Hong Kong Peg Turning 30 as Another Decade Forecast: Currencies

Banny Lam recalls how, in the first nine months of 1983, he helped his family stockpile rice as a drop of more than 30 percent in Hong Kong’s dollar led to panic-buying of goods.

“Sometimes the shelves would be empty,” said Lam, the 41-year-old co-head of research at Agricultural Bank of China International Securities Co. in Hong Kong. “At that time, we just didn’t know what would happen tomorrow with the currency.”

Calm was restored when the city pegged its currency to the U.S. dollar 30 years ago today at a rate of about HK$7.80, providing stability as China and the U.K. negotiated Hong Kong’s return to mainland rule. During the 1997-98 Asian financial crisis, Hong Kong used $15 billion of reserves to defend the peg from a speculative attack. Financial Secretary John Tsang says the link remains the “most appropriate” system for the city.

Memories linger of bare supermarket shelves before the peg, and seven of 13 analysts polled by Bloomberg News this month predicted the fixed exchange rate would last for another decade. John Greenwood, the system’s architect, said there’s a “strong case” for a permanent peg in Hong Kong, which is a small and open economy with large capital flows, and therefore vulnerable to market volatility.

‘Proved Correct’

“Many people criticized me, because at that time other economies were still switching from pegged rates under Bretton Woods to more flexible exchange rates, whereas Hong Kong was going in the opposite direction,” Greenwood, the London-based chief economist at Invesco Asset Management, said in an Oct. 3 interview by e-mail. “Hong Kong’s economy was very flexible, I was confident that I would be proved correct.”

The Bretton Woods agreement of 1944 was a response to World War II and aimed to stabilize exchange rates by tying them to the U.S. dollar.

Hong Kong’s currency peg means its monetary policy is dictated by the Federal Reserve’s, and calls to review the system have mounted since 2008 as near-zero U.S. interest rates fueled a surge in property prices and living costs.

If there is a change to the peg, it should be to a basket of currencies or China’s yuan, according to eight of the 13 analysts surveyed by Bloomberg. The Hong Kong dollar’s trading band could also be widened, four of the analysts said.

Adjusted Peg

Policy makers committed to limiting the Hong Kong dollar’s decline to HK$7.85 versus the U.S. currency and capping gains at HK$7.75 in an adjustment to the monetary system in 2005. It traded at HK$7.7541 as of 1:16 p.m. in New York, within 0.1 percent of the strong end of its trading range.

Hong Kong island and the Kowloon peninsula came under British rule in 1842, while an area to the north known as the New Territories was leased for 99 years until June 30, 1997. In 1982, China rejected then-U.K. Prime Minister Margaret Thatcher’s request for Britain to continue administering the city, saying it would resume sovereignty over the whole of Hong Kong in 1997.

The Hang Seng Index of shares slid 31 percent to 758.3 by the end of September 1983 amid tensions sparked by the handover talks, from its high for that year of 1,102.6 in July, according to data compiled by Bloomberg. The gauge closed at 23,094.88 today and reached a record 31,368.22 in October 2007.

‘Empty Shelves’

Hong Kong’s dollar slid to nearly HK$10 versus the greenback in the runup to the peg, from HK$6.5 at the start of 1983, according to Hong Kong Monetary Authority Chief Executive Norman Chan. There’s no need to change the currency link, said Chan, who remembers the panic-buying of food in the early 1980s.

“On my way home from work I saw a long queue of people outside a large supermarket, waiting to snatch whatever goods they could for fear of further devaluation,” he wrote on the HKMA’s website Oct. 14. “The empty shelves in the supermarket, once filled with groceries, staple food and toilet papers, further amplified people’s anxiety.”

Tsang, the finance chief in Hong Kong’s government, wrote in a report released today that the currency policy “has been the cornerstone” of the city’s stability and banished the “anxiety in the community” caused by the local dollar’s decline in the 1980s. While “some in the younger generation” may be less aware of the peg’s benefits, the government “sees no need and has no intention” of changing it, he wrote.

Low Volatility

One-year implied volatility on the Hong Kong dollar, a measure of expected swings in the exchange rate used to price options, is 0.71 percent, according to data compiled by Bloomberg. That’s the lowest rate among 11 Asian currencies tracked by Bloomberg, followed by 2.8 percent for China’s yuan.

In June 2012, Joseph Yam, a former HKMA chief who helped introduce the peg and defended it against speculators during the Asian crisis of the 1990s, called for a review of the currency policy. Yam is the most senior serving or former Hong Kong official to speculate on such changes, and declined an interview request by Bloomberg News this month.

Many of the city’s problems such as inflation and lower living standards can be attributed to the exchange-rate policy, and ultimately the local currency should be tied to the yuan, Bank of East Asia Ltd. Chairman David Li was quoted as saying in the Hong Kong Economic Journal on Oct. 15. Consumer prices rose 4.5 percent from a year earlier in August following a 6.9 percent increase in July that was the biggest in two years, official data show.

China’s Yuan

China ended its U.S. dollar peg in 2005, after keeping the exchange rate stable for a decade, and the yuan has strengthened 36 percent since then, data compiled by Bloomberg show. The currency now trades in a managed range against a basket of major counterparts. Its daily moves versus the greenback in Shanghai are limited to 1 percent either side of a reference rate set by the People’s Bank of China.

“In five years, with the transaction volume of the renminbi in the region and the status of a reserve currency continuing to improve, the Chinese yuan can be a viable competition to the U.S. dollar,” Hao Hong, the Hong Kong-based chief China strategist at Bocom International Holdings Co., a subsidiary of China’s fifth-largest bank by market value, said in an Oct. 11 phone interview. Renminbi is another term for China’s currency.

Hong, who forecasts that Hong Kong’s peg with the U.S. dollar will end in less than five years, said the yuan will become a “natural choice” as a replacement.

Yuan Roadblocks

Greenwood, who formulated the peg 30 years ago, predicts it will be “many years” before China fully liberalizes domestic capital and credit markets and abolishes capital controls, changes necessary for switching to a link with the yuan.

“However, I would also expect any responsible officer in the Treasury or the HKMA, or any serious scholar, to have considered alternative monetary regimes,” Greenwood said.

Chan of the HKMA said it’s too early to consider a yuan link because “the pre-conditions don’t exist.” The monetary authority has more than $300 billion of foreign-exchange assets, mostly in the U.S. currency, he said. Switching the peg to the yuan would force the HKMA to hold almost 2 trillion yuan ($328 billion) of assets, bigger than the entire offshore yuan market, according to Chan.

For Lam, who as an 11-year-old lugged sacks of rice through the crowded streets of Hong Kong’s To Kwa Wan district, the peg has been nothing but a benefit for the city.

“I went to the supermarket nearby in shorts and sneakers to grab bags of rice, though sometimes the shelves could be empty, and then I climbed the stairs back home with the bags on my back,” Lam said in an Oct. 8 phone interview. “The peg has given the financial stability that Hong Kong needs most to prosper. We shouldn’t forget its success in these three decades.”

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