After 40 years of stability, Hong Kong’s US dollar peg is here to stay

Four decades ago, Hong Kong made a significant decision to link its currency to the US dollar through a system known as the linked exchange rate system. For the past three decades, I have been involved with this system in my work at the Hong Kong Monetary Authority. This system has been a crucial part of Hong Kong's financial structure. The linked exchange rate system has proven to be effective. It has been the foundation of monetary and financial stability in Hong Kong, providing a stable environment for the growth of our economy and community. It has also helped Hong Kong navigate through various shocks and crises, demonstrating the system's resilience and robustness. The success of the system can be attributed to its robust design, which aligns with market disciplines, its highly transparent and rule-based mode of operation, and Hong Kong's abundant foreign reserves, strong fiscal position, and dynamic economy. The system operates under a currency board arrangement, which limits the discretion of the Monetary Authority. In 1998, we introduced seven technical measures, and in 2005, we made three refinements to make the system more rule-based and aligned with our policy intent. The market has observed the system functioning strictly according to its design. Since 2005, the 'strong-side convertibility undertaking' has been triggered 321 times, with the HKMA purchasing US dollars equivalent to nearly HK$1. 45 trillion (US$185 billion) to maintain the Hong Kong dollar below the higher limit of the trading band. The 'weak-side convertibility undertaking', which prevents the Hong Kong dollar from weakening excessively, has been triggered 84 times, resulting in the sale of US dollars equivalent to nearly HK$420 billion. These inflows and outflows have operated seamlessly. The system's high degree of transparency, which bolsters market confidence, is underpinned by two key factors: the openness inherent in the system's design, and the timely and accurate disclosure of crucial data. Whenever we intervene in the market to fulfil the obligations imposed by the convertibility undertakings, we promptly inform the market and the public by publishing related transaction data. We regularly release the latest Exchange Fund balance sheet data, currency board accounts, and other information about the linked exchange rate system, and communicate about the system to the market and the public through appropriate channels. The system's resilience has been tested numerous times, such as during the shocks caused by various financial crises, the severe challenges Hong Kong has faced in recent years, and the immense pressure exerted on the financial system, as well as the numerous market rumours over the years, whether intentional, unintentional, or even malicious. The system has weathered all these challenges. No exchange rate regime is flawless. Policymakers in every economy must consider its unique circumstances and historical factors when deciding on the arrangements that best suit its needs, in order to gain the greatest benefits at the lowest costs. The exchange rate regime is a serious and important matter. Once a decision is made, it should not be altered lightly. Recently, prolonged high US interest rates and a strong US dollar have sparked discussions about the implications for the local economy and livelihoods due to the linked exchange rate system. As the Hong Kong dollar strengthens, it is often said that it becomes cheaper for residents to travel abroad, while tourists visiting Hong Kong become more cautious in their spending. The exchange rate can be a contributing factor. However, there may also be cyclical and structural factors at play, such as the eagerness of Hong Kong residents to travel following the reopening of the border, or visitors seeking 'in-depth experiences' rather than mere consumption during their stay. Given Hong Kong's heavy reliance on imports for our daily and production needs, a stronger Hong Kong dollar helps lower import costs and alleviate some inflationary pressure. Indeed, many other advanced economies are also grappling with persistent inflationary pressures. The strengthening and weakening of any currency is cyclical, and a stronger or weaker Hong Kong dollar each has its advantages and disadvantages. The linked exchange rate system means that Hong Kong dollar rates follow their US dollar counterparts, while also being influenced by the supply and demand of Hong Kong dollar funding in the local market. With the Hong Kong dollar interbank offered rates (HIBORs) having gradually increased alongside their US dollar counterparts, the high interest-rate environment is likely to persist for some time. It is worth noting, however, that many other economies and financial centres are also experiencing the pain of high interest rates, even those that do not adopt a fixed exchange rate. Whether Hong Kong implements the linked exchange rate system does not appear to be the most critical factor. Furthermore, local interest rates have not risen too sharply. The composite interest rate, a measure of banks' funding cost, has increased from 0. 24 per cent at the end of March last year to 2. 55 per cent at the end of August this year. Since March last year, the local best lending rates, or prime rates, have increased moderately by less than one percentage point, against the cumulative increase of 5. 25 percentage points by the US Federal Reserve. Change is a constant, especially in the financial markets, and the implications are far-reaching. The HKMA must always be prepared to embrace change. However, we must also remember the value of maintaining a good system – not for the sake of preservation, but because we have carefully considered and made an informed decision. As we have reiterated many times, we have no intention and see no need to change the linked exchange rate system. Eddie Yue Wai-man is the chief executive of the Hong Kong Monetary Authority.