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Thursday, Jan. 3, 2002
Hong Kong's ills raise serious doubts about fixed dollar peg
Special to The Japan Times
HONG KONG -- Argentina's economic crisis and the disappearance of the peso as the national currency will put the Hong Kong in the spotlight and the local dollar under pressure in foreign exchange markets.
Hong Kong is the most important economy with a currency pegged to the U.S. dollar, and already leading exporters and some prominent economists have begun to complain that the pegged currency is crippling an already ailing economy.
What gives the debate more piquancy is that only a matter of weeks ago, Hong Kong's new financial secretary, Antony Leung Kam-chung, sent financial markets into a spin by raising questions about problems with the H.K.-U.S. link.
The Hong Kong dollar has been fixed at 7.80 to the greenback, a rate that has remained happily steadfast for 17 years, during which none of Leung's predecessors dared to discuss a change, either of the rate or the regime.
In addition, surely finance ministers -- above all -- know the golden rule that you do not do anything to encourage markets to speculate about the value of your currency.
For a former banker like Leung -- previously Asia-Pacific head of Chase Manhattan Bank, who surely knows how volatile financial markets are and how fragile economic confidence can be -- to venture into a discussion about the currency suggested that something serious was afoot.
Seen as obstacle
Yet Leung in August commented that the peg was an obstacle to an efficient economy. When he followed it in October with remarks that removing the peg would increase flexibility, the markets disregarded his additional proviso that now was not the time to get rid of the peg. Traders instead focused on the fact that a discussion was in play.
"(These) are very bullish statements from a government official," said Craig Chan, economist for Greater China with ING Barings. "We never heard Donald Tsang (Leung's immediate predecessor) say anything like that when he was financial secretary. I think it's a softening of stance from the government on the peg and the market is losing confidence."
Bank of America currency strategist Frank Gong added: "The market somehow believes the peg will eventually have to go, and now they're demanding some risk premium."
Indeed, the one-year Hong Kong dollar surged to a premium of 280-300 basis points over the spot rate during intraday trade in late October after Leung's remarks, a sharp rise from the 72-83 range of the previous day.
The financial secretary's comments tapped into deep unease among some economists and business executives about the high costs and drag on economic growth of being linked to the U.S. dollar when other rival economies have benefited from a devaluation against the greenback. It would be nice, one businessman mused, to see a devaluation of up to 30 percent, or maybe how about a nice round HK$10 to the U.S. greenback?
At this point, the head of the Hong Kong Monetary Authority Joseph Yam waded in with the strongest words, giving a definite "no" to the idea of abandoning the link to the U.S. dollar. "The outcome, even with the most benign conditions and the best judged strategy, can be summarized in two words: uncertainty and instability," Yam said.
He added, "If, heaven forbid, de-pegging were to be carried out in the conditions that we have now, then we might add a third word to uncertainty and instability -- catastrophe.
"At this time of great global uncertainty and local distress, our efforts should be directed toward building stability, not destroying or undermining it."
This blunt rebuff to Leung had the effect of calming the market, where the premium in the one-year forward market for the H.K. dollar fell to 100-120 basis points over the spot rate.
Although the immediate H.K. dollar jitters were calmed, the debate goes on, given a new twist by Argentina's misfortunes. Some economists believe that the financial secretary was embarking on a softening up campaign and that in the end the peg will have to go.
Even Leung's critics admit that the financial secretary has certainly got a lot to worry about. Donald Tsang commented bleakly in his new capacity as chief secretary for administration that, "We are facing a rough time, a pretty tough time . . . perhaps the worst since the Korean War."
Not only is Hong Kong in recession, with few signs of an upturn -- and one international investment bank predicting negative growth of 7 per cent -- but unemployment is at new highs and the government budget deficit is growing by the week and heading toward (US)$10 billion, massive for a territory that is noted for fiscal prudence.
No wonder Leung and others are casting round looking for some magic bullet that might restore fortunes. A devaluation looks attractive because it would, its advocates assert, boost competitiveness at a stroke.
On the World Economic Forum's Global Competitiveness survey released in October, Hong Kong slumped to 13th place from seventh last year and second in 1999, partly because of the high costs imposed by the peg.
The problem with a devaluation is that once you change the rate the market may get in the mood for further change and try to force it. In addition, although a devaluation would make Hong Kong's goods and services cheaper, it would trigger inflation through higher prices of imported goods on which Hong Kong also depends.
Those with longer memories also recall what happened immediately before then financial secretary Sir John Bremridge imposed the peg in the early 1980s. There was a crisis of confidence, which saw the dollar skid in a day from HK$5 to almost HK$10 against the U.S. dollar and a scared Hong Kong public swept supermarket shelves bare as they feared their money was worthless.
Alan Smith, vice chairman of Credit Suisse First Boston, along with chief secretary Tsang, trust that once the world economy gets on the road to recovery, Hong Kong will once again show the way. Tsang said: "As soon as you see the U.S. economy on a climb, you'll find Hong Kong close behind."
Some commentators say they can predict when the Hong Kong dollar peg to the US unit will be removed -- when China makes its renminbi fully convertible and then Hong Kong will hitch its dollar to China.