Hong Kong Monetary Authority (HKMA) has drained HK$9.664 billion from the financial system after four interventions over two days in a bid to defend the peg.
The scale and pace of the latest interventions exceeded market expectations.
Is that something investors should be concerned a lot about?
First, the scale of intervention, though larger than what we have seen before, is not unduly large.
Between 2004 and 2005, when the local currency weakened to hit the lower end of the band, the de facto central bank had come out to drain liquidity at HK$2.5 billion per day to maintain the peg, Goldman Sachs said in a report.
In its recent moves, the HKMA has drained over HK$4.8 billion per day on average. However, that’s because the monetary base (about HK$1.7 trillion) is currently five times bigger than in 2005.
Also worth clarifying is that the authority buys Hong Kong dollars and sells the greenback to ensure that the local unit doesn’t fall below 7.85 per US dollar, which it does only when the local currency hits the weaker end of the trading band and local banks show no interest in doing such a trade.
So, it is largely a passive response to market forces.
What then is the reason behind this wave of market participants selling Hong Kong dollars and buying the greenback?
It has little to do with deteriorating economic or investment fundamentals. Interest rate arbitrage is the main reason behind the activity.
The interest rate gap between the US dollar and the Hong Kong unit has been widening since the US Federal Reserve has hiked rates six times since 2015, while the Hong Kong market rate has remained unchanged due to ample market liquidity.
The current three-month LIBOR and HIBOR have exceeded 1 percent, prompting many investors to switch to the US dollar to enjoy higher interest income.
Now, with the HKMA starting to buy Hong Kong dollar and taking liquidity out of the banking system, that will put upward pressure on the local currency’s interest rate.
When the rate gap narrows, there will be less incentive for rate arbitrage, and the selling pressure on the Hong Kong dollar will naturally dissipate.
Norman Chan Tak-Lam, the authority’s chief executive, said earlier that intervention will pave the way for rate normalization.
Excessive liquidity and super low-interest rates, when sustained for too long, can lead to over-investment, rising inflation, asset bubbles and financial risks.
The selling pressure on the local currency does not necessarily mean that money is leaving the territory. Investors can sell Hong Kong dollars for the greenback and still keep them in our banking system.
Even if the funds do leave Hong Kong, it’s not much of a concern as global capital flows freely. Money will return quickly if there are good investment opportunities here.
The property market, though, could see some downward pressure as interest rates are set to creep up, raising the cost of mortgages.
This article appeared in the Hong Kong Economic Journal on April 16
Translation by Julie Zhu
[Chinese version 中文版]
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