Hong Kong Peg to Yuan Is ‘Many Years’ Off, Greenwood Says

Hong Kong’s dollar peg shields the local economy from external shocks and it will be “many years” before a switch to a yuan link can be considered, according to John Greenwood, architect of the city’s exchange-rate system.

“At the time being, the renminbi is not fully convertible and therefore it’s not suitable for the Hong Kong dollar to peg to,” Greenwood, chief economist of Invesco Asset Management, said in a speech in Hong Kong today. “The Hong Kong dollar linked exchange-rate mechanism requires a fully convertible currency as anchor currency.”

The city’s dollar peg was adopted in 1983 when negotiations between China and the U.K. over returning the city to Chinese control triggered capital outflows and Greenwood suggested a currency board system to stabilize the exchange rate. He has been a member of the currency board operations committee of the Hong Kong Monetary Authority since 1998.

The Hong Kong dollar’s value is kept at around HK$7.8 versus the greenback. In 2005, policy makers committed to limiting the currency’s decline to HK$7.85 and capping gains at HK$7.75. It would be unwise to switch to a peg versus a basket of currencies or to allow the Hong Kong dollar to float, Greenwood said, adding that the existing system works well.

The Hong Kong Monetary Authority bought almost $14 billion between October and December as the local currency’s move to HK$7.75 obliged it to buy U.S. dollars in the foreign-exchange market. Signs of a pickup in China’s economy and monetary easing in the U.S., Europe and Japan had spurred capital inflows to the city.

Ackman’s Bet

The Hong Kong dollar traded at HK$7.7629 versus its U.S. counterpart as of 4:16 p.m. in the city. It has weakened 0.16 percent this year. Twelve-month forwards traded at HK$7.7531.

All but one of the 20 analysts polled by Bloomberg News in November, including Citigroup Inc. and JPMorgan Chase & Co., said they expected the city’s fixed exchange-rate system to last for at least five more years.

William Ackman, founder of Pershing Square Capital Management LP, told a conference in September 2011 that the easiest way for Hong Kong to allow an appreciation would be a reset of the peg at HK$6 versus the U.S. currency followed by a switch to a yuan link over three to six years. The hedge-fund manager said in October 2012 that he was keeping the wager.

Such a bet has so far been a losing trade as Hong Kong officials repeatedly pledged to keep an exchange-rate system that survived the Asian financial crisis in the late 1990s and the global recession in 2009. K.C. Chan, the city’s secretary for financial services and the treasury, said in January Ackman won’t realize his bet.

’Greater Force’

China’s economy will continue to grow rapidly over the next several decades, making it a “greater force” in the global business cycle as well as that of Hong Kong, Greenwood said. That may make a shift for Hong Kong’s U.S. dollar peg to having the yuan as an anchor possible, he said.

“No doubt officials in Hong Kong government would be thinking about these questions and they may have developed their own sets of criteria against which to assess the viability of switching to the renminbi,” said Greenwood.

China ended its currency peg to the dollar in July 2005 after keeping the exchange rate stable for a decade. HSBC Holdings Plc forecast in March the yuan will become fully convertible within five years. Interest-rate liberalization is necessary before capital controls can end and policy makers are making “slow” progress on this front, Greenwood said.

Yuan Controls

“Consequently, I believe it will be many years for the renminbi to be fully convertible, so many years before it becomes suitable as an anchor currency for the Hong Kong dollar,” said Greenwood.

The yuan strengthened to a 19-year high of 6.1616 per dollar on April 26 after the People’s Bank of China set a record reference rate for the currency amid signs capital inflows are gathering pace. The spot rate in Shanghai is allowed to diverge a maximum 1 percent on either side of the daily fixing.

PBOC Deputy Governor Yi Gang said April 18 that the yuan’s trading band would be widened “in the near future.” The last revision, which doubled the maximum permitted divergence from the reference rate, was announced on April 14, 2012. The yuan ended last week at 6.1650 per dollar, 0.9 percent stronger than the PBOC’s fixing on April 26. China’s financial markets are closed April 29 to May 1 for a holiday.

In Hong Kong’s offshore market, the yuan was 0.06 percent stronger today at 6.1630 per dollar, according to data compiled by Bloomberg. It touched 6.1617 on April 26, the strongest level since trading began in 2010.

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