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Hong Kong can rise up to the challenges

A gist of the blog:

The US Federal Reserve has raised interest rates six times since December 2015, widening the spreads between the interest rates of HKD and that of USD, and thereby attracting arbitrage transactions with funds flowing from the HKD into the USD The HKD has weakened recently as a result. However, I don’t think that should be a cause for concern.

Firstly, according to the mechanism of the Linked Exchange Rate system: outflow of funds contraction of aggregate balance HKD interest rates to increase HKD exchange rates to stabilise. The capital outflow of HKD will slow down or even cease when the HKD interest rates normalise and the spreads between the interest rates of two currencies diminish. The HKD exchange rates will also subsequently stabilise. All these are part of normal operation in accordance to the design of the currency peg.

Secondly, the Government has made early preparation for this situation. Since the introduction of the Quantitative Easing by the US in 2009, there has been roughly US $130 billion worth of capital flowing into Hong Kong. The Hong Kong Monetary Authority (HKMA) has placed these funds, equivalent to about HK $1 trillion, entirely in highly liquid, high quality US dollar-denominated assets (such as US Treasuries) that can be readily converted into USD cash.

Even under extreme circumstances where there is a huge demand for buying USD and selling HKD, the HKMA is fully capable to meet such a demand. Currently, the HKD Monetary Base amounts to about HK$1.7 trillion and is fully backed by USD assets, providing a strong buffer in the event of fund outflows. Moreover, the HKMA has been strengthening risk management of the banking sector and enhancing the vigilance and preparedness of the banks through stress tests. Therefore, I am confident that Hong Kong can rise up to challenges from potential fund outflows in extreme situations.

April 15, 2018