One of the current hot topics in Hong Kong’s financial market is Hong Kong dollar (HKD) fund flows. It is natural for the general public of an international financial centre like Hong Kong to be interested in this subject. Let me offer some more information in this article for reference.
To evaluate HKD fund flows, one has to consider many different aspects. The first question to ask is whether deposits in the Hong Kong’s banking system have declined recently. The short answer is no. The HKMA publishes monetary statistics, including total deposits in the banking system, every month. As of the end of June, total deposits amounted to HK$13.6 trillion, which was HK$0.2 trillion higher than the figure at the end of 2018. The split between HKD and foreign currency deposits remained roughly equal. The end-of-July figures will be published next week, and preliminary data indicate a steady trend. But we have to be mindful that bank deposits are also influenced by factors other than fund flows, such as increases or declines in bank loans. Therefore even if we see fluctuations in bank deposits, we have to do further analyses before coming to a conclusion of the underlying causes.
Another important factor to note is that the weak-side Convertibility Undertaking has not been triggered since March, and the HKMA has not bought Hong Kong dollars and sell US dollars under this mechanism. Actually, fund flows into and out of Hong Kong’s financial market are nothing unusual. Free flow of capital is a key attribute to Hong Kong’s status as an international financial centre, and has been stipulated in the Basic Law. We have no foreign exchange control; the HKD is freely convertible; and markets for different asset classes like foreign exchange, gold, securities, and futures are highly open. Overseas and local investors as well as the general public can put their monies in whatever locations that best suit their asset allocation plans. As we pointed out in several articles1 in the past two years, any fund outflow from the HKD market upon triggering of the weak-side Convertibility Undertaking is a natural normalisation process given the massive inflows in the past. The HKMA is fully capable of handling this and there is no cause for concern.
Recently some people also pay close attention to the trends of interbank rates. The HKD interbank rates indeed saw some fluctuations in recent months, but this can be well expected. The reduction of the Aggregate Balance of the banking sector from over HK$200 billion a couple of years ago to the current level of HK$54 billion has made the HKD interbank rates more sensitive to changes in supply and demand of HKD funding. Compared with earlier times when the Aggregate Balance was much higher, seasonal factors (e.g. dividend payments by corporations, year-ends and quarter-ends) or short-term increases in demand for HKD funding (e.g. large IPOs) can more easily cause HKD interbank rates to fluctuate noticeably. These factors were clearly at work behind the interbank rate movements in the past few months. In fact, HKD interbank rates were also volatile in the same period last year. For example, the average one-month interbank rate climbed from 0.79% in March last year to 1.81% in July, before declining to 1.42% in August and bouncing back to 1.81 in September. Of course, market situation can be different every year. I want to point out that interbank rates are affected by many variables, and it is impossible to predict or quantify the impact of individual factors.
As always, the HKMA is closely monitoring the HKD market. In addition to the interbank rates, we also closely watch other market information such as HKD spot and forward exchange rates and the volume of option and swap outstanding contracts. We collect market intelligence through different channels, including our contacts with banks and market participants, as well as over-the-counter derivatives trade repository. We also work closely with the Securities and Futures Commission on cross-market surveillance. Continuous market surveillance is crucial to the maintenance of monetary stability, which is one of the key functions of the HKMA that we always do, rain or shine.
Finally, I would like to touch on recent news reports about HKD forward exchange rate weakening beyond 7.85 and some HKD option contracts with strike prices surpassing 7.85 in the market. Some people were puzzled by these transactions, wondering whether these prices suggested that the market was questioning about the Linked Exchange Rate System. Since this topic involves highly technical details such as option pricing,let me try to use a rather simple analogy to explain: If an earthquake happens in another place causing huge losses, some people might think about buying insurance for such catastrophe. They may then find out that the premiums for earthquake insurance policy covering Hong Kong are extremely low as we are not located in an earthquake zone, meaning it would cost very little to get such a cover. As a result, one person flocks after another to buy earthquake insurance, “pushing” the premiums up. People not in the know might misinterpret an increase in the premiums as an increase in the “probability” of Hong Kong having an earthquake. Such “implied probability”, of course, does not reflect the truth.
In fact, during the over-thirty-year history of the Linked Exchange Rate System, HKD forward exchange rates have always been more volatile than the spot rates because the former has a thinner market. It is not unusual for the forward exchange rate to go beyond the strong-side or weak-side Convertibility Undertaking. Stability in the HKD spot exchange rate and the effective operation of the Linked Exchange Rate System are not affected by HKD forward exchange rates or option strike prices being beyond 7.85. Using these forward exchange rates or option strike prices to project the so-called “implied probability” of unpegging of the HKD is not meaningful at all. International and local investors who are familiar with Hong Kong understand very well Hong Kong’s capability and resolve to maintain the Linked Exchange Rate System.
The financial markets are ever changing, and market movements and dynamics have impact on every member of the public. While some financial topics are indeed complex and dry, my colleagues and I will continue to try our best to discuss these topics in simpler terms through different channels.
Deputy Chief Executive
Hong Kong Monetary Authority
23 August 2019