Peg ceiling likely in bid to stop 'hot cash' SCMP.com
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Saturday, May 14, 2005
Peg ceiling likely in bid to stop 'hot cash'LOUIS BECKERLING
Hong Kong's 21-year-old currency peg is likely to be adjusted to stem the flow of "hot money" into the banking system that threatens to ignite inflation by keeping interest rates artificially low.
The move was revealed yesterday by John Greenwood, the so-called "father of the peg", who said monetary officials were considering setting an upper limit for the dollar, above which the government would not allow the currency to appreciate.
"It's certainly being discussed in a lot of circles," he told Reuters. "The reason that [a ceiling] is being looked at is solely ... to ensure that interest rates return more quickly to what are perceived to be normal levels in the face of speculative inflows associated with possible revaluation of the yuan."
Mr Greenwood, who is also a member of the Hong Kong Monetary Authority's sub-committee on currency board operations, was visiting Hong Kong this week.
James Malcolm, senior foreign exchange strategist for Deutsche Bank, said he expected the government to set a "band" of about 200 "pips" - or two Hong Kong cents to the US dollar - with a floor of $7.80 and a ceiling of $7.78. Tactically, however, the government was likely to make the move only once the yuan were revalued, he said.
The market has already responded to the prospect by driving the Hong Kong dollar down towards the 7.80 level, and taking domestic interest rates higher.The first sign that the government planned a strike on speculators came on Friday last week, when HKMA chief Joseph Yam Chi-kwong warned: "We have room to do something in the market to trim this [excess liquidity]."
He told Legco's finance panel: "We are researching ways to make local interest rates track those of the US more closely, and reduce the volatility of Hong Kong dollar rates."
On Monday, foreign exchange dealers reported unusually aggressive buying of forward contracts on the Hong Kong dollar, which had the effect of raising domestic interest rates. And on the same day, Financial Secretary Henry Tang Ying-yen told reporters in Kuala Lumpur that while there was no plan to scrap the peg system, the government was studying whether changes might be required in response to a possible revaluation of the yuan.
Under the currency board system followed in Hong Kong since October 17, 1983, the local dollar is pegged to the US dollar at a floor level of $7.80, and the HKMA defends it on the "weak side" by buying dollars whenever the exchange rate threatens to fall below this level.
But until now, in a strategy defended by Mr Yam as "constructive ambiguity", the HKMA has left the market to guess at what level it will step in on the "strong side" to sell the dollar and stem any gains it might make against the greenback.
This ambiguity has periodically led to money pouring into the domestic market - most notably in the last quarter of last year, but again in recent weeks - as currency punters bet on a revaluation of the yuan, which they believed would push the Hong Kong dollar higher as well.
The results of those inflows have been low interest rates.
The ambiguity also discouraged holders of Hong Kong dollars from switching into US dollars to earn higher interest rates, because of concern they might lose money when they switched back into a possibly stronger Hong Kong dollar later.
If a ceiling is imposed and succeeds in slamming the door on "hot money", the interest rate holiday enjoyed by home owners and other borrowers would come to an end as speculative cash flows back out of the system and domestic rates are forced into line with higher US rates.
