After a net inflow of around US$100 billion into the Hong Kong dollar between August 2008 and December 2012, the exchange rate of the Hong Kong dollar against US dollar has again strengthened to 7.75, triggering the strong-side Convertibility Undertaking (CU) multiple times since 1 July. Within two weeks (between 1 and 15 July), the HKMA has bought in a cumulative total of US$5.64 billion. During New York trading hours yesterday, the HKMA further bought in US$690 million. Since early July, the Aggregate Balance has increased by HK$49.05 billion to HK$212.92 billion due to net inflows.
With the Fed’s tapering of asset purchases and a general market expectation for policy rate rise by the Fed next year, compounded by the implementation of the Shanghai-Hong Kong Stock Connect, the net inflows of funds into the Hong Kong dollar has led many to second-guess. Indeed, the exchange rate has only eased slightly after a net inflow of US$13.8 billion into the Hong Kong dollar in the fourth-quarter of 2012. During most part of 2013 and the first half of 2014, the Hong Kong dollar exchange rate stayed close to 7.75, reflecting strong demand for the Hong Kong dollar.
So what caused the eventual triggering of the strong-side CU at 7.75 at this time of the year? According to our market information, the recent increase in demand for Hong Kong dollar was mainly attributable to ordinary commercial activities. While some of the recent purchases of Hong Kong dollars may be associated with increases in allocations in Hong Kong equities by overseas investors, we find that the main reasons underlying the net inflows of funds should include the following –
(i) The period between June and September each year is the peak season for dividend distributions by H-share companies, and the total amount of this year’s dividend distributions, is as large as HK$200 billion. The Mainland companies concerned may have a certain amount of Hong Kong dollar. But, given the large overall amount of H-share dividend distribution, and the fact that most of the income of these companies are in other currencies, there is very strong demand for Hong Kong dollar.
(ii) Furthermore, a number of cross-border merger and acquisition deals also added to the demand for Hong Kong dollar. One of them was HK$53 billion share issuance by Citic Pacific for acquisition of its parent's assets, and another was Oversea-Chinese Banking Corporation's acquisition of Wing Hang Bank involving about HK$40 billion. These two deals alone already involved around HK$100 billion. We have already asked banks to advise their clients to spread out their Hong Kong dollar acquisition to reduce volatility in the exchange rate caused by large amount of purchase of Hong Kong dollar to settle the deals. However, the large amount of funds involved in these merger and acquisition deals still posed upward pressure on the Hong Kong dollar exchange rate.
(iii) Owing to active initial public offerings, mergers and acquisitions, as well as dividend distributions in the market, the Hong Kong dollar liquidity has concentrated on a few receiving banks. At the same time, banks were inclined to hold more liquidity for precautionary purposes around half-year end. As such, the interbank Hong Kong dollar liquidity has been somewhat tightened, which jacked up the short-term Hong Kong dollar interbank offered rate to slightly higher than the US rate. This induced some demand for Hong Kong dollar although the impact should be relatively small.
(iv) Some suggested possible pre-positioning in Hong Kong dollar associated with the implementation of Shanghai-Hong Kong Stock Connect, thus driving up demand for Hong Kong dollar. However, there is no need to buy Hong Kong dollar for this purpose since investment in A-shares via this conduit will be settled in renminbi, and overseas investors may convert US dollar into renminbi directly without first converting to Hong Kong dollar.
The direction of fund flows is influenced by changes in the market sentiment and external environment and is therefore difficult to predict. It is equally difficult to predict the duration and size of inflows of funds into the Hong Kong dollar. However, having regard to the ongoing listings, mergers and acquisitions, and dividend distributions in the market, we expect that the Hong Kong dollar exchange rate would remain strong in the near-term. But funds do not flow in one direction only. If investors convert their H-share dividends, or fundraisers convert the Hong Kong dollar raised, into foreign currencies, the upward pressure on the Hong Kong dollar could ease.
If funds continue to flow into the Hong Kong dollar, the HKMA will, in accordance with the Currency Board principles, sell Hong Kong dollar and buy US dollar at the rate of 7.75 to maintain stability of the exchange rate. The inflows of funds will increase liquidity and hence stimulate asset prices, to which the public should stay alert. Last year’s market turmoil caused by a large-scale outflow of funds from certain emerging markets showed that the direction of fund flows could change spontaneously in response to investors’ sentiments. As the US economy recovers and its monetary environment normalises, there remain considerable uncertainties in the future direction of fund flows. The public should be prudent when borrowing and investing.
Deputy Chief Executive
26 July 2014