Abstract

ㅁA number of hedge funds have shifted their attention to Hong Kong Dollar (HKD), speculating on the possibility of the currency abandoning its decades-old peg to the USD. It has led the HKD to soften against the USD and raised the interbank interest rate.

ㅁHowever, we believe that HKD de-pegging is an unlikely scenario for a number of reasons: (1) The FX regime in Hong Kong is different from that in the mainland; (2) The HKMA has plenty of ammunition to defend the linked exchange rate system looking forward; and 3) The political will to defend the exchange rate remains strong.

ㅁA currency board system is under good management in Hong Kong. In other words, the HKMA does not hold FX assets for reasons other than to safeguard the stability of its exchange rate, leaving the entirety of its FX reserves available to defend the currency against a potential speculative attack.

ㅁReforms like pegging the HKD to the RMB or a basket of currencies appear unrealistic when the pressure on the HKD has been piling up. A wavering policy stance in this respect could make things worse and expedite a systemic debacle of Hong Kong’s gigantic financial sector. Any change in the exchange rate regime is also difficult from a political perspective.

ㅁThe authorities’ commitment to the currency peg could add to growth headwinds. Financial asset prices, both equity and housing prices, are subject to deeper downward pressure. We have therefore revised our GDP forecasts for Hong Kong from 2.5% to 2.3% for 2016, and from 2.6% to 2.5% in 2017 while highlight downside risks if speculative attacks on the HKD last longer than expected and trigger more capital outflows.