Asia debating which currency to peg its hopes on

Raymond Yeung

Chief Economist Greater China, ANZ

Since 1983 there have been many calls for Hong Kong to change its Hong Kong Dollar peg. It was in the October of that year the Hong Kong Monetary Authority was given the job to keep its dollar trading at a narrow range, currently set at HK$7.75 to HK$7.85 per US dollar.

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But as geopolitics and economies change, so do pressures on the HK Dollar peg. In recent months, more countries have expressed interest in using the yuan for transactions with China.

“If the history of the HKD peg mirrors the global standard, its future will also witness a new economic paradigm. Amid market talk about the yuan’s emergence in global markets, the HKD can also be a reserve currency candidate, in our view.”

The potential emergence of a ‘petro-yuan’ regime may seem to promote the reserve currency status of the Chinese Yuan or renminbi. Speculation about pegging HK Dollars with the renminbi and ending the US Dollar’s hegemony is also intensifying.

But we need to distinguish between the concept of reserve currency versus exchange rate anchoring. The Euro and Japanese Yen are highly liquid currencies which are included in the International Monetary Fund’s “Special Drawing Rights” basket.

Aussie dollars and Canadian dollars are also currencies considered in the IMF’s Currency Composition of Official Foreign Exchange Reserves survey. Hong Kong does not peg with them. The Exchange Fund, comprising also the Investment Portfolio and Long-term Growth Portfolio, can invest in these currencies.

But the rising status of the Chinese Yuan is not a sufficient condition for unpegging from the US Dollar.

HKD RTGS performs well even when aggregate balance is low

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Another argument for unpegging appears justifiable. Since the city is highly integrated with China’s economy, the currency should be compatible with China’s business cycle instead of that of the US.

The theory of Optimal Currency Area also seems to lend support because using the same currency for economies in a single market should promote economic efficiency. However, it is not totally applicable to Hong Kong because the Renminbi market has been extended to it. Trade, investments and financial flows can already be transacted in Chinese Yuan.

In our view, the Yuan could eventually be a functioning currency in the stock market for transactions, including dividend payments, amid increased acceptance by global investors. Therefore, there is no need to impose unnecessary changes on the existing peg.

Binds

Bound by legal constraints, the scope for Hong Kong to adjust the currency system before the year of 2047 is subject to two main limitations.

One is that Hong Kong has to run a currency board system rather than conventional central banking. The latter does not have specific requirements for foreign exchange reserves. The US Federal Reserve is an extreme case where no reserves are required. But the HKMA need to maintain the fund to meet redemption requirements.

The second limitation comes from the fact that – in modern language – the HK Dollar is like a “stable coin”. The currency needs to have low exchange rate volatility against the benchmark, ie HK Dollars should not behave like an emerging market currency or cryptocurrency that fluctuates widely against the US Dollar.

In short, stability is key. Although there has been rising concerns about the long-term outlook of the US dollar after the recent banking crisis, it remains a global standard. Unnecessary change may do more harm than good.

Green and digital era

China’s Belt and Road initiative may also attract new segments of investor interest. Countries worried about ‘weaponisation’ of USD could also see an alternative in HKD as Hong Kong maintains free capital flows and its legal system is based on the common law. It is reported that the BRICS economies (Brazil, Russia, India, China) are working on establishing a new reserve currency to better serve their economic interests.

The President of the New Development Bank, the BRICS Bank, Dilma Rousseff has spoken about

Plans to de-dollarise and to increase loans in local currencies.

Technological migration can help upgrade the peg. As we pointed out last year, the blockchain-based mBridge Project is a viable alternative to the traditional currency settlement system. The government officials perceive the digital currency to provide a good infrastructure for wholesale cross-border payments.

It is not merely a low cost and efficient infrastructure but also will enhance financial security. The HKMA has also started the process of development of e-HKD. The Hong Kong government has positioned fintech and green finance as key drivers for the city’s development as an international financial centre.

In February this year, the government issued the first HKD-denominated tokenised green bond. The beneficial interests in the bond and the claim for HKD cash were settled across a private blockchain network.

In the 1970s, USD financial instruments gained support via petro-dollar recycling when the world needed to burn oil. Now that many countries are launching de-carbonisation campaigns, the tokenised green bond symbolises a reversal amid de-dollarisation.

If the history of the HKD peg mirrors the global standard, its future will also witness a new economic paradigm. Amid market talk about the yuan’s emergence in global markets, the HKD can also be a reserve currency candidate, in our view.

Raymond Yeung is Chief Economist, Greater China at ANZ Institutional.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.