HK dollar peg safe but Argentina offers lessons

Hong Kong, Jan 7: Hong Kong looks set to becomethe only major economy still holding on to a strict currency board system now that Argentina has devalued its peso and may move to a full float.
And Hong Kong has every intention to keep holding on.

The territory adopted a currency board in 1983 to counter financial market turmoil in the early days of talks between London and Beijing on returning the British colony to China.

For many years, the system has worked well. And the Hong Kong government has said, repeatedly, that the peg will not go.
"The policy will not change," Hong Kong chief executive Tung Chee-hwa said again last Thursday.

Under the territory’s currency board system, Hong Kong dollars are fully backed by US dollars. The Hong Kong unit is linked at a rate of HK$7.8 to US$1 and is permitted to trade in a narrow band around that level.

On Monday, the Hong Kong dollar forward market - where sentiment toward the linked currency is reflected - shrugged off Argentina’s latest move. Dealers said the decision was already priced into the market.

Besides, they said, Hong Kong and Argentina have almost nothing in common. Certainly, that is the view of the government.

The Hong Kong Monetary Authority on Monday said that it had been closely studying developments in Argentina because both maintain currency board systems.

"Our view is that Hong Kong and Argentina experience entirely different economic and financial conditions and that the currency board arrangements of each place are too dissimilar to allow direct comparisons or connections to be made," it said.

Last Thursday, HKMA chief executive Joseph Yam put it even more bluntly.

"Calm yourselves down", about the peg, he told Hong Kong people in his regular weekly column.

While Argentina is grappling with a debt crisis, Hong Kong does not have any external government debt. It also has huge fiscal reserves.
The Latin American country also is facing a liquidity crunch. In Hong Kong, banks are flush with liquidity. That’s not to say that Hong Kong’s peg does not bring its pitfalls.

Because of the link, adjustments in the economy must be made through asset prices, rather than through the exchange rate. And they have, with the territory’s property and share prices falling sharply since the bubble period before 1997.

The Hong Kong dollar also has strengthened relative to the currencies of its Asian neighbours, rendering it less competitive. But with most of its trade with mainland China, which also links its currency to the dollar, and the United States, the effect is muted.

The positive, and it’s a big one, is that the steady currency sharply reduces risks for foreign investors, a key factor keeping the money flowing into Hong Kong.

The government repeatedly has said that de-pegging the currency would do little to bolster the economy, but would lead to heavy capital flight. Most analysts agree.

But they also say that doesn’t mean Hong Kong can’t learn from Argentina.

"The lesson is that no currency system is forever," said Samuel Chiu, an economist at Kim Eng Securities. "If economic realities warrant it, then Hong Kong’s peg would have to go."

Currency traders know this, which is why the forward market, though quiet lately, has responded to Argentina’s ups and downs over the past several months.

It’s not that traders fear an attack on the peg. Speculators tried in August 1998 at the height of the Asian crisis when Hong Kong was particularly vulnerable, and were beaten badly.

— Reuters