in anticipation of the British colony’s return to Chinese rule in 1997, the government linked the Hong Kong dollar to the greenback at a rate of about 7.8 Hong Kong dollars to one U.S. dollar. Since Beijing resumed control over Hong Kong, the rate has remained in place. That’s helped Hong Kong weather the Asian crisis, the SARS epidemic, and the Great Recession.

The downside to the policy, known as the peg, is that Hong Kong interest rates must follow the lead of the Federal Reserve to avoid big discrepancies between the two currencies. With Fed Chairman Ben S. Bernanke’s pledge to keep borrowing costs at record lows until mid-2013, the peg is proving painful for Hong Kong.

As the greenback weakens against China’s yuan and other Asian currencies, it is dragging the Hong Kong dollar down with it, making imports more expensive and increasing property prices. The consumer price index rose 7.9 percent in July and 5.7 percent in August. Real estate prices have jumped 73 percent since early 2009.

With the yuan likely to go up against the dollar for the foreseeable future, the costs of keeping the peg will grow too painful. “The peg will have to go,” Rupert Watson, head of asset allocation at Skandia Investment Group, told reporters on Sept. 15. The day before, William Ackman, founder of hedge fund Pershing Square Capital Management, told investors in New York that he is buying Hong Kong dollar call options (which give investors the right to buy the currency at a set price) on the expectation that the peg will end and the currency will rise in value. In the last decade, the yuan has appreciated 29 percent against the U.S. dollar. The Singapore currency has risen 37 percent, while the Hong Kong dollar has not moved.

Hong Kong officials say they have no plans to end the peg. “The peg has come through for us,” says Hong Kong Financial Secretary John Tsang. Given the debt crisis in Europe and weakness in the U.S., “it’s difficult to see the HKMA [Hong Kong Monetary Authority] taking the risky move to change the policy,” says David Dimmock, director of fixed income and securities at Société Générale in Hong Kong. Aligning more closely with the yuan has its downside, too, since a rising Chinese currency could harm Hong Kong’s exports. Tommy Ong, a Hong Kong-based senior vice-president at DBS Bank, says change won’t be likely until at least 2015. That’s when Chinese officials have said they will make the yuan fully convertible.


    The bottom line: Investors are wondering how long Hong Kong can maintain its peg to the U.S. dollar, which has sparked high inflation.

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