Weekly: Hong Kong under spotlight
- Currency crises happen if confidence in the sovereign ebbs and there is overwhelming capital outflow
- Confidence in HKD is not yet dented, and HKMA has strong buffers
- The key is the confidence of Hong Kong’s residents
- Resolution of the ongoing unrest will help the HKD, but the macro misalignment concerns will persist
This week’s protests have renewed investors’ attention to Hong Kong. Market volatility has risen along with demonstrations against a proposed extradition legislation. On-shore liquidity has tightened, with the HIBOR spiking to a level not seen since 2008.
Overnight rates can rise for a variety of reasons, including seasonal liquidity demand for transactional purposes. Moreover, since Hong Kong’s rates follow US short-term rates given the peg to the US dollar, much for the rise in HIBOR in 2018 was directly attributable to Fed rate hikes. But the latest spike goes well beyond innocuous seasonality or cues from US monetary policy.
Source: Bloomberg, DBS
The latest spike clearly reflects capital outflows and worsening of sentiments. Although the immediate reason behind that is the ongoing political unrest, there are deeper reasons why investors are questioning the state of HKD’s long-standing peg to the USD.
Hong Kong’s economy, despite being a world class financial centre that thrives on openness and Western-style rule of law, is far more tied to the Chinese economy today than any other place. Hong Kong’s banks’ claims to China make up 28% of total external claims, up from 7% during 2000-09. Bulk of Hong Kong’s FDIs go to and come from China; same holds with respect to its trade.
Most critically, the economy has experienced a sharp rise in leverage build-up in the past decade, largely due to a property market bubble of enormous proportions. Hong Kong today boasts the highest per square meter price for residential properties in the world, helped by enormous buying interest from mainland China. The rising prices have caused a leverage-fuelled frenzy.
Source: CEIC, DBS
The sharp rise in leverage has affected Hong Kong’s monetary aggregates. M3 has quadrupled over the past decade and half, extraordinary for an economy of which the nominal GDP expanded by just two times during the same period. While the currency peg against the USD looks fine when the reserves-to-base money ratio is considered, the fact is if there is a sharp correction in the property market or a panic selling of the HKD, the peg would be challenged. Recent movements in HIBOR already show that the cost of defending the currency will have to be borne by higher interest rates, as selling of USD by HKMA is unlikely to be a sufficient tool.
The complicating factor is that higher rates could affect the property market and further erode confidence and erode confidence. If the political situation does not improve soon, speculative pressure against the peg would rise. HKMA has difficult days ahead.
Source: HKMA, DBS
Source: CEIC, DBS
Source: World Bank, BIS, DBS
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