#Market Strategy — 12.09.2019

Why don’t we worry about the HKD peg?

Prashant Bhayani & Grace Tam

  • Recent events in Hong Kong have triggered concerns over the stability of the USDHKD peg, especially there have been some market participants questioning the viability of the peg. 

      There seems to be some confusions about the concepts of aggregate balance (which has             shrunk from the peak of USD 51 billion in 2015 to the current USD 7bn) and forex reserves             (which is currently USD 449 billion, much higher than USD 359 billion in 2015). 

      Therefore, it is now timely for us to revisit the fundamentals of the currency peg.

  • The aggregate balance refers to the sum of the balances in the clearing accounts maintained by the banks with the Hong Kong Monetary Authority (HKMA), representing the interbank liquidity. 

      The aggregate balance is only a small part of the monetary base. Exchange Fund bills &                 notes (above HKD 1 trillion i.e. USD 128 billion) actually account for a much bigger part of the       monetary base.     

  • The HKMA, as a Currency Board, must hold anchor-currency reserves at least equal to or exceeding the monetary base. In fact, Hong Kong’s current forex reserves is 2.1x of the monetary base. This literally means that every 7.8 HKDs is covered with 1 USD twice over. (Refer to Gateway City Fact below for further details of the Currency Board mechanism)

      Also, Hong Kong’s forex reserves are greater than the size of the Hong Kong economy                 (USD 369 billion). 

     The reserves are equal to 46% of M3 money supply. This ratio is higher than in 1998 Asia                Financial Crisis (35%), 2003 SARS epidemic (43%) and 2008 Global Financial Crisis (33%).            

    Therefore, the HKMA should have sufficient USD that can be sold to keep the USDHKD rate         below 7.85.

hkd peg
  • Bank deposits in Hong Kong are massive (HKD 13.6 trillion i.e. USD 1.7 trillion), and have been growing steadily with the HKD loan-to-deposit ratio staying in the range of 70-90% over the past decade. Even in the worst case scenario (definitely not our base case) with a 15% of outflows in bank deposits (severe banking crisis tends to see a 10-15% flee of deposit), Hong Kong should have enough reserves to deal with.  
  • In fact, Hong Kong’s aggregate balance had been at very low levels (below USD 200 million) for an extended period pre-2008 crisis without breaking the HKD peg. The post-2008 crisis ballooning and shrinking of Hong Kong’s aggregate balance is largely due to the Fed’s quantitative easing and tightening. 
  • Furthermore, HKD has been supported by "twin surplus" - a budget surplus and a current account surplus.  Hong Kong’s fiscal reserve to GDP has been rising since 2007, currently accounting for 40% of GDP, while Hong Kong’s current account surplus is 4.8% of GDP. We believe the HKD peg remains resilient and is here to stay.


1.       How does Hong Kong’s Currency Board mechanism operate?

·         The HKD is officially linked to the USD at the rate of HKD7.8 to USD1. The Linked Exchange Rate system operates through a Currency Board mechanism, which requires the monetary base to be fully backed by forex reserves. The stability of HKD is maintain through an automatic interest rate adjustment mechanism, where interest rates rather than the exchanges rate adjust to the capital inflow or outflow.  

·         For instance, recent capital outflows have pushed the HKD towards the weak side of the convertibility range, triggering the HKMA’s autopilot mechanism of passively selling USD/buying HKD to keep the exchange rate constant. This has then tightened the local money market, lifting local interbank rates (HIBOR), which in turn, will discourage selling of HKD. This actually shows that the Currency Board mechanism has been working well as intended, rather than burning through forex reserves.

2.       Hong Kong remains a Key Gateway City for capital raising, attracting foreign inflows and RMB internationalization. Hong Kong is/accounts for…

  • Home to 73% of Mainland companies’ offshore IPOs (2010-2018)
  • 60% of China’s overseas bond issuance
  • 64% of FDI inflows to China
  • Channel for 65% of China’s outward direct investment
  • Two-thirds of China’s offshore RMB deposits