Hong Kong has a public relations problem on its hands, and it’s not about the usual suspects. It’s not about pollution, inequality or executives leaving for Singapore—it’s about the currency. Currencies aren’t normally PR matters. Yet, when your dollar has been pegged to the US dollar since 1983 and the world’s policymakers are calling for greater flexibility in exchange rates, it’s bound to be a hot issue. That’s especially true now that the former finance secretary admitted Hong Kong “seriously” considered scrapping the peg five years ago.
That disclosure by Antony Leung may have the George Soros’ of the world looking at a return to currency speculation in Asia. If that happens, the city’s leaders may have themselves to blame for neglecting an issue that’s been simmering for 10 years now.
“Neglecting” may seem a strong word here. After all, the peg has weathered the Asian crisis, the city’s handover to Chinese sovereignty in 1997 and China’s yuan rising past it in January this year. Yet, officials in Hong Kong should’ve de-pegged the dollar years ago.
For all the talk about how the peg promotes stability, it has been at the centre of many of the economy’s problems in recent years. Earlier this decade, for example, an overvalued dollar at various times caused deflation and worsened employment conditions. These days, amid risks of rising inflation as home prices surge and an appreciating Chinese currency, a stronger Hong Kong dollar would help.
Faster yuan appreciation may prompt speculators, including huge hedge funds, to test the dollar peg. Their actions in 1997 left governments with no choice but to let currencies plunge as Asia’s crisis spread from Thailand to Indonesia to South Korea and elsewhere. Hong Kong’s de facto central bank spent $15 billion fighting off speculators.
This time, Hong Kong may not get off so easy. As Asia’s sixth-biggest holder of foreign exchange reserves—$136 billion (Rs5.58 trillion)—Hong Kong won’t be an easy target. Yet, Leung’s disclosure that Hong Kong mulled scrapping the peg of about 7.8 to the US dollar will make defence from future challenges much harder.
The episode came after Standard & Poor’s lowered the outlooks on some of Hong Kong’s debt ratings in 2002 as the budget deficit widened to a record HK$63.3 billion ($8.1 billion) in the financial year to April 2002, and HK$61.7 billion in 2003.
Leung told Bloomberg reporter Jake Lee last week that he, Hong Kong Monetary Authority chief Joseph Yam and then-Hong Kong chief executive Tung Chee-Hwa “did seriously evaluate the various options, including unpegging. Speculators were attempting to attack the peg in view of the very large fiscal deficit at that point of time”.
Tung chose instead to increase taxes and cut government spending. Last week, he told the Standard newspaper that history would decide whether the decision to retain the peg was correct. The odds favour history deciding it was a mistake.
On Sunday, Leung, who is now with Blackstone Group LP, said the city should consider pegging the Hong Kong dollar to China’s yuan once it becomes fully convertible, Radio Television Hong Kong reported. Yet, why is a peg needed?
Hong Kong is routinely named the world’s freest economy by the Heritage Foundation and The Wall Street Journal, which, together, publish the annual “Index of Economic Freedom”. They like the city because of its duty-free port, the free entry of foreign capital and the rule of law. Oddly, Hong Kong gets a pass on its currency peg while mainland China gets slammed for manipulating its own.
China has a plausible excuse for holding down the yuan: the need to create hundreds of millions of jobs. It’s harder for Hong Kong, which has a far higher standard of living and is growing at 5.6%, to make that argument.
That won’t be lost on hedge funds, traders or Soros and his ilk who might see potential opportunities in Asian currencies. With so much capital flowing towards the region, exchange rates are under increasing pressure to rise. It’s becoming harder and harder to fight markets, and speculators are well aware of it. Knowing officials came close once before to freeing the dollar—and that they could possibly be pushed to act—may give speculators courage to test Hong Kong’s resolve. On Sunday, Hong Kong’s current chief executive, Donald Tsang, said the government has no plan to discontinue the currency link with the US dollar, but who believes it at this point?
The Hong Kong dollar has dropped 0.5% against the US currency and weakened 2.4% versus the yuan this year.
Hong Kong has come a long way indeed since the Asian crisis. In 2006, it rivalled London as a global centre for raising capital and its stock market is near record highs. Yet its role as an Asian financial centre is being challenged by Singapore, which boasts booming commodity and currency markets, and Shanghai, China’s showcase city.
A decade after its return to China, the city still has a way to go to fend off such challenges as well as innovate to create more jobs from the ground up. Achieving these goals will require every tool in Hong Kong’s arsenal, including an exchange rate that matches the economy’s needs.
In the meantime, Hong Kong shouldn’t be surprised if the speculators of the world begin looking its way.