BREAKINGVIEWS-Hong Kong’s US dollar peg is least worst option

By Hudson Lockett

HONG KONG, June 24 (Reuters Breakingviews) - Whenever some aspect of Hong Kong’s U.S. dollar peg HKD=D4 appears askew, observers suggest that the scheme’s end is nigh — or has already arrived. This time, it's the persistent wide gap in overnight interest rates between the city HIHKDOND= and the U.S. market USDSOFR= that is reviving the argument for ditching the 41-year-old currency board. But the current system is the least worst option.

Granted, a key mandate is to match interest rates with those in the U.S. to keep the currency's spot price in line. The Hong Kong Monetary Authority does this by buying or selling currency to raise or lower short-term rates, which then push the exchange rate back between HK$7.75 and HK$7.85 against the greenback. Hence concerns that overnight borrowing costs are some 4.3% stateside compared with almost nothing in the city.

That lending rates have been low for six weeks, however, is not a sign of imminent doom but rather the system working as intended: until the currency breaches the trading band floor, there is no reason for the HKMA to intervene since interest rates are only a policy tool — not the ultimate target. And to drop the system now would be deeply unwise.

Hong Kong’s autonomy, however diminished, is undergirded by its role as a reliable venue for China’s companies to raise de facto dollar funds despite mainland capital controls. That would disappear if the current system were replaced with a yuan peg — one option frequently floated.

First, this would create a huge offshore pool of Chinese currency, which is anathema to Beijing. Companies listed on the Hong Kong Stock Exchange rely on the peg for their valuations and continued ability to tap equity funding. And in any event, the city’s Basic Law requires its currency to remain freely convertible.

Those against the existing currency board argue it hurts the economy by ceding monetary policy control. But abandoning the peg now would probably cause more damage. The low overnight rate, which serves as a mortgage benchmark, is providing relief to locals whose savings are tied up in the city’s beleaguered real estate market — enough that it has upped the odds of residential property prices finally bottoming out, per Jefferies.

A trade-weighted currency basket like Singapore's is the obvious alternative but would be vulnerable to manipulation and complicate monetary policy, according to John Greenwood, the currency board’s architect.

Past doom-mongers include U.S. hedge fund managers Kyle Bass and Bill Ackman, but the peg has shrugged off both bets. Chances are, it'll see off any newcomers, too.

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CONTEXT NEWS

Hong Kong’s overnight lending rate has languished at almost zero for nearly a month amid a surge in interbank liquidity, leaving it well below the American overnight rate of 4.3% and stoking speculation about the sustainability of the financial hub’s four-decade-old U.S. dollar peg.