The recent devaluation of the renminbi and fears about economic shifts in Asia and the continued strength of the US dollar, have prompted thoughts about a number of long-standing currency "pegs". What could happen in Hong Kong?

When one currency exchange rate makes a sudden shift it encourages speculators to see if there are other juicy targets waiting to be toppled. What, for example, could happen in the case of the Hong Kong dollar and its long-standing peg to the US dollar? Could it break free and find another suitor, or go it alone?

At AXA Investment Managers Asia, Aidan Yao, of the research and investment strategy team, reckons the chance of a “de-pegging” of the Hong Kong and US currencies is remote for a variety of reasons. Such musings are understandable, he says, given that a number of currencies with a dollar link, such as the Saudi Arabia riyal and United Arab Emirates Dirham have come under pressure. At UBS, meanwhile, strategists at its wealth management side also think the chances of the Hong Kong and US dollars divorcing are low.

At AXA, Yao starts by noting that the Hong Kong Monetary Authority, the jurisdiction’s de facto central bank, has a large foreign exchange swap line with the People’s Bank of China, to the tune of RMB400 billion ($62.7 billion). “In an emergency situation, such as a speculative attack, the HKMA can tap the swap line and use the extra liquidity provided by the PBoC to fend off speculators. In reality, if the currency peg is under severe pressure, we think the financial support that HK can get from Beijing will go well beyond the RMB400bn swap line,” Yao says.

Yao reminds readers that authorities in Hong Kong have for many years maintained a strong preference for a fixed exchange rate in order to bring currency stability to users of Hong Kong dollars; removing the peg to the US dollar and pegging with the Chinese currency would pose the obvious difficulty in that the renminbi is not a fully convertible currency.

“For a financial centre like Hong Kong, ensuring free flows of capital is paramount. Subjecting its currency to capital controls will undermine Hong Kong’s position in global capital and financial intermediation,” Yao says.

On a cyclical basis, the current instability in the renminbi market would not give a good opportunity for the Hong Kong dollar to change the currency to which it wishes to be pegged.

“While moving towards a market-oriented exchange rate is positive for the yuan [aka renminbi] over the long run, the (HKMA) has to think about stability for its own currency and try to minimize forex risks for Hong Kong dollar users,” Yao says.

“We think the chance of an imminent HKD de-peg is very low. Hong Kong has a very strong FX reserve position, which amounts to $340 billion or 120 per cent of GDP,” Yao says.

UBS position

UBS Wealth Management also noted that the Hong Kong dollar/US dollar exchange rate peg is in the limelight after recent Chinese forex shifts but thinks this link will remain. 

“Although the Hong Kong dollar 9HKD) has risen in trade-weighted terms, we do not expect the HK economy to fall into recession/deflation. Back in 2009 and 1997, a strong trade-weighted HKD coincided with sharp economic recession and deflation, but yet the HKMA held steadfastly to the USDHKD currency board regime. 

Importantly, the HMKA [Hong Kong Monetary Authority] believes that changing the currency regime would significantly hurt investor confidence, which could trigger a significant outflow of funds and pose an even bigger threat to Hong Kong's economic and monetary stability,” UBS continued.
 
“Given the HKMA’s credibility and commitment to maintain the currency regime, we believe the risk of a HKD devaluation versus the USD is low. The real risk for the HK economy comes from HK interest rates rising alongside US interest rates at a time when HK faces a peaking credit cycle and property market, reduced China tourist spending, weakening exports and a China economic slowdown,” the bank said, adding that its “base case” scenario is for a gradual rise in Hong Kong’s interest rates.