As Hong Kong’s currency peg turns 40, analysts are divided if it should be aligned with the Chinese yuan instead of the US dollar
Veteran banker Chan Tze-ching still remembers the day the Hong Kong government officially pegged its currency to the US dollar four decades ago.
“Back then, I was a money and currency trader at Citibank, and I clearly remembered the Saturday morning when the Reuters machine suddenly flashed the breaking news that the Hong Kong dollar was to be fixed at 7.8 per US dollar” with effect from October 17, 1983, he said, recalling the initial announcement.
“We in the dealing room were shocked, and nobody knew how to react to the government’s move to scrap the floating rate and announce a US dollar-pegged regime without warning,” said Chan, who is now an adviser to a local banking group. “It was chaotic in the dealing room” the following Monday, he added.
According to a report published by the HKMA, the slump in the Hong Kong dollar was made worse by speculative attacks and an escalating crisis of confidence in the future of Hong Kong. At one point in September 1983, it fell to a record low of HK$9.60 per dollar, from HK$6.50 at the start of that year, it said.
A front-page report in the South China Morning Post on October 16, 1983, a day after the peg was announced. Photo: SCMP
Until that peg decision, the Hong Kong dollar had gone through several system changes. The currency was linked to the value of silver and to the British pound in the early part of the last century. It was allowed to float freely in 1974 when wild swings and a confidence crisis gripped the markets amid efforts linked to the 1997 handover of Hong Kong.
During 1983, “the uncertainties surrounding the transitional arrangements affected the general confidence on the future of Hong Kong,” said Joseph Yam Chi-kwong, who was then the principal assistant secretary for monetary affairs in the Hong Kong government.
Some businesses refused to accept payment in the local currency, insisting on US dollars. Such was the panic that many consumers stocked up on household necessities ranging from foodstuff to toilet paper.
Joseph Yam Chi-kwong was the principal assistant secretary for monetary affairs in the government when the local currency was pegged to the US dollar in October 1983. Photo: Edmond So
To stabilise the local currency, the government introduced the linked exchange rate system, pegging its value at HK$7.80 per dollar. The Hong Kong Monetary Authority was only formed in April 1993, with Yam serving as its first chief executive through September 2009. The HK$7.75 to HK$7.85 trading band was only introduced in 2005.
As the peg turns 40 on Tuesday, some analysts are asking if the city would benefit from an alternative currency linkage, such as the Chinese yuan. Hong Kong risks being increasingly led by US monetary policy, which could see local property prices and the economy come crashing down, said Andy Xie, an independent economist.
“With China’s interest rates expected to stay lower than US rates, due to lower Chinese inflation, embracing the yuan would stabilise Hong Kong’s asset markets,” said Xie, who previously worked as an economist at Morgan Stanley and the World Bank.
The economic cycles of the US and Hong Kong markets have at times varied, complicating the conduct of monetary policy. For example, the Federal Reserve had to cut rates in the early 1990s to shore up the economy, while Hong Kong was battling high levels of inflation which required a tighter monetary policy.
The current environment poses a similar dilemma, said Chan, the former Citibank trader. The dollar peg has created problems from time to time because the system forces the HKMA to align the city’s interest rates with US dollar interest rate movements, he said.
“Hong Kong’s current economy is weak, inflation is normal and the property market is soft,” said Chan. “We do not need and could not afford to have high interest rates, but we still need to follow the US interest rate tightening because of the peg.”
Eddie Yue Wai-man speaks in an interview with SCMP in Causeway Bay on October 5. Photo: Nathan Tsui
The HKMA is determined to sustain the existing mechanism. The system has withstood a number of financial crises and challenges over the past four decades, as well as fended off occasional speculative attacks by global hedge funds.
“We have no intention, no interest, no plans to change the linked exchange rate system,” said Eddie Yue Wai-man, CEO of HKMA in an interview with the Post earlier this month. “It has proven its worth as the pillar of stability for Hong Kong. There is no reason why we should change a system that has been operating well.”
Hong Kong, as an open and small economy with a lot of international trade and financial activities, will need a stable exchange rate to provide confidence to both companies and investors to invest in Hong Kong, Yue said.
“For any monetary system, that is the trade-off,” Yue said. “If we want our interest rate policy back, then you forgo exchange rate stability.”
Agustin Carstens, general manager of the Bank for International Settlements (BIS), also endorsed the peg, saying it had given the city monetary stability.
“Certainly the dynamism of Hong Kong and the region as a whole has preserved this economy in a very bright and vibrant state, and kept it very competitive,” Carstens said in an interview with the Post in December.
Even small businesses in the city have given their vote of confidence to the peg. Vince Chan, the owner of Peanut Florist in Wan Chai, wants the fixed exchange rate system to stay.
“I import flowers from Holland, South Africa and sometimes from Japan, at prices which are usually expressed in US dollars,” Chan said. “A fixed exchange rate protects me from exchange-rate losses. It allowed me to run my business these past 26 years. A high fluctuation of the currency will hurt my business.”
HKMA’s Yue said Hong Kong needs an “anchor currency that is fully compatible with a deep global treasury market or bond market that can be accessed anytime”. While China has allowed the yuan to be used for international settlement since 2009, the currency was still not freely convertible under the nation’s capital control measures.
Besides, there is “no economic reason” for China to peg the Hong Kong dollar to the yuan, said Raymond Yeung, chief economist for Greater China at ANZ Banking Group.
“The mainland authorities can simply increase the circulation of the offshore yuan to boost the internationalisation of yuan,” he said in a note to clients. “It does not need to change the peg to achieve such a result.”
The Hong Kong dollar is “a symbol of globalisation” and the peg was still “valuable to the national interest”, showing the city remains a free market. The e-HKD projects, and other virtual asset development, will be another chance to enhance its international status, raising its appeal as a possible reserve currency in the new digital economy era, he added.
But Chan, the former Citibank currency trader, said there was room for discussions regarding the future of Hong Kong dollar peg.
“The historical mission of the peg is largely complete,” he said. “It is time to review the possibility of aligning our exchange rate more with the Chinese yuan rather than the US dollar, because the yuan is on course to becoming an international currency.”
