Get a Full Grasp of the Situation and Stay Calm

(Translation)

Going into 2016, the rainy chill is like the sentiments in the financial markets in recent days.  This morning, I was supposed to report to members of the Legislative Council and the public on the latest situation of the financial markets at the meeting of the Legislative Council Panel on Financial Affairs .  Unfortunately, the meeting was adjourned.  Let me offer my views, through this inSight article, on some public concerns and anxieties on the Hong Kong dollar exchange rate and fund flows recently.

Our economic and financial environment is facing challenges on various fronts: slowdown in economic growth, moderation in credit expansion of banks with signs of deterioration in their asset quality, uncertainties in the property market and volatility in the financial markets.  Compounded by the easing growth rate of the Mainland China economy and weakening renminbi exchange rate, some investors turned bearish on the prospects of the Mainland and Hong Kong economy.  Rumours about financial market predators taking short positions against the Hong Kong dollar are rampant.

Amid worries about the stability of Hong Kong’s financial systems, some compared the current situation with the Asian financial crisis in 1997-98 when the Hong Kong dollar was subject to a double-play attack staged by financial market predators.  The fierce battle my colleagues and I had with those predators seemed like yesterday.  But there is no cause for anxiety now as our financial systems are way more robust than at that time.

This is not wishful thinking.  You will know the reason when you look at the table below on assessment of risks to Hong Kong’s financial stability:

() denotes the magnitude of change
*refers to figures in Jun 97 and Dec 2015.
# P/E and P/B ratios correspond to those of the Hang Seng Index.

The Aggregate Balance of the banking sector, the Monetary Base and foreign assets of the Exchange Fund have grown exponentially since 1997.  This tells us that speculators will have to mobilise hundreds of billions of Hong Kong dollars to short-sell the Hong Kong dollar in order to push up interest rates.  This is very difficult.  Moreover, the current price-to-earnings ratio of Hong Kong stock market is only 8x, comparing to 19x in 1997.  There is limited scope to profit by short-selling Hong Kong stocks or futures.

Technically, speculators short-selling the Hong Kong dollar will have to take huge short positions in the Hong Kong dollar forward market.  However, the forward market is thin.  If speculators were to make drastic moves in the forward market, the Hong Kong dollar forward exchange rate would drop quickly due to scanty trades, driving up the cost of short-selling.  As such operation is not discreet, coupled with the escalating costs involved, it could rarely be successful.

Besides, ever since the global financial crisis in 2008, governments all over the world have been implementing financial reforms and tightening supervision.  Constrained by Basel III and various supervisory requirements, banks are less likely to lend large amount of Hong Kong dollar funds to speculators as in the past.  This limits the scale of the speculative activities.

In addition, the banking sector in Hong Kong remains robust, with the overall capital adequacy ratio exceeding international standards and abundant liquidity.  The seven rounds of countercyclical and other prudential measures introduced by the HKMA over the past years have also significantly strengthened resilience of our banking system. 

That said, there is no room for complacency and the HKMA remains vigilant.  We monitor and collect real time intelligence in the market and are therefore able to respond promptly if abnormalities in the markets are detected.

The US rate hike last December kick-started the process of interest rate normalisation.  There have been some outflows from the Hong Kong dollar, driving up Hong Kong dollar interbank rates and narrowing the spreads between Hong Kong dollar and US dollar interest rates.  However, we believe that the pace of further US rate hikes should be gradual.  Buttressed by a sizable Monetary Base (some US$130 billion have flown into the Hong Kong dollar since 2008, with the Monetary Base now standing at HK$1.6 trillion), we have large buffer to withstand outflows.  Therefore, we believe that adjustments in local interbank rates should not be too rapid.

With fund outflows from Hong Kong, we should be prepared that the Hong Kong dollar will eventually weaken to 7.85, the weak-side Convertibility Undertaking.  This is unavoidable in the process of the normalisation of Hong Kong dollar interest rates.  When this happens, according to the automatic adjustment mechanism of the currency board arrangement, the HKMA will buy Hong Kong dollars from and sell US dollars to banks, resulting in a contraction in the Monetary Base and an increase in the Hong Kong dollar interest rates, such that the Hong Kong dollar exchange rate will  stay within the convertibility zone of 7.75-7.85. 

I hope the foregoing can reinforce your confidence in the financial stability of Hong Kong.  There are always scaremongers spreading anxiety, pessimism and even panic whenever the market rattles.  They do this in order to make gains during a market downturn.  Vigilance is one thing but panicking is another.  Therefore, we must get a full grasp of the situation and stay calm, especially when referring to the Linked Exchange Rate System.  The HKMA’s determination and ability to maintain the System are beyond doubt.

The Observatory forecasts a sunny spell during the Chinese New Year next week.  Though the Hong Kong markets will be closed, we will continue to keep a watchful eye on the external markets.

Norman Chan
Chief Executive
Hong Kong Monetary Authority

1 February 2016