Hong Kong Suffers for Its Devotion to the Peg

The link to the greenback makes the city expensive for the Chinese
“Nobody was in the mood to buy an apartment”
Hong Kong has pegged the value of its dollar to the greenback since 1983. The peg was meant to ensure financial stability as the city embarked on the long process of re-integrating with China. Since then its currency has been one of the most stable in the region. To lock the HK dollar’s trading range against the greenback into a narrow band, about 7.75 to the U.S. dollar, the Hong Kong Monetary Authority (HKMA) buys and sells the two currencies. Whenever the Federal Reserve raises or lowers interest rates, Hong Kong follows suit.
With Fed officials poised to raise rates, Hong Kong is caught between tightening monetary policy in the U.S. and the economic slump of its main trading partner, China. If the Fed makes a move soon, Hong Kong will have to raise interest rates even as the mainland’s slowdown puts pressure on Hong Kong wages and property prices. “It’s a double whammy,” says BNP Paribas economist Mole Hau.
China’s surprise devaluation of the yuan last month helped trigger currency declines worldwide and increased speculation about Hong Kong’s willingness to keep putting up with such pain. In the options market, bets on an end to the peg jumped to their highest in more than a decade. On his blog in late August, Hong Kong Financial Secretary John Tsang warned that the economy may slow from the 2.6 percent growth rate it managed in the first half of the year. “Hong Kong still needs to face the challenges brought by the fluctuating financial markets, weak foreign trade, and slower tourism,” he wrote.
Hurt by the Chinese devaluation as well as low prices for oil and other commodities, regional currencies have declined an average 6.4 percent against the U.S. dollar in the past six months. That’s making the prices at the city’s stores more expensive for visitors, including the Chinese.
As tourist arrivals from China fell 9.8 percent in July compared with a year earlier, the Hong Kong retail industry’s sales for the month fell 2.8 percent to HK$37.6 billion ($4.85 billion). That was the fifth consecutive month of declines, and it was much worse than the 1.2 percent contraction economists surveyed by Bloomberg had predicted.
Home prices in Hong Kong have increased 60 percent since 2010, fueled by strong demand from the mainland and low interest rates. But Hong Kong in August had the weakest home sales in 17 months. With the stock market plummeting, “nobody was in the mood to buy an apartment,” says Louis Chan, chief executive officer of the residential unit of Centaline Property Agency, one of the city’s two largest brokers. Home prices may start falling as much as 10 percent a year starting in 2016, says Cusson Leung, an analyst with JPMorgan Chase.
Investors and economists have been talking about the peg’s demise since China regained control of the city in 1997. There’s always the possibility of the HKMA pegging the HK dollar to the yuan instead of the greenback. Zhang Yichen, chairman and CEO of Citic Capital, the Chinese investment bank, says that won’t occur soon. Speaking at the World Economic Forum in the Chinese city of Dalian on Sept. 9, Zhang said the Hong Kong government will be hard-pressed to end the peg until the yuan becomes a truly convertible currency, meaning that it must be exchangeable for foreign currencies in unlimited amounts.
The bottom line Hong Kong’s peg to the dollar means that when the Fed raises interest rates, Hong Kong must follow suit.
Bruce Einhorn, Fion Li, and Enda Curran